3 Good Reads Daily, February 2012

02/24 Natty: Game changer
02/24 Madoff: In Japan
02/24 ECRI: Still looking 4 recession

02/23 Avg household: Retail spend
02/23 Mergers: Driving up health care cost
02/23 Hedge fund assets: Record

02/22 Sears: Crash and burn
02/22 Euro carry trade:  Tired
02/22 Unemployment: Going higher?

02/21 Rich people: Walking away from Mortgages
02/21 Greece: Risks loom large
02/21 Military budget: Out of control

02/17 Austerity: Not working in Europe
02/17 Austerity: Crushing Spain
02/17 Austerity: Destroying Greece

02/16 Fear: Keeping inflation in check
02/16 Liquidity:  Jacking world financial mkts
02/16 Energy: Independence within reach

02/15 Bulls:  Less of them
02/15 Factory output: Up, again
02/15 Apps: 50 Best

02/14 Iran: Declares war on Dollar
02/14 Distressed Debt Conf: Day 2
02/14 Distressed Debt Conf: Day 1

02/13 Mitt: Will say anything to get elected
02/13 Funniest stuff: On the internet  
02/13 FT: Case for strong dollar

Early Feb: Focused on other stuff

JANUARY

Tom Keene, Ken Prewitt - Winning

I abandoned CNBC a few weeks ago.  Got tired of the infantile humor,  and lack of tradable business news reporting.  A few weeks later,  I am regretting that decision ... deeply.  I regret that I didn't do it sooner!

What happened?  I discovered Bloomberg Radio ... Tom Keene and Ken Prewitt, 7 - 10 am.  Holy moly,  what a useful financial tool.   These two guys are financial industry rock stars.  Their line-up of guests are FAR superior to anything CNBC serves up.  Their questioning of guests is far more astute.  And they actually allow guests to talk, in-depth!  The useful and informative business related news is overwhelming compared to the crap I got used to on CNBC.

Bloomberg Radio.  Tom Keene and Ken Prewitt.  These guys are must listen.  Period.

Apple kicks "Open Source" in the teeth

I'm young enough to remember that huge "Open Source" investment theme that reigned supreme in the 90s.  Every computer hardware and software company on earth declared that the only path to success was opening up their product development to third parties.  The theory was that you develop the base code,  then allow a very large audience of companies to develop and sell snap-on products that work in conjunction with your product.  As it turns out,  Apple is proving that "open source" was not the path to wild success.   Although it's taken two decades to play out,  keeping their operating systems proprietary has been a key competitive advantage to Apple that wound up minting them money.  Who would have thunk it?

Why has a proprietary system worked so well?  Apple's products just plain work well with each other.  That's because Apple controls all aspects of the code for these products,  without possible conflicts arising from 3rd party developers.  More importantly,  with only one finger in the development pot,  their code stays more secure. 

Contrast this with Microsoft.  Third party Windows developers have layered on so many demands to the Windows system that Windows computers are constantly taking up compute and internet connection time looking for vendor updates.  That bloat and complexity causes the Windows system to run appreciably slower,  and take far longer to just plain boot up.  And those blue screens of death so common in Windows?  They are mostly from bad 3rd party developer code on some errant piece of hardware or software riding on the Windows system.  Those problems just don't occur in Apple.

The Apple lesson?  Keep it in-house,  and under your thumb.  Control quality and don't rely on anyone you can't control.  In the long run, this tight control maximizes profitability.

Sitting on record cash

I'm not posting much.  Been far too busy selling down my long positions over the last couple of weeks.  Am now sitting with 75% cash.  And with hedges,  am net neutral the mkt.  I'm not betting either direction.  Just sitting and watching.

This is the first time since 2008 that I've been neutral. I can now walk away from the market and not give a damn what happens.  And I haven't been in this position for so long,  I forgot what it felt like.  It feels,  well,  liberating.

CNBC - kicked to the curb

I am close to completely cutting the cord on CNBC.  Bloomberg is now my main source of information throughout the day,  both radio,  and TV.

When I started trading full-time over 13 years ago,  CNBC was a must watch.  And I had it on constantly.  It was a source of valuable business and economic news.  But over the years,  CNBC has floated away from the niche of serious traders and investors,  and worked its way into serving as THE VIEW for couch potatoes.  It's become a mix of mindless entertainment, jokes, silliness,  with a minimum of business news thrown in the pot.  It's aimed directly to the Mom and Pop investor,  and old, retired people with nothing better to do during the day.  But behind the trading screens,  it's viewed as trash TV.

How did CNBC's decline happen?  Well,  Mark passed away.  Ron left.  David moved to a meaningless time slot.  We (the trading community) were left with incompetence in the important pre-trading time slot of 6 am - opening bell.  Joe Kernen,  who's stupidity was masked by Mark, Ron and David,  wound up coming front and center.  CNBC's decline rapidly followed.

Joe is a clown.  He imparts nothing in the way of useful information.  His childish jokes are pathetic. His constant stream of sarcasm only serves to distract.  In fact,  if a serious discussion breaks out in Kernen's presence,  you can count on Joe to destroy the momentum with a childish joke.  It's his way of deflecting his inability to moderate any type of serious discussion.  Joe Kernen has destroyed CNBC's credibility.

Kernen's insolence is especially annoying when it comes to politics.  He's a rabid Republican who doesn't miss an opportunity to bash Obama and push his right wing beliefs down viewers' throats.  Its a constant, consistent drone of politics,  on what should be a business news channel. If we wanted politics,  we'd watch FOX.  We want business news.  We're served a big plate of right wing conservatism via Kernen.

