On a dinghy in a sea of debt

So here we are, on dinghy in a sea of debt and derivatives and no land in sight. As an approximate $250 billion worth of M&A activity is still in the pipeline, news that financing for Chrysler and Alliance Boots, two of the highest profile private equity deals on the dockets essentially shatters the myth of the “LBO-put.” And folks, this is it. You couldn't get through even 2-minutes of market commentary without a strategist, portfolio manager or LBO pirate proclaiming "liquidity" as being the primary catalysts for stocks to continue their upward trajectory. This is leaving and frankly, there isn't a good fundamental reason for owning a broad basket of stocks anywhere, at current valuations amidst a backdrop of slowing world growth. And this week's "set back" feels a bit more acute than what we went through in late February when the first wave of subprime issues roiled markets. Take a look at the leveraged bond funds that trade on the NYSE. Even as Treasury rates fell like a rock this week, usually good for fixed income and often very good for leveraged bond funds, many of these funds were actually being purged. Folks, leverage is getting unwound and I sense that this last week is just the beginning. Given the duration of this re-leveraging process of the world's financial system that began in late 2001 after 9/11, the untold amount of debt and levels of derivatives backed by even more leverage, makes it utterly impossible to get one's arms around the situation. The fact that the White House hastily assembled a coffee klatch consisting of its economic advisers, including Hank Paulson, yesterday for public viewing and emceed by Dylan Ratigan of CNBC America, was odd and felt more like hand holding than anything else. Doesn't it take a death in the family for strangers to offer you their hand? Still, CNBC and its ilk continue to site the copious amounts of reserves resting in “sovereign funds” as being earmarked as a prop for the world's overvalued, over leveraged paper assets. Just don't tell China that they've already lost roughly $750-million or 25-percent of its $3-billion investment in shares of private-equity group, The Blackstone Group (BX), which it had purchased from funds in its "sovereign fund" just last month. If I were China, I might begin to wonder if there isn't something else we could do with these funds. It seems possible and probable that China is soon going to grow weary of being the lender of last resort for the debt-binging U.S.A. They already own a slug of U.S. Treasury debt that only loses money, year after year, due to the wilting value of the U.S. Dollar. Regardless, the week was a shot over the bow for the leveraged crowd.

Check please

Stock futures in the U.S. collapsed in the morning about the same time DR Horton (DHI) and Beazer Homes (BZH) rolled-out their depressing “lack-of-earnings” reports. Rumors were also swirling concerning potential credit problems roiling Germany’s financial markets as a CEO at a major German bank up and left without warning. Obviously, as previously announced LBOs are struggling to scrape together the necessary financing, many of the major Wall Street investment banks are being forced to open wide. Today, credit-default swaps on Goldman Sachs Group (GS) and Bear Stearns (BS) rose to records on concerns investment banks will be stuck with this toxic debt. We’ve been sliding towards this point for some time now and the day of reckoning for the woefully over-levered world financial system appears to be knocking on its doorstep. Whether or not the world’s investment banking cartel and central banks are capable of stemming an all-out rout remains to be seen, but forestalling the massive and accruing global financial imbalances has only guaranteed eventual disaster when its shear weight renders the “cartel” irrelevant. The Dow Jones Industrials suffered is second largest set-back of 2007, down over 300-points, but still a mere 3.5-percent from its all-time high.

Amazon (AMZN), a second chance to impale yourself on its overpriced shares

Amazon.com (AMZN) saw its market-cap increase by over $7-billion today--essentially 100-times their reported quarterly net income. The bulls were eager to try to paint Amazon's "better-then-expected" earnings as summarily magnificent for all of tech, even though Amazon is actually a retailer. Google (GOOG), on the other hand, was deemed to be "company specific" when they disappointed with their slowing rate of net income growth as reported last week. Shares of Amazon.com now trades at a trailing 12-month P/E (price/earnings) ratio of 120x and a forward (expected) 12-month P/E of 62x. A multiple often reserved for companies on the brink of cures for serious medical ailments. Unfortunately, Amazon is a retailer that doesn’t make anything. Six full "self-serving" brokerage firms upgraded shares of the online retailer. Earnings and margins have improved dramatically for Amazon over the last two quarters, but that is primarily due to a huge drop in capital spending. Upon hearing news of the “better than expected” increase in net earnings of $0.19/share, Jim Goldman of CNBC proclaimed that this number bodes very well for technology in general. Again, in case people don’t know, Amazon is a retailer, not a tech stock. And morevover, Amazon’s recent improvement in reported earnings can largely be attributed to its slower pace of technology upgrade costs relative to prior periods. Got that? Amazon is spending less on technological upgrades, which would summarily bode "less well" for technology. Also, let’s dissect the Amazon number to put things in its proper light. The headlines said that earning per shares surged 280% year-over-year. Not a lie. But this $0.19/share quarterly number, pathetic for stock trading just shy of $90/share, is being compared to the 2Q number a year ago of $0.05/share, which just so happened to be the worst quarter since its 1Q number back in 2003. Nevertheless, its proclamation of a “280% increase in net income" is pretty relative. Unfortunately, that will be the easiest year-over-year comparison for Amazon for a while. After increasing by nearly 25-percent today, closing at $86.18/share, Amazon.com now sells at a forward P/E of 62x. Of course, the market is making a bold assumption that the slowdown consumer spending, already visible across an array of consumer related data, will not become even more problematic. Also, Amazon now trades at a higher price than even its highest price seen at the epic heights of the dot-com bubble back in February or March of 2000. To sum it up, Amazon is among the most ridiculously priced stock on the U.S. stock market, again. However, for those that missed the opportunity to impale oneself on shares of Amazon in the year 2000, you've been given a second chance.

