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Mark Mansfield's  Instablog

Mark Mansfield has 3 years of experience in brokerage with Fidelity Investments. Mark has passed two levels of the Chartered Financial Analyst exam, interned as a fixed income analyst for Principal Global Investors, and has an MBA-Finance from Indiana University.
  • While one Month Doesn’t Make a Trend…

    The data for September thus far has disappointed. Strong increases in home sales and prices in July, as well as manufacturing in July and August may be dissipating. Orders for durable goods in August disappointed relative to July, as did new and existing home sales. The recent release showing an increase in the Case-Schiller home price index looked encouraging, but market participants should remember that that report was for July, a month for which we saw banner sales. It is likely that Case-Schiller for August will not impress given the slowdown in sales relative to July. While pending home sales for August were strong, given the need for credit approvals it is questionable as to whether many of those sales will come to fruition.

                    Perhaps the most disturbing data came in the form of manufacturing. I have heard some who are dismissive of the Chicago PMI data. “Chicago PMI isn’t normally a market mover.” Dismissing a dramatic miss in Midwest manufacturing data is a big mistake. The prior month Chicago PMI came in at a break-even 50, indicating no expansion or contraction in manufacturing activity. Consensus expectations were for an increase to 52.0. The actual result came in at 46.1. Perhaps you are saying that the expiration of “cash for clunkers” may be responsible. This is actually not the case, as the cash for clunkers program depleted dealers of the inventory of popular vehicle models and should have necessitated an increase in manufacturing as result of the need to replenish these vehicles. As a result of the Chicago PMI data, I anticipated a miss today for ISM. That is indeed what happened as ISM came in at 52.6 v. a consensus of 54, and 0.3 lower than the August result of 52.9. Now granted an ISM above 50 is indicative of expansion, but it is disturbing to see this metric not increasing on a m/m basis when the argument is for a V-shaped recovery.

                    Initial claims also missed with 551k v. consensus of 537k. Employment index information contained within the ISM report also resulted in Goldman Sachs revising down their expectation for tomorrow’s September employment report from a job loss of 200k to 250k. While personal spending and income data came in strong for the August report, employment data of this nature is discouraging for future income and spending expectations and may make it hard to argue for any decisive trend of improvement in employment.

                    Today the markets suffered some pretty strong declines in the wake of September economic data. Technical damage was also done with the S&P ending well below its 20EMA at 1047 and the trendline off the July/September lows at around 1040. Of course we saw a strong downdraft at the beginning of September, and some bulls would argue that this “correction” will be short and shallow and of a similar nature to the beginning of September. I would argue that this time is different due to a fundamental backdrop that looks a little weaker. At the beginning of September all the bears had was an argument that we had gone “too far, too fast,” but now there is some data that suggest that even in the wake of extraordinary stimulus the recovery is slowing. Of course the recovery may be one of fits and starts, but the data from September is certainly not encouraging.

    Disclosure: Long SDS, Long QID

    Tags: SPY, SDS, QQQQ, QID
    Oct 01 07:06 pm | Link | Comment!
  • Walter Energy: Overbought, Overvalued, and Crowded

     

