H.J. Huneycutt's  Instablog

I've been running these little news-oriented columns on Motley Fool's CAPS for awhile and I decided to experiment with putting them here on Seeking Alpha's instablogs as well.  Essentially, I'll post a bunch of news items that stuck out to me and sometimes comment on them.  These are not limited to finance and economics, as I will post science- and policy- related items frequently, as well.

Here goes:


National Housing Survey and RE in a Bear Market

Link - Seeking Alpha

Felix Salmon laments the latest figures that suggest that Americans still overwhelmingly believe high levels of home ownerships are necessary for a vibrant economy.  I feel his pain.  I'd actually make the argument that home ownership in America not only creates problems such as the recent bubble, but also creates economic inefficiencies in an age where most people work outside of the home.  It seems to me that specialists could more efficiently provide a lot of services that homeowners get stuck with. 

Btw, I agree that the housing bear will last for several years.  Most RE busts last at least 6 years and this was the mother of all RE bull markets, so this could be potentially even be an 8-10 year RE bear market. With Federal support slowly being withdrawn, a massive backlog of foreclosures, and rising interest rates (b/c they can't move downwards much more, can they?), I'd be surprised if housing bottomed before 2012 and it may take even longer than that.  Houses are still expensive on a historical basis and people are still under the delusion that their houses' values will come back soon.

Housing and Cognitive Dissonance on Wall Street 

Link - Seeking Alpha

Yet another excellent article on housing.  I'd put this near the top of my recommendation list for financial readings this year.  
 

Who Controls the Bank of Japan?

Link - Seeking Alpha

And speaking of "top recommendations", this article falls into that category, as well.  The article deals with the Bank of Japan's Dilemma in the Aughts and how no matter how much liquidity they pumped into the system, the result was the same --- no significant inflation.  The article really provides a sobering view of what the US could face over the next 5-10 years.  

Inflation Low on List of Worries, Says Dallas Fed Chair

Link - Wall Street Journal

Chair of the Dallas Fed, who was critical of the Fed's relunctance to up interest rates during the 07-08 inflationary episode, talks about inflation and how he views it as an unlikely problem for the next few years.  

Deflation on the Prowl

Link - The Telegraph

Another article suggesting that deflation is a bigger concern right now than inflation.  The author also criticizes the Fed for eliminating the M3 money supply measure, which seemed to be a very prescient indicator of what was about-to-come back in '05 and '06.  The Fed not only ignored the warning signal, but decided that M3 was an irrelevant measure, a big mistake according to the author.  Now, M3 seems to suggest the exact opposite --- it's crashing downwards like a plane without any engines.  

Taxes, GDP, and Over-Taxation

Link -Money Illusion

Excellent piece on the topics in the article title.  

EPA Tightens Rules on Mountain-Top Removal Mining

Link - Smart Money

Good move by the EPA.  I'd say we need to go a step further and gradually ban mountain-top removal. Not only are the environmental hazards tremendous (groundwater contamination is a *major* issue), but it basically is a wholesale destruction of objects of significant cultural value in the Appalachia region.  For those who want to look at this from a market perspective, I'd argue that one of the major problems with this type of mining is that it passes tremendous costs onto the taxpayers, which means the miners profit at taxpayer expense.  The miners should absolutely be subject to heavier regulation and higher costs to reimburse the taxpayers for their wanton destruction.  

Mexico City's Air Quality Improves

Link - Washington Post

It's not all bad news on the environmental front as Mexico City's air quality has been improving over the past decade.  China and India should consider modeling themselves more after Mexico City in this regard.  

Interactive View of Unemployment Since 1948

Link - WSJ

Dan Quayle's Whiny Editorial

Link - Washington Post

Last, and almost certainly "least", is this editorial from Dan Quayle that appeared in the Washington Post recently.  It's one of the most infuriating pieces of whining I've ever read and it reminds me why the two party system in America is so thoroughly broken. 

Essentially, Quayle blames Perot voters for Clinton's election.  This was f@#$ing 16 years ago --- get over it you whiny jacka@@! 

