Tom Armistead's  Instablog

Back in July, I wrote an article suggesting the use of NIPA Corporate Profits as a yardstick for measuring the level of the S&P 500 index. NIPA stands for National Income and Product Accounts, one of which is Corporate Profits. The US Bureau of Economic Analysis – BEA – includes this number as a sub account in GDP, and as such it is logically consistent with GDP.

At the time, with the S&P at 950, Corporate Profits suggested that a more normal level for the index would be 1,200. As the situation developed, the S&P has since made substantial progress closing the gap. Today's revision of GDP updates Corporate Profits through the end of the 3^rd quarter, and it is now possible to develop a revised target or normal level for the S&P based on the new information.

Here are updates of two charts: the first plots the two sets of data over time; the second is a scatter chart which derives a formula for the S&P as a function of Corporate Profits.

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Ben Graham has become associated with a tangible book style of stock picking, where the investor looks to physical assets, particularly cash, for value and margin of security. While he was fascinated by the market inefficiencies that made it possible at times to buy real companies for less than net cash, he also was also aware of the merits of what he called “goodwill giants.”
 

From “The Intelligent Investor,” here is a brief discussion:
 

...here we found – contrary to our investment philosophy – that companies that combined major size with a large good-will component in their market price did very well as a whole in the 2 1/2-year holding period. (By “goodwill component” we mean the part of the price that exceeds the book value.) Our list of “good-will giants” was made up of 30 issues, each of which has a good-will component of of over a billion dollars...the group...acquitted itself best among the 20-odd lists studied.
 

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MBIA (MBI) recently filed an 8-K with the SEC, explaining its current situation with regard to the availability of tax refunds under the recently enacted 5 year NOL carryback provisions.  I have read it over several times and I am still scratching my head in puzzlement. 

Here is a link: http://www.sec.gov/Archives/edgar/data/814585/000115752309008138/a6102877.htm 

From the conference call I knew that they have approximately 500 million of available tax refunds under the new law, but for 2008 they were not in an NOL position, while 2009 to date had a small NOL. 

Now it develops that under section 382 of the IRS code there are limitations on NOL carrybacks, based on the increase of the aggregate ownership of 5% shareholders over a three year period.  As of 10/31, this increase stood at 43%, and if it goes to 50% by the end of the year the NOL can't be utilized. 

Meanwhile, certain shareholders have notified the company of increased positions, while others have notified the SEC of decreased positions.  Looking at recent filings, Third Avenue Management filed an SC 13G reporting their ownership was well under 5% as of 10/31.  It had been substantially higher.  

Finally, MBI still has 115 million on their share repurchase plan, and could buy shares at any time, which could push the increase in 5% ownership over the top.  Or they could do a rights offering or take other actions in an effort to preserve the tax benefits. 

I thought it was so simple, the company could just jack up their losses, buy back a heap of undervalued shares, then fund the purchases by getting a tax refund. At recent prices, they could buy back 30 million shares, enough to soak up most of the short interest and set the stage for a wonderful short squeeze.  Sadly, it doesn't work that way.   

Disclosure - long MBI

Cobra Electronic (COBR) is now entering a crucial period where possible risk/reward is heightened. I wrote the stock up favorably in December last year at 1.10, setting a target of 7, citing the combination of low p/b and a real business with some brand name recognition. Cobra makes radar detectors and CB radios, and has developed AURA, a verified data-base of speed and red-light cameras worldwide.

Trading as high as 1.65 following 3^rd quarter earnings, the company is at a crossroads, suffering financial stress in the form of breach and waiver activity on its loan covenants, but offering potential rewards from a recovery in its business. The 3Q 09 conference call included a statement that Cobra has executed an agreement with a major manufacturer of mobile phone and navigation products to include the AURA data-base in selected North American and European products beginning early next year. This is expected to be launched and announced early next year. Revenue from the deal is expected in the 2^nd half of 2010.

On the breach and waiver, COBR was not in compliance as of the end of the 3^rd quarter. They expect to be in compliance with their existing covenants at the end of the 4^th quarter, and as of the conference call they had agreed to a waiver with fee, but did not modify their credit terms as they expected to be able to comply with what they have.

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U.S. Financial Institutions are interconnected – as the fall of Lehman demonstrated, they are tied together and interwoven in a complex web of obligations which can rip, run or unravel with unexpected consequences. As such, they may be regarded, for analytical purposes, as having one balance sheet. Double entry bookkeeping, which underlies all GAAP accounting, suggests that assets should equal liabilities for this giant composite balance sheet. I doubt that it does. The purpose of the article is to raise questions on two areas that do not seem to add up, and suggest that exploring these relationships would be a good task for the systemic regulator.

Derivative Assets and Liabilities – Five large banks together constitute the bulk of the U.S. Derivative market. The nature of the derivative transaction is such that each position has two sides, an asset and a liability, which will be on the books of the counter-parties. While numerous hedge funds and other bit players add complexity to the picture, it is evident that collectively derivative assets should equal liabilities for the banks involved, since a majority of the trades eventually make their way back to the largest players.

 

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Many pundits have opined that the American consumer is on the ropes, so far in debt that he will be unable to contribute to the economic recovery. Because consumer spending has recently been about 70% of GDP, this has led many to declare that the recovery cannot proceed until a lengthy de-leveraging process has been completed. Factual information is available to assist in quantifying this concern: here is a link to the Federal Reserve's Household Debt Service and Financial Obligations Ratios. After downloading and studying this information, a plausible case can be made for the possibility that this process can be completed in a one or two year time frame, after which a strong and sustainable economic recovery would be possible.

The household debt service ratio - DSR - is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt. The Fed provides information going back to 1980, so it gives us a look at a number of troughs/recessions which preceded strong recoveries.



How much debt is too much? - The average ratio from 1980 to the present is 12.06%, with a max of 13.90% in 3Q 2007 and a min of 10.60% in 1Q 1983. My impression, after eyeballing the data, is that a DSR of less than 11% is optimal as a prelude to a strong economic growth spurt. Consumers are not over-extended and can safely handle more debt and drive the economy. This condition was present in the early 80's and again in the early 90's, when strong recoveries resulted. In the early 2000's and subsequent, DSR was not meaningfully reduced, which may be attributed to the extremely lenient monetary policies in place at the time. Very possibly this de-leveraging was not avoided but only deferred, and is taking place now.

DSR as of 2Q 2009, the last data point available, stood at 13.11%, and has been declining since the high of 13.90 % in 3Q 2007. Is it possible for DSR to be brought down as far as 11%, and if so, how long would that take? How about 12%, a little below average?

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