Canaries chirp an ugly tune

Today felt as if reality intrudes. Shares of Apple Inc (AAPL) fell over 8-points when AT&T (T) said that its subscriber numbers for customers of Apple's iPhone were well below even the most sobering of estimates. As the exclusive service provider for Apple’s iPhone, possibly the most over-hyped piece of silicon and plastic ever, said it signed up just 146,000 iPhone subscriber customers in the first two days of the iPhone rollout. Some analysts had estimated sales of the iPhone to be somewhere "north of 500,000." Even as many semiconductor issues were getting hit rather hard, particularly the capital equipment makers thanks to another airball by a major semiconductor company, Texas Instruments (TXN), Sandisk (SNDK), the maker of flash memory was up as much as $1.60 before finishing essentially flat based on some regurgitating by Jim Cramer. This was even in light of the bad Apple data point from AT&T. Apple, as you know, is a major buyer of flash memory for its many i-gadgets….As folks were being forced to grapple with more bad news from their “non-housing” play, tech, everything even slightly related to housing, mortgages and CDOs were cracking-up. Countrywide Financial (CFC), the largest mortgage lender in the U.S. missed earnings by a wide margin and dramatically lowered forward guidance. Then its CEO Angelo Mozilo slathered on a thick layer of reality on during his conference call with analysts. He uttered the “D” word while trying to describe the prior precedence of home value depreciation. “D” as in Depression. Finally, as the housing and mortgage complex was unraveling, the Yen set out on a pretty robust spring of its own. The yen, probably the most putrid currencies on the planet, is ironically also the currency most likely to see the biggest appreciation in value vis-à-vis other currencies as the great credit bubble unwinds. The yen has been the source of a tremendous amount of leveraging due to its nearly free borrowing costs. These yen will be “called” as the most leveraged “carry-traders” are forced to unwind their bets. Even though crude oil sold-off over $1/barrel, the precious metals finished nearly unchanged after trading green most of the day. This remains to be a healthy development as it concerns the precious metals versus similar broad market sell-offs in late February and again in June when news of the Bear Stearns hedge funds were being felt. Finally, the “canaries in the coalmine” as it concerns the private-equity and hedge fund bubbles, the major investment banks, continue to get sold. Goldman Sachs (GS) closed under $200/share for the first time since early March.

Lastly, Bill Gross’ August Investment Outlook reads like an emotional catharsis. The missive from the “Bond King” may have also been part and parcel to some of the overall angst that accompanied the day’s trading as the Dow Industrials suffered its second largest sell-off of 2007, down over 200-points. Below is a small teaser of Gross’ recent prose:


“That the golden glazed surfboards of the 21st century seem unique with their decals of ‘private equity’ and ‘hedge finance’ is mostly a mirage. Wealth has always gravitated towards those that take risk with other people’s money but especially so when taxes are low. The rich are different – but they are not necessarily society’s paragons. It is in fact society’s wind and its current willingness to nurture the rich that fills their sails.” And, “If gluttony describes the acquisitive reach of the mega-rich, then the same gastronomical metaphor applies to today’s state of the credit markets. Stuffed! Both borrowers and lenders may have bitten off more than they can chew, and even those that swallow their hot dogs whole – Nathan’s Famous Coney Island style – are having a serious bout of indigestion.” And in regards to the backing-up of junk bond yields and its relationship with the mortgage/subprime convulsions, Gross says, “Some wonder what squelched the hunger of potential lenders so abruptly, while in the same breath suggesting that the subprime crisis is ‘isolated’ and not contagious to other markets or even the overall economy. Not so, and the sudden liquidity crisis in the high yield debt market is just the latest sign that there is a connection, a chain that links all markets and ultimately their prices and yields to the fate of the U.S. economy…..To be blunt, they seem to be thinking that if Moody’s and Standard & Poor’s have done such a lousy job of rating subprime structures, how can the market have confidence that they’re not repeating the same structural, formulaic, mistake with CLOs and CDOs?”