He claims he doesn't want Tea Party members to make the same mistake --- that is, abandon the sacred Republican Party.  Let's just ignore the fact that the Republicans have been every bit as bad as the Democrats in the "big government" department over the last two decades and that the GOP is probably more to blame for our budgetary nightmare than the Democrats, as well.  

No, I'm not happy with the Democrats, either, but I do find Quayle's editorial almost insulting.  If anything, I think our nation missed a golden opportunity to displace the two party system and set ourselves on a more responsible pathway when Perot got relegated to 3rd Place in the 1992 election. 

If anything, the lesson shouldn't be to mindlessly support the Republicans (or alternatively, the Democrats).  Rather, the lesson should be to support a third party candidate with momentum even if they are trailing and it hurts your choice of "lesser of the two evils".  There's a good chance that we wouldn't be in nearly as big of a mess if Perot had been elected for 8 years rather than Clinton (or the two Bushes).  There's virtually no chance that Bush I would have changed the political culture.

It’s been awhile since I’ve written a more general analysis of the market.  I prefer to write equity analysis pieces for individual companies, but these pieces might give one a misleading impression of my form of stock analysis, as I am more macro-oriented than I probably appear and I do not consider myself a Buffett-style investor, even if my value orientation is similar.  Rather, I have always modeled myself more along the lines of George Soros. 

Some investors describe themselves as “bottom-up” or “top-down.”  I would say that I am both.  I will pick macro themes and then start searching for companies to buy into based on those themes.  But I also do “bottom-up” picks, as well if I can find very cheap companies out there. 

My research strategy is a bit unique.  On one extreme, there are the Warren Buffett-types that like to deeply analyze individual companies.  On the other extreme, you have those who rely solely on quantitative models to pick their stocks.  I’d say my approach comes somewhere in between --- I have a method of quick research and valuation that I apply, then from that, I might dig deeper into companies that look particularly attractive from my initial analysis.  Then again, I might not.  It’s a trade-off; I have limited time and the more of the market I can survey, the greater likelihood that I will find stocks that have high return potential. 

I like to sector-buy when I see a particular sector that is severely beaten down, so you could say from that perspective, I am a “top-down” investor; but in the end, it’s always individual companies that interest me and I’m willing to wait for the stocks to rebound, even if it takes a few years.  I’m also much more willing than most to jump out in front of the proverbial falling knives. 

That said, here are my thoughts on some particular sectors and the overall market:

REITs

I have been buying into REITs since about March of ’09, when I first spotted Winthrop Realty Trust (FUR) and was absolutely baffled as to how a company with a large amount of real estate assets, a massive cash balance, and relatively low leverage could be selling below the value of its cash on hand.  This got me interested in REITs and I ended up analyzing about 20-30 of them, eventually buying into Pennsylvania REIT (PEI), Brandywine (BDN), DCT Industrial (DCT), One Liberty Properties (OLP), Lexington Realty Trust (LXP), Glimcher (GRT), First Industrial (FR), and Hersha Hospitality Trust (HT) at various points.  All of those have been huge winners, with the exception of DCT, which I have made more minor returns on.  It was, however, probably the safest REIT of the bunch. 

Even after a massive run-up in prices, I still believe REITs are undervalued in the aggregate.  We can talk about falling real estate prices all we want; most REITs have a built-in accounting cushion, since their assets depreciate on the books, but generally appreciate in the real world.  Even with precipitous declines in real estate prices, many REITs’ assets are still undervalued on the books.  Moreover, most of them still have decent, if not good, cash flows.  Remember, “earnings” for REITs are pretty much irrelevant because of the depreciation and amortization charges that do not reflect reality. 

When the U.S. eventually merges GAAP with IFRS, it’s completely possible that fair value accounting will become a reality in the U.S.  REITs will likely be the biggest beneficiaries of such a paradigm shift, which is yet another reason I remain bullish long-term. 

However, my bullishness is tempered by the declining yields.  It is inevitable as the market has finally started to warm up to REITs, the prices have risen, meaning lesser returns for investors.  For this reason, while I still believe the sector is undervalued, I have stopped most of my buying into the commercial and residential REIT arena.  The one exception right now is FUR, which I like because the huge cash balance should help position them to take advantage of depressed prices. 

