Doug's Daily Diary -- Monday, 11/21/2011

One Last Think (Part Deux) 4:13 p.m. EST Brocade Earnings One last thing. -- Lt. Columbo Big beat top and bottom line for Brocade. Long BRCD. Just a Thought 3:35 p.m. EST I think I figured out the super committee's super power. One last thing. -- Lt. Columbo An optimist (and cynic) would say that a member of the super committee could conceivably trade on inside information regarding its progress. Wouldn't it be funny if they bought SPDR S&P 500 ETF Trust (SPY) today? Well, it wouldn't be that funny! Congress and insider trading -- you simply can't make these things up. Over the River and Through the Woods 3:01 p.m. EST I am signing off a little early to travel for Thanksgiving. I am leaving early today to go up north for Thanksgiving. I will be back in my perch on Friday morning. To all our subscribers, contributors, editors, techies and management, I want to wish everyone a Happy Thanksgiving! Recommended Reading (Part Deux) 2:48 p.m. EST Run, don't walk, to read Sir Thomas Keene's interview with James K. Galbraith on Bloomberg. Economist James K. Galbraith (son of!) agrees with the view I expressed earlier this afternoon that the failure of the compromise in Washington over the weekend is a good thing. Here is a Bloomberg article that addresses his view in an interview with Sir Thomas Keene. Good stuff. Lockhart's Outlook 2:31 p.m. EST The Fed president sees a less-than-30% chance of a recession in the U.S. Break in: Federal Reserve President Lockhart says that the probability of a U.S. recession is less than 30%. I agree, as mentioned in my most recent Kass model portfolio update. Baucus Bolsters Markets 2:20 p.m EST According to a report, Senator Baucus made some positive comments on the progress of the super committee. Break in: The proximate reason for the small rally in the last 20 minutes is a Dow Jones report that Senator Baucus, a member of the super committee, has said, We are still going forward. In addition, he vaguely cites a new idea and, astonishingly, that both sides are feeling angst. He should understand investors' angst! But I suppose that is too much to ask! Case for Super Committee Positive 1:33 p.m. EST There is a case being made by some that the failure of the Super Committee to reach a compromise is a net positive. It goes something like this (Hat Tip Daniel!): 1. Cutting spending and raising taxes with such strong cyclical and structural headwinds to aggregate demand would have been a mistake. 2. The low bond yields in the U.S. are sending a message that fiscal spending is not nearly as aggressive as it should be. 3. The fiscal pullback over the last 18-24 months was more important than quantitative easing (in part because the U.S. banks didn't aggressively lend). For more on this view watch the well-regarded Richard Koo, who is the chief economist of the Nomura Research Institute. Technical Difficulties 12:47 p.m. EST The site I use to monitor individual stocks has crashed. Realtick, the stock system I use, has had a complete site-wide breakdown today, so I am unable to monitor individual stocks. As a result, my posts discussing individual stocks will be infrequent this afternoon! A heads up! Au Contraire 12:37 p.m. EST We could be closer to the end than the beginning of the eurozone sovereign debt concerns and poor sentiment that it brings to our markets. The Wall Street Journal just introduced a column on the cover of the online edition that shows the 10-year yields, the spread against German bunds and the basis-point change during the day on Italian, French, Portuguese and Spanish debt. The contrarian in me says this could mean we are closer to the end than the beginning of the eurozone sovereign debt concerns and poor sentiment that it brings to our markets. Euro Starts to Take Off 12:23 p.m. EST Too bad this isn't a typical market. As Jim El Capitan Cramer just wrote, the CurrencyShares Euro Trust (FXE) is starting to rally. This is typically a good sign for U.S. equities, but there is nothing typical about the markets (and their correlations) these days. Afraid Not 12:18 p.m. EST I am doing little. Late last week, I wrote a column on confronting fear. Fear I see today in spades. But I am doing little. JEF Stands Out 11:26 a.m. EST Jefferies is the only green stock on my monitor. It is somewhat ironic that the only stock in the green today on my monitor is Jefferies (JEF). Largest Long and Short 11:17 a.m. EST My largest long is Lincoln National, and my largest short is Henry Schein. Largest long: Lincoln National (LNC). Largest short: Henry Schein (HSIC). Long LNC common and calls; short HSIC common Covered Groupon Short 10:58 a.m. EST I have covered my Groupon