    Walter Energy is a Tampa producer of metallurgical coal for the global steel industry. Walter’s export markets according to Walter’s 2008 annual report are: North America 3.2%, South America 31.5%, Europe 62.3%, and other 3%. Walter is the largest US exporter of coal to the South American metals industry. This annual report may be viewed at: http://www.walterenergy.com/investorcenter/ars/2008/pdfs/WIAR08.pdf  Walter’s coal is of very high quality, high BTU content. Additionally Walter has traditionally maintained higher margins than its competitors in its coal business. Walter has transitioned this year away from a diversified conglomerate to focus on its coal business, spinning off homebuilding and REIT business. This is certainly likely to be a good move given the current environment. There is little doubt that Walter is an attractive company on a fundamental basis.
    However while a company may be attractive on a fundamental basis, that does not mean that it is attractive from a relative value perspective at this time. According to consensus estimates for 2009 earnings, Walter should earn $1.67 this year. At current stock prices that would make for a P/E ratio of 25.74. For comparison here are some other coal companies with their respective P/Es based on full year 2009 estimates arrived at by dividing current stock prices by Thompson/First Call estimates:
    Ticker    P/E
    ANR      12.71
    FCL       16.54
    BTU      15.42
    MEE     17.45
    These estimates would give us an average P/E for these companies of 15.53. Walter, by this analysis, trades at a 66% premium to its competitors. Is this a reasonable valuation? I certainly think not. If we were to apply a 15 P/E to the 2009 estimate we would arrive at 26.72, and if we were to attribute a more generous estimate of a 20 P/E, we would arrive at a value of 33.40, well below the current share price of $43.00. This sentiment was also echoed in the recent Brean Murray downgrade from buy to hold based on valuation given that WLT has surpassed their $37.00 price target, though they are still favorable on the stock from a fundamental/longer term basis.
    What is the cause for this apparent price discrepancy? I would attribute this anomaly to four causes:
    1.       Enthusiasm over China and the “reflation trade,” which does not directly affect WLT, as WLT does not export to China, but may have a tertiary effect if indeed China demand were to push up metallurgical coal prices.
    2.       Speculation over M&A in the coal space, particularly after ANR’s bid for FCL. However after the recent run up in WLT share price and market cap, it is likely that coal producers may look for less costly acquisitions.
    3.       Momentum and technical traders who are viewing recent chart patterns and apparent breakouts as positives. Given the low average volume traded in WLT relative to a more liquid issue like BTU, momentum players can much more easily bid up an issue like WLT. Additionally with a relatively low float shorts are easily pushed out of this stock.
     Once again Walter Energy is an attractive company from a fundamental perspective, and may well be worth far in excess of its current price when the economy, and therefore the metals industry, returns to normal growth. However it is premature to speculate on any resumption in metals production on a scale even close to that seen in early 2008. If one does wish to make such a bet on economic recovery, they should do so in the most cost effective manner possible. Accordingly, if one is looking for metallurgical coal exposure, it would be far more reasonable to purchase the shares in a company such as ANR, which trades at a very reasonable P/E. For those looking for a pairs trade, long ANR/short WLT may be appropriate. If one is looking merely for coal exposure, without a preference for metallurgical coal, an issue like JRCC with a P/E of approximately 6 looks significantly more attractive. For China exposure, BTU, which exports metallurgical coal to China, is likely the best play and trades at a very reasonable P/E of just over 15.
    While technically WLT appears to have “broken out” recently, the stock is now significantly overbought from an RSI and/or stochastic perspective. This stock is very much due for a near-term pullback on this basis. If earnings disappoint from Peabody and particularly from Walter itself this week, that correction could be rather severe given how crowded this particular trade has become. WLT is an attractive fundamental issue, but relative value has become excessive. 
    This article is a reflection of my opinions and analysis and should not be construed as an investment recommendation. You must evaluate for yourself what investments are appropriate given your individual circumstances.
    Disclosure: Short WLT
    Tags: WLT, KOL, BTU, MEE, JRCC, ANR, FCL
    Jul 19 03:40 pm | Link | Comment!
  • A Week of Irrational Exuberance

                    We saw a sharp rally last week in the major indices, including a nearly 60 point run in the S&P 500 index. The explanations for this sudden and sharp rally are many, but three in particular seem to stand out: 1. Meredith Whitney’s “change of heart” relative to the banks, 2. the invalidation of the head and shoulders pattern as a result of a break above the neckline at approximately 893 in the S&P, and finally, 3. better than expected earnings and economic indicators. However before we all join the stampede of the bulls, I think it is necessary to deconstruct some of these “bullish signals.”