Though, I still believe REITs are a good buy if one does not own any; I’ve mostly stopped buying because they form about 35% of my personal portfolio and maybe 20% of the fund I manage.  At this point, I feel as if I’m “full up” on REITs and it doesn’t make sense for me to continue buying in unless I see some very deep values again (or I stop seeing better value in the rest of the market.) 

Small Commercial Banks

I started becoming bullish on small commercial banks around September and October of ’09.  There were a handful of banks I was looking at and while I felt that some could potentially see major trouble, the sector in the aggregate was deeply depressed.  Therefore, my strategy was to buy into a basket of about 15-20 bank stocks with various risk profiles.

The most successful buy in that sector for me thus far has been Green Bankshares (GRNB), which I was fortunate enough to choose to write an article on.  One of the least successful buys in that sector for me thus far has been Hampton Roads Bankshares (HMPR), which I was unfortunate enough to choose to write an article on.  My returns on GRNB have been around 100%.  My losses on HMPR were maybe 20%.  My views on HMPR have changed and I have sold out of my position with a loss.    

The rest of my bank portfolio has been mostly positive, with sizable gains on Synovus (SNV), Savannah Bancorp (SAVB), Susquehanna (SUSQ), Whitney Holding Corp (WTNY), Citizens Republic (CRBC), and Western Alliance (WAL).  My biggest losers (aside from HMPR) have been Riverview Bancorp (RVSB) and Sun Bancorp (SNBC).  Overall gains on the bank portfolio have probably been around 30% - 40% since last November. 

Right now, I am still extremely bullish on many commercial banks.  One of the things I love about this sector is that there are so many companies; it will take a long time for the market to discover all of the good ones out there.  I continue to find great bargains among microcap banks and I may write about a few more in the upcoming months.  Even the big regional banks are probably still significantly undervalued, however. 

Don’t misread what I am saying.  Many, many, many banks will fail or be required to do extremely dilutive share offerings either in order to survive or to pay back their TARP funds.  In fact, that’s the primary reason I’ve bailed on HMPR; I’ve become more skeptical of the bank as time has progressed and I don’t see them escaping TARP without a massively dilutive offering.  I’m also disturbed by the fact that they’ve failed to pay out a TARP dividend twice now and have never filed their 10-K for 2009. 

HMPR still might be undervalued even with all the negative events, but I now favor CRBC and a few other higher risks banks (which I will withhold for now, as I may continue to buy them) over it. 

Commodities

I was a big buyer of commodity stocks in late ’08.  It’s one of the reasons my score on Motley Fool’s CAPS moved into the upper echelons and my returns on KaChing skyrocketed in early ’09.   However, I have become increasingly bearish on particular commodities. 

I am closer in agreement to James Chanos’ bearishness on China than Jim Rogers’ bullishness.  My belief is that China’s GDP growth has been driven heavily by three factors: (1) heavy governmental expenditures, (2) distortive reporting, and (3) mercantilistic trade policies. 

With or without retaliation against China’s mercantilist trade policies, the China real estate bubble may soon unravel.  If the US does label China a “currency manipulator” and impose tariffs to retaliate, I believe that this could put China at risk of a severe economic contraction.   This means that many commodity related stocks will get absolutely destroyed.

China is only part of the reason for my commodity bearishness.  There are other dynamics, as well.  There will be winners and losers in the giant energy paradigm shift that occurs throughout this century.  I view coal as the biggest loser and even though cash flows are currently very high for coal companies, I would be very reluctant to invest in any company that has significant exposure to coal. 

I’m bearish on Walter Industries (WLT), which has had a phenomenonal run over the past year, but there seems to be some major insider dumping going on right now.  When you combine that with macroeconomic concerns, that’s enough to scare me away.  If it continues to move upwards, I might even be tempted to buy put options on it.  The same goes for Massey Energy (MEE), which also has an unsettlingly large amount of insider sells.

Aside from coal, I’m also bearish on copper and would highlight yet another company with large insider fleeing in Freeport-McMoran (FCX).  I’m also somewhat bearish on gold miners, which seem to be selling as if gold prices have risen to $1500/ounce with no cost increases passed along to them.  Peter Psaras’ recent article on Seeking Alpha highlights the fact that gold miners still do not seem to be producing much in the way of free cash flows, but are selling at relatively high multiples. 