short. Housekeeping item: I have covered my Groupon (GRPN) short. Fired Up! 10:37 a.m. EST Break in: If no deal is reached, the debt panel will make an announcement this afternoon. The debt panel plans to make an announcement this afternoon if no deal is reached. As I have written earlier, fire the bums! Recommended Reading 10:31 a.m. EST Run, don't walk, to read Jefferies' letter. Jefferies (JEF) has just released an extensive letter to its clients, shareholders, bondholders, employees and friends. Boockvar's Take on ECB Debt Purchases 10:27 a.m. EST Miller Tabak's lynx-eyed strategist has some interesting comments. Interesting comments by Miller Tabak's Peter Boockvar on ECB sovereign bond purchases last week: Capturing a more aggressive ECB on Nov 10 and Nov 11, the ECB said it settled sovereign bond purchases of 7.99 billion euros for last week, up from 4.48 billion euros in the week before and vs. 9.52 billion euros in the week prior to that. They now have a total of 194.5 billion euros to sterilize with the latest purchases continuing to be Spanish and Italian debt. To measure the effectiveness or lack thereof of the buying of Italian bonds, today's 10-year yield is at 6.68% vs. 6.09% the close before the buying started Aug. 8 and the Spanish 10-year is at 6.57% vs. 6.04% right before. The Italian two-year yield is at 6.38% vs. 4.52% on Aug. 5, and the Spanish two-year yield is at 5.57% vs. 4.35% on Aug 5. Recommended Viewing 10:23 a.m. EST Run, don't walk, to watch Barton Biggs' renewed market and economic pessimism. Run, don't walk, to watch Barton Biggs' renewed market and economic pessimism, an outgrowth of the Super Committee's failure and the ECB's sluggish response to the growing contagion. Kass Katch: Buy E*Trade 8:55 a.m. EST The reward vs. risk had turned favorable. At $8.25 a share, E*Trade's (ETFC) common shares represent an inexpensive option on an improving U.S. stock market, the return of a more active individual investor, a gradual improvement in the residential real estate market (through its large portfolio of home equity loans) and lower loan-loss provisioning, a rise in interest rates and an opportunity to refinance or pay down/off nearly $1 billion of debt (with a 12.5% current interest payment) at a large cost savings. As an additional potential catalyst, led by Citadel Advisors LLC (which rescued the company with a capital infusion several years ago), E*Trade has several large and motivated holders that might continue to put pressure on the company to consider being acquired (even though the recent effort failed to result in a transaction). Background E*Trade is a discount broker with about 2.8 million accounts and over $175 billion of customer assets. Commentary I have gone back and forth (mostly back!) on this investment over the past six months. Most recently, I purchased shares during the market's correction and sold the shares (at a loss) after the company failed to find a buyer recently (and third-quarter results were slightly weaker than expected). Last week, as the shares continued to slide (nearly revisiting their early-2009 low), I revisited my analysis and concluded that the reward vs. risk had turned favorable, and I have re-established my long position. On July 21, 2011, this discount broker announced its intention to evaluate all strategic alternatives including a possible sale. Recently, E*Trade announced continued execution of its current business plan was the best alternative to increase shareholder value. The Bullish Investment Case As of Sept., 30, 2011, E*Trade had unencumbered cash of $1.67 billion and another $1.2 billion of cash required to be segregated based on federal regulations. Against cash, E*Trade had corporate debt of $1.49 billion (and a similar amount of excess capital at the bank). Nearly two-thirds of parent company debt is in expensive 12.5% paper. E*Trade's bank is generating about $100 million of excess capital per quarter. At some point, fed regulators will allow the company to release its excess capital and pay down its high cost debt. E*Trade has not initiated any new loans nor has it purchased any loans since 2007. Though the portfolio remains at a high loan-to-value, it's amortizing (rolling off) at almost $700 million a quarter -- a big positive. Though core earnings (and net interest margins) have been pressured by the Fed's zero interest rate policy, the company is still profitable. Given my expectations of reasonably solid domestic economic growth, interest rates should rise and the pressure on margins (and profits) should abate. For the year ended 2010, E*Trade was profitable despite a $780 million provision for consumer loans. This year provisioning is estimated to be about $370 million. Given the (aforementioned) rapid amortization (roll off) of loans, I conservatively expect loan-loss provisions to gradually move down to about $150 million by Dec. 31, 2013. The combination of lower interest expenses achieved by paying down/off corporate debt (Fed permission will be necessary) with the reduced weight of loan-loss provisions may result in an after-tax earnings swing of as much as $1.25 a share. Fourth-quarter profits should improve over the relatively weak third-quarter 2011 results, reflecting better October DARTS (daily average revenue trades) and a lower provisioning for bad loans. The shares of E*Trade were featured in Mike Santoli's column in Barron's over the weekend. Based on more normalized 2013 EPS of $1.20 a share, a 12% discount rate, a 13x to14x P/E multiple and a 1.5-year discount factor, I see an upside to $12.50 to $13.00 a share over the next six months (up 50%). Downside risk is seen to $7.00 a share (down 15%). If a takeover occurs, $15 to $16 a share appears a likely takeout price. Long ETFC and GS Added to SPY 8:50 a.m. EST I added to SPY at $119.95. I have further added to my long exposure on today's swoosh lower by adding SPDR S&P 500 ETF Trust (SPY) at $119.95. I am tempted to make another ludicrous forecast that we could recoup most of the futures' losses, but I am so ticked off over the Super Committee's inaction that I won't for now. So, though not a ludicrous forecast, I still think it is a possibility. Long SPY Fire the Bums on the Super Committee 7:47 a.m. EST I am disappointed that our political leaders in the Super Committee have failed to come to any compromise. Back in late 2010, one of the primary surprises on my surprise list for 2011 was that partisan politics would inhibit economic growth and limit the upside to equities. As the year proceeded, there were many signs that there would be no compromise and that we would have to wait for the November 2012 elections for a referendum on deficit cutting. I watched the talk shows on Sunday, and the unrelenting intransigence from both sides of the pew and the venom that they had for each other clearly signaled the inevitability of today's failure by the deficit-cutting committee to reach an agreement. I have written numerous critical articles, citing the failures of our politicians, their collective partisanship and their mistaken policies. While I am not surprised that our political leaders in the Super Committee have failed to come to any compromise, I am disappointed -- and so are the futures market and markets around the world, as they are giving a Bronx cheer to the failure in Washington, D.C. (I admit to being taken aback by the magnitude of the early drop in futures as most expected this outcome.) Back in August I highlighted 10 changes that I would introduce if I were in power. Based on the divisive and divided Republican and Democrats this morning, I would like to emphasize change No. 1 below this morning: Establish term limits for all our representatives. Limit government spending. Set a specific limitation on the annual gains in spending to be less than the increase in consumer price index. Develop a comprehensive jobs plan. Fix housing. Over 15 million homeowners are underwater with their mortgages, the shadow inventory of unsold homes is a drag on a housing recovery, and we must find a way to find a way to reemploy over 2 million former housing-related workers. We need a Marshall Plan for housing. I would suggest that the Obama administration reach out to the two most knowledgeable and smartest guys in the residential real estate markets, Eli Broad and Bob Toll. I would have them all meet in a locked room with Fed Chairman Ben Bernanke, Treasury Secretary Geithner and President Obama (and his economic team). Raise taxes on the rich. Put a three-year income tax surcharge (of 10% to 15%) on incomes above $500,000. Create a health care czar and tackle our health care industry's delivery and costs. Mean test entitlements, freeze entitlement payouts and gradually increase the social security retirement age to 70 years old. Exit Afghanistan and Iraq immediately. More effectively rationalize the defense budget and provide returning soldiers full tuition to vocational schools and colleges as they have sacrificed much. Build infrastructure. Set up an infrastructure bank, and place the money saved on defense into a massive build-out and improvement of the U.S. infrastructure base. Create energy self-sufficiency. Develop a comprehensive plan designed to rapidly develop all of our energy resources. I say, Fire the bums on the Super Committee.

Doug's Daily Diary -- Monday, 11/21/2011

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