                    Let’s start with Meredith Whitney’s comments on Monday. She was bullish on the financials in a “trading call” as a result of the wave of mortgage refinance that would benefit traditional banking and corporate debt issuance that would benefit I-Banking. Meredith felt that BAC was the cheapest bank from a tangible book value perspective. She was particularly enamored with Goldman Sachs. These positive comments created a strong run in the financials on Monday and Wednesday, leaving the XLF up nearly 10% on the week. Yet Whitney was not altogether bullish on the banks, as she stated this was a trading call, and ultimately credit losses, unemployment, and a weak consumer would catch up to the banks. She believed unemployment would peak north of 13%, which banks would not be prepared to deal with.
                    Technical analysis has played an increasingly larger role in the markets as of late given the erosion of confidence relative to the accuracy of any forward estimates of fundamentals. While we could argue how accurate analysts have been historically at predicting future earnings, it is fair to say that in the midst of this crisis the challenge has been harder than ever to accurately predict where the next quarter’s earnings will fall. As a result the markets are increasingly reliant on technical signals to indicate directionality. We had a strong head and shoulders formation in the markets with a left shoulder formed in May when the S&P rallied to 930 and then fell back, a head when the S&P rallied to 950 in June and fell back, and a right shoulder formed by a second rally to 930 in later June. When the S&P plunged through the neckline of the head and shoulders pattern at 893, many expected the markets to collapse to 800-850. A break back above the neckline invalidated this pattern and caused short covering and a rapid spike in the market. Contrarians would tell us this should have been expected given how many institutional investors became bearish all at once. Where we go from here technically is tough to say. Some believe that we will challenge the 950-956 level in the S&P (June highs) and if we can get a break of those levels we will rally. The more bearish side believes we are simply forming a second right shoulder or even a “double top” which will throw us back into the abyss should we not break through the aforementioned levels. Given the real fundamental concerns that still exist, and did not meaningfully change since last week, I am not of the camp that we move meaningfully above those levels and rally to 1000 or so as the bulls would have us believe. As for early next week, we are likely to see at least some degree of correction off this impulsive move to correct overbought conditions. Friday represented a doji day in the markets, which during a trend generally suggest the likelihood of at least a near-term reversal. Whether this reversal is a quick small drop to correct overbought conditions during an intact uptrend, or something more meaningful remains to be seen.
                    We are also told that this rally was the result of earnings beats and better economic news. I find this contention strange when we were told by the financial press last week that “cost cutting alone will not be enough this quarter.” Earnings were a mixed bag this week, they certainly were nothing to be gleeful over, and many companies that did beat on EPS missed on revenues or experienced only tepid revenue growth. Intel and Goldman Sachs did post some good quarters, to be fair, but the rest of the major reports were not nearly as positive. Over in techland we saw Intel beat, we saw Dell warn, Xilinx miss, and Google beat but foreshadow a less rapid growth than had been seen in the past. Importantly on the industrial side we saw GE rather substantially miss on revenues. Outside of Goldman, the banks were not a positive picture, regardless of the spin to the contrary. JPMorgan posted nice results, but mostly as a result of their I-bank performance, whereas traditional banking at JPMorgan saw increasing loan loss provisions and expected consumer/commercial defaults. Interestingly we also had the new Prince of Wall Street, Jamie Diamond, warn over what would be a mess in the regional bank space. Citigroup had a beat, but only as a result of selling their Smith Barney unit to Morgan Stanley. Were it not for this one time gain, Citigroup would have been deeply in the red and more importantly Citigroup saw declines in a myriad of business groups leading this skeptic to question Citigroup’s long term sustainability. Bank of America beat earnings, but BAC also beat as a result of onetime gains including the sale of a stake in China Construction Bank. Were it not for onetime items, BAC also would have been in the red. The seemingly ever optimistic Ken Lewis from last quarter was also a bit more down to Earth on this earnings call, indicating that it would be difficult to see profits in the second half of 2009. Of course as is the case over at JPMorgan, Bank of America and Citigroup also saw rising loan loss provisions. Interestingly we also saw BB&T, the darling of the regional bank space and a bank which did pay back the TARP, miss on EPS and indicate that they did not anticipate the extent of loan losses which were experienced this quarter. Regional banks suffered as a result on Friday with the KRE down over 4%. Some more optimistic analysts would tell us that the rate of increase in these loan loss provisions appeared to be slowing, that oft touted 2nd derivative positive, but I would be highly skeptical of such optimism given the rising tide of unemployment. While Larry Kudlow might insist that “even a banker can make money with an upward sloping yield curve,” that would appear not to be the case unless that banker has strong capital markets and investment banking functions to offset losses in traditional banking.
                    Over on the economic front we also had CNBC parading out the “better than expected” results. Unemployment initial and continuing claims dropped on Thursday, somewhat unexpectedly, particularly on the continuing claims side, but we also had the Department of Labor warn that these apparent better than expected results may be due to seasonality and technical factors which may result in an increase in the numbers later in the summer. Housing starts were positive as well, but this result is also somewhat suspect as this may be due to both seasonality and a rush to lock in the Obama first time home buyer credit that will expire later this year. The Philly Fed manufacturing number on the other hand was rather unexpectedly negative, bringing into question the notion of growth on the industrial side of the economy. These results may portend something positive, but we also saw “better than expected results” in May on the unemployment side, only to get an unexpectedly worse number for June unemployment. The May results sparked a rally that was quickly given back after the June unemployment read. The healthy skeptic should view these possible green shoots in that light.
                    Only one week into earnings, Goldman and Intel positive earnings results, the comments of one rather noteworthy analyst, the invalidation of a technical pattern, and some possible green shots caused a sudden and sharp rally in the markets. There is ample reason to be highly skeptical of this impulsive move. Earnings quality, particularly from the banks, has not been impressive and real revenue growth has yet to be seen. Economic data has been somewhat contradictory and it is too early to call a meaningful improvement in economic conditions due to at best the possibility of 2nd derivative improvement.

    Disclosure: Long FAZ

    Tags: SPY, FAZ, SDS, BAC, BBT, KRE, XLF, GS, C, GE, INTC, XLNX, GOOG, DELL, JPM, SKF
    Jul 18 04:37 pm | Link | Comment!
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