Energy & Utilities

Energy is becoming an increasing difficult nut to crack these days.  We are at a crossroads of sorts and I don’t think too many people would deny that we will see a significant paradigm shift in the energy sector over the course of the 21^st Century.  But how will things change?

Bill Gates certainly sheds some light on the issue, with an excellently argued case in favor of nuclear power.  Small modular reactors may very well be the future.  However, I’d differ with Gates on one thing --- I believe geothermal may have a great future in the Western U.S., as well.  I’d keep an eye on Ormat (ORA), which has been hammered recently.  There are some other microcap players in this arena, if you’re willing to dig into them. 

I’ve finally given up on Raser Tech (RZ); in spite of having the most interesting technology in the geothermal sector, the company has been run so poorly from a financial perspective, that I have completely lost faith in it.  It was never more than a speculative pick for me, but I do think their technologies have great potential.  It would be interesting to see if some savvy big-money investor tries to buy out the company’s assets on the cheap. 

For the near-term, I like natural gas and nuclear power.  I have bought into a few companies in the natural gas sphere over the past six months.  My favorites have included Encana (ECA), Western Gas Partners (WES), Constellation Energy Partners (CEP).  Plains Exploration (PXP), and Petroleum Development Corp (PETD); all of which I have bought into in some capacity. 

It has been more difficult for me to pin down any winners in nuclear, however.  The only direct play on my nuclear bullishness has been the severely beaten-down USEC (USU), which I recommended (but never bought) around $3.50.   I’m more skeptical at the current price of $5.70. 

I do like a number of utilities that are in the nuclear sphere, including out-of-favor Entergy (ETR) and Excelon (EXC).  These also double as defensive positions since they pay out significant dividends.

Finally, I have mostly limited my exposure to oil as it moved above $75/barrel.  I do like two offshore drilling service companies --- Ensco (ESV) and Noble Energy (NE).  I have been long both in my personal account since last summer.  Jamie Potkul lays out the long case much better than I ever could.   

The Macro Environment

For the first time in awhile, I find myself a bit torn on the direction of the macroeconomic picture.  Many people were calling for hyperinflation beginning in late ’08; I do not foresee that.  However, my predictions in regards to inflation and interest rates are that a Federal pull-out from the housing sector will cause rates to rise some, but the Federal Funds rate will stay near zero for at least the next year; maybe 2-3 years.

Some other things to consider:

(1) We will see continued deflation in real estate and inflation in certain commodity sectors.  This fits in with the idea of commodity scarcity.  All the same, I see too many risks to commodities (as noted above) to feel comfortable jumping in on most of them (with some exceptions) right now.

(2) The Eurozone will continue to struggle and many European economies will continue to contract as governmental spending declines as a result of excessive debt levels.  This could trigger more deflation in Europe. It’s difficult to know whether or not the Euro will survive over the next decade and what changes we will see in the US by 2020.

(3) China has a near-term potential for high inflation due to rapidly increasing money supply.  This could end up being the event that triggers a broader crash; the Chinese economy has been sustained by smoke and mirrors for far too long and the Chinese have no choice but to raise interest rates right now, which is going to put the brakes on the economy. 

(4) The U.S. will fare better than most of Europe.  This doesn’t mean we’re out of the woods --- merely that we will probably prolong our pain further into the future than European debtors.  Governmental spending will stay high, but tax increases could steadily chip into US economic productivity.  It’s unclear to me what direction the US will go.  I don’t think hedging one’s bets would be a bad idea.  My best guess is that we’ll see moderate economic growth for a few years, before another (more minor) downturn.  That view is subject to change, though. 

Some quick notes on a few companies I have been looking at lately:

Genworth Financial (GNW)

As I have detailed in my article on taking advantage of bankruptcy risks, one can often make substantial gains by diversifying holdings in companies with significant risks that have been overly discounted by the market on an individual basis.  Oftentimes, risk-reward greatly favors the long side in such situations even though risk is very high.  Genworth might prove to be a classical case on this.  Do I know whether Genworth will survive?  No.  But by going long, worst case scenario is that you lose 100% of your investment.  If Genworth survives, there's potentially a 400% - 1500% gain in it at the current price. 