You can read Mr. Gross’ full depressing Investment Outlook below:

Bill Gross, “Enough is Enough”

Every pullback, no matter how miniscule, is a “buying opportuity”

For a day that saw a pretty sprite bounce in the indexes, the “canaries in the coalmine,” Goldman Sachs (GS), Bear Stearns (BSC), Lehman Brothers (LEH) and their ilk, barely got a look today. Housing and mortgage was again the stand-out weak-link. Remember how intimate housing had become with the market as a whole a few years ago? Its astonishing how folks have been able to pretend that the crashing of the same will have no broader repercussions...After hours, Altera Corp. (ALTR), a manufacturer of programmable logic devices, said second quarter profit increased year-over-year, despite a dip in revenues. Revenues declined 4% year-over-year to $319.7 million from $334.10 million. However, it was even worse than that. If it wasn’t for some good old channel stuffing, Altera would have reported a large miss. Receivables increased from $130-million just 3-months ago and $93.3-million at the end of December to $188.5-million in the June quarter just ended. Also, year-over-year growth in North America dropped by 19-percent. But as most well educated semiconductor has learned to do, they too rolled-out some plans to financially engineer their reality. Altera declared a 4-cent per share dividend and said that it intends to repurchase up to $1.5 billion of its common stock from the beginning of 2007 through the first half of 2008, using a “long-term credit facility.” Also, Texas Instruments (TXN) saw revenues drop to $3.42-billion from $3.70-billion year-over year even as Inventories increased slightly year-over-year. Gross profits dropped from $1.907-billion to $1.784-billion. No growth at all. Why the infatuation with tech and semiconductors? I see nothing but overcapacity, collapsing margins and lower profits. At least its not housing. The Dow Industrials recovered nearly 100-points of what it lost last Friday.

Coming into focus

Joining the “what are they thinking parade?”, Chipmaker Xilinx (XLNX) posted higher quarterly profit, but revenues fell on weakness in Europe. The company also guided revenues to be flat to down slightly sequentially for its September quarter. First-quarter revenue fell to $445.9 million from $481.4 million. Profits were $84.3 million, or 28 cents per share. Analysts, on average, were looking for net profit of 29 cents on revenues of $452.9. Miss, miss and lowered guidance. I’ve been chronicling the semiconductor and capital equipment group over the last week and I don’t see a real encouraging theme here. But this is the sector that is not specifically housing and mortgage, so by default it has been a “Buy” for Wall Street for a lack of any other viable theme. Again, these folks aren’t paid to warn folks to head for the hills, so they have to come up with something and it usually involves the recommendations of a group from which they get some of their underwriting and M&A fees. Advanced Micro Devices (AMD), Intel’s primary rival reported its third quarterly loss in a row last night on its prolonged price war with Intel. Advanced Micro said its net loss was $600 million, which equates to $1.09 per share loss for its second quarter, compared with a profit of $88.9 million, or 18 cents a year earlier. This loss occurred even as Revenues were up 13-percent to $1.38 billion, from $1.22 billion a year earlier. What does that say about an industry that shows robust sales increases but loses that much money anyway? Just think when demand falls off as the so-called “contained” housing and mortgage crunch works its way through the pipeline. As a reminder, Intel came in with horrific margins earlier in the week. Sandisk (SNDK) said that its average price per megabyte sold declined 65% on a year-over-year basis and 26% sequentially. SanDisk is largest manufacturer of flash storage cards used in cameras and other consumer electronics gadgets. Accounts Receivables also increased sequentially to $311.7-million from $144-million in April. But shares surged this morning because Chief Executive, Eli Harari, predicted that demand for some of SanDisk's memory products could “outstrip supply” in the coming months. More empty promises from another chip related CEO, but little beef.…. Cypress Semiconductor (CY) said “second-quarter profit rose sharply.” No kidding, that was the headline. But that feat was achieved by the liquidation of 7.5-million shares of SunPower Corp. (SPWR) that it had owned and subsequently counted the proceeds as revenues. Its balance sheet raised numerous questions with huge bulges in Accounts Receivables, Inventories and Goodwill. Away from chips, Google (GOOG), of course is one of those “love the company, suspicious of the current stock price things.” Its price took a pounding today after reporting year-over-year net-per share profit growth of just 25.8-percent. A stock with a $171-billion market that trades at a 46x multiple is just plain vulnerable when it becomes clearer that it’s in the twilight of its hyper-speed earnings growth era…. On the private-equity front, shares of previously LBO’d online travel agency Orbitz Worldwide (OWW) fell 3-percent in its reintroduction as a public company. Orbitz was spun off from Travelport, which is part-owned by private-equity firm Blackstone Group (BX). This was even as underwriters had to lower its projected offering price. This spells trouble for all those LBOd deals that have been financed and are targeted to be reintroduced into the IPO market in the future. And we can pretty much forget about the deals that have been announced, but not yet financed. Instances like the Orbitz fizzle will certainly add to consternation among bankers concerning the viability and wisdom of these deals. And for anyone with cognitive abilities, I believe it’s safe to conclude that the environment is only going to deteriorate from this point forward in spite of protestations otherwise. The denial we’re about to see concerning this issue will navigate a similar path of denial seen traveled by that of housing/mortgage and CDO parade of denial…The yen popped higher around 10:15 AM EST in the U.S. It looks like someone is being forced to reverse their carry-trade. A chart of the yen looks fairly appealing to me. Also very noteworthy was the fact that gold moved higher even as the subprime/CDO/structured credit complex stressed again. The dollar index, now down to levels last seen in 1992, may have been the primary catalyst for gold’s sturdiness. This was in stark contrast to the first major convulsions in late February and again a few weeks ago when news of Bear Stearns’ un-hedged, hedge funds hit the tape, gold had headed lower with everything else in those two prior instances. The Dow finished lower by 149-points, just 1.1-percent from its all-time high. Naturally, seeking a flight to safety, Apple Computer (AAPL) was up over $4/share at one point during the day indicating that even on a day of risk aversion, a palpable lack of fear was still easy enough to find.