The market might also be overreacting a little bit.  The fact that they will not collect any TARP money has scared people off, but things aren't completely horrible for Genworth. Their balance sheet mostly consists of less risky securities that have been beaten down. There's a good chance those securities have bottomed (on their balance sheet). I'd value their fixed maturity portfolio somewhat higher than accounting rules require them to. Their real problem is they are overlevered and need to be more liquid, but not so much that I couldn't potentially forsee them riding this out. It's also notable that there have been some insider buys over the past few months - nothing huge, but still, sizable enough to be worth mentioning.

I give GNW 50% odds of survival, but given the downside risks and the upside potential, risk-reward greatly favors the long-position.  This is not something I would ever bet the bank on, but I decided to add a small position to my KaChing simulated portfolio.  It's only about 0.3% of my total portfolio, so I'm not out much if I lose the bet.  Just for fun, I also put a couple hundred bucks on this in real life.  Once again, I'm not out too much if I lose. 

Hospitality Properties Trust (HPT)

Oh dear market, why do you always overreact to bad news?  Last Thursday, HPT suspended its quarterly dividend and shares plunged.  I might be the only person on Earth who sees things like this as great news.  For long-term investors, you should be delighted that HPT suspended the dividend.  Sure, you won't collect as much money in the short-term, but it's in your best interest for the company to improve its liquidity.  And really --- liquidity might be Hospitality's only major problem.

I have not had a chance to analyze this one in detail yet, but I can't help but to notice that HPT's book value is $59 per share.  The stock currently sells in the $9 - $10 range. 

Leverage, you say?  It's not too shabby.  Right now, their liability/value ratio is 53.4%.  That's fairly low for a REIT. 

HPT has about $5.35 billion in real property on their books.  Certainly, some of that could be overvalued on the balance sheet, but you'd have to write it down by at least 30% before things started to look ugly. 

Like I said, I haven't had a chance to thoroughly analyze this one yet, but from a shallow glance, it looks like the market might be overreacting a tad bit.  I added a 0.7% position to this on my KaChing simulated portfolio and might increase that a bit over the next few days after further investigation. 

Chicago Bridge & Iron (CBI)

I've seen a number of people recommend this stock lately.  It's been beaten down a lot since the market downturn.  It also intrigues me as an energy & infrastructure play, but after glancing over the financials, I'm not too hot on it.  For one, their balance sheet is pretty ugly.  They have $555 million in equity compared to $2.44 billion in liabilities; liability/value ratio is 81.5%.  From the face of it, they have high leverage, but if you glance at their asset accounts, it only gets worse.  They have $962 million in "Goodwill" and another $236 million attributed to intangibles.  So in essence, their actual equity is more like $600 million in the hole. 

Current ratio is not too hot at 0.6.  They recorded a loss in their last fiscal year; while that is somewhat deceiving and they appear to be profitable in reality, it's not as if they are overwhelmingly profitable.  If they could back to FY 2007 and FY 2006 and bringing in over $3.50 per year in free cash flows (FCFs), then things might not be so bad.  For FY '08, they were in the negative on FCFs to the tune of about -$1.05 per share. 

Decided to run a quick DCF on this; with an adjusted book value of -$6 (to reflect negative real equity) and a high growth rate of 5%.  if you assume they bring in $1 in FCFs for Year 1 and use a 12% cost-of-capital, you end up with about an $8 valuation.  That doesn't make me too comfortable.  I could see them bringing in over $1 in FCFs again, but 12% COC seems pretty aggressive given their high leverage.  At some point in the future, their cost of capital might be quite a bit higher than that (if it's not already - I haven't bothered to check yet). 

If I start the DCF at $2 in FCFs (instead of $1) and raise COC to 14%, the valuation comes out to $16.  Not completely unrealistic, but it does not seem as if the upside here compensates for the downside risks.  I definitely would not go short on this, but I'd keep away from it on the long end, as well.

Disclosure:  Author is long GNW and may choose to go long on HPT within the next few weeks.