“Resilience" or “Delusion”

Punk Ziegler, the boutique finance and banking research and broker, lowered their ratings on four of the largest U.S. investment banks to “SELL”. Dick Bove, Punk’s banking and finance analyst, said "I do not view this as a Bear Stearns problem but a systemic one." Following Bove’s research over the years, he’s worth listening to. More interesting was their own proprietary estimates on the growth of U.S. M3 (broad money supply). As you might know, Ben Bernanke and the U.S. Federal Reserve decided for us in March 2006 that publishing M3 data was no longer relevant and too costly. Punk & Ziegler estimate that M3 is currently expanding at apace of over 13-percent!!!! Perhaps Ben and his friends at the Fed had realized that being on the cusp of a housing crash in the U.S., they would soon have to start printing money like never before? Fairchild Semi (FCS), was the latest major semiconductor to report no growth and little prospects for the immediate future. Revenues, year-over-year, were essentially flat; margins dropped and Net Earnings dropped a lot. They also gave weaker forward guidance of 2-percent sequential revenue growth from an expected 4-percent. Cash and short-term investments have dropped by nearly $139-million since the beginning of the year—a nearly 24-percent drop in cash equivs. But of course, according to the “Delusionists Guide to the Galaxy: Bad news is always isolated, and good news can be extrapolated as also being good for the entire universe.….Motorola (MOT), which had already warned was a horror show!!!. Revenues dropped from $10.8-billion to $8.73-billion year-over-year!! IBM, of course reported positive numbers, and all else was forgotten. Within the first minute of trading, the Dow was again busting thru the 14,000 level. Yesterday’s news, which looked a little disconcerting along the subprime/CDO/structured credit-front, was essentially wiped clean within minutes of this mornings opening of trading in the U.S. If the bubble apologists hadn’t been so wrong as it concerned housing, and later subprime, as it migrated from froth, to peak, to “leveling-out”, to “correction”, to “difficult”, to “Get me the hell out!!!”, I would be far more open to accepting their current thesis that the structured credit problems will be isolated. It won’t be, and sometime over the next 6 to 12-months, a large number of folks’ net-worth’s are going to wiped-clean. The “canaries in the coal mine,” the large Wall Street investment banks weakened as the day wore-on. Goldman Sachs (GS) and Lehman Bros. (LEH) even broke thru some minor resistance back to levels last seen in early April…American Home Mortgage Investment (AHM) crumbled into the close on a rumor that a Wall Street investment firm had withdrawn a credit facility. It’s a small company, less than $1-billion market-cap. But nonetheless, it looks like another portfolio of mortgage-backed securities may be getting singed. A mere fly on the windshield as the Dow closed at a new record high, and exactly on 14,000. What a coincidence? Ya know, if it took a million or so thrown at the Dow futures in the last few seconds of trading today, the Wall Street cartel, I’m sure, believes its money well spent for reaching a new century mark and the soon-to-follow arm-waving that it will elicit on the night's news cycle.