Even more annoying is Joe's halting,  stumbling,  stammering, stuttering, long-winded delivery style. It takes forever for Joe to ask a question.   And more than often,  Joe doesn't ask questions.  He expresses opinions and asks for confirmation.  And then he's quick on the draw to interrupt guests when there's even a hint of direction away from Joe's firm political beliefs.

Recently,  CNBC brought in Andrew Sorkin as a balance.  It's not working.  Joe's treatment of Andrew is embarrassing to watch.  Andrew is a meek,  mild person.  He's easily pushed around.  Joe doesn't miss an opportunity to put Andrew down,  and layer on the sarcasm when Andrew gets on a roll of departing informative news to the audience.  Andrew just takes the insults. Unfortunately,  that encourages a constant stream of Kernen sarcasm thrown in Andrew's direction.  So Andrew's expertise is wasted.

I'm not the only person noticing this decline.  It's obvious to the big names in the business world as well.   Notice how the quality of the guests on CNBC has dramatically declined of late?  They're all over Bloomberg radio and Bloomberg TV in the morning.  At Bloomberg you'll find short,  concise questions,  followed by a period of guests talking uninterrupted.  You hear useful news and opinion (of the guests) on Bloomberg.  There's nothing but trash on CNBC.

It's been tough to cut the CNBC cord,  simply because CNBC has been there from the beginning.  But Bloomberg is a vast improvement.  I'm constantly amazed at the quality of the guests,  the usefulness of the information,  and it's simply a breath of fresh air after listening to that idiot Kernen.

Bloomberg,  Radio and TV.   It's what CNBC used to be.

The open policy at the FED is a huge mistake

Put me down as someone who is not at all happy with the sunshine policy at the FED.  The Bernank opened the curtains wide.  Unfortunately, its only served to put a dysfunctional FED on display.  People don't like hearing their leaders constantly bickering in the open. Case on point?  The debt ceiling debate in Washington DC last August.  Eric Cantor's stupidity led to $2.4 Trillion in wealth being wiped off the map.  Our leaders need to debate among themselves,  behind closed doors,  then come forward with a uniform agreement as to direction.  What's happening now only serves to create an environment of unnerving uncertainty and volatility.

What bugs me the most?  I'm just damn tired of hearing Dick Fischer blast Ben Bernanke.  Dick is a clueless dolt.  This is a man who laughed at length in the 2006-07 meetings at the references to trouble in the housing market.  He laughed,  while housing,  and our economy,  tanked hard.  Dick just needs to shut the hell up and keep his opinions out of the public arena.  We're tired of hearing open debates at the Fed.  We're tired of key members of the Fed voicing widely divergent opinions as to what the Fed should do.  ENOUGH.

Ben needs to put a muzzle on the mouths of the individual members of the FED.  The sooner,  the better.

Addendum - A day after making the post above,  Steve Liesman came to screen on CNBC with a report that the major trading houses are complaining to the FED about all the mixed signals. They are complaining that the FED's new policy of openness is making it worse, not better.   So,  it appears I'm in good company.   We ... traders ... are just damn tired of hearing the FED go in an infinite number of directions with their opinions.  We're tired of their sniping and criticism of each other.  We don't need to see the hot dogs being made.  Do it behind closed doors.  Make us believe you know what the hell you're doing.  But,  as it stands now,  you have us wondering if our economy would be better off if guided by Larry, Moe and Curly.

CYT review

Latest 10-Q
Transcripts from latest earnings call

I'm attracted to CYT for a couple reasons:

1.  Looking for opportunity to leverage off abundance of Nat Gas in the US.  Chemical companies are the natural play.  Nat Gas is a major cost line.  Lower Nat Gas costs should lead to higher profit margins in the future - provided they have not traded away this advantage by entering LT supply contracts at fixed prices,  or entered unfavorable hedging contracts.

2.  CYT's Engineered Materials segment will benefit greatly from the ramp in Aerospace of the use of composite materials ... especially BA's 787.

I looked at the latest Q,  and read the transcripts from CYT's last earnings call.  I will carefully review the upcoming filing of the K in a couple weeks.

Some observations:

• Big ramp in EPS this last quarter is misleading.  Almost all of it is coming from price increases.  None of it is from higher sales volumes.  And the segment where greatest growth is expected,  Engineered Materials,  saw minimal price increases.
• While they had hedged Nat Gas in the past,  they halted that process in late 2011.
• I have not yet been able to determine how important Nat Gas is to their operations.
• The stock has ramped big off these latest results.  It appears to now be fairly valued on an EV/EBIDTA basis.
• I might be barking up the wrong tree in terms of CYT being a beneficiary of lower NatGas prices.  It appears that propylene is one of their main raw material inputs.  It is tied to oil prices,  not NatGas.
• Bottom line - wait, watch.  Maybe grab some if it gets a 15 - 20% selloff from current prices.  While maybe not a good play on lower NatGas,  it's a backdoor on Aerospace growth.

US returns lag the world

Since touching a near-term low last Oct 3,  returns around the world:

2011 was just, well, OK

A little over a year ago I was taking a look back at the financial results of 12 years of trading:

__________________________________________________


POST FROM OCT 2010:

12 years ago I started trading full-time. It was Oct 1, 1998 when I resolved that I was going to spend all my efforts making a living at trading. Those were heady days, coming off the Russian debt crises and headed into the go-go years of the dot.bomb era. I used to freak out when my I lost more than a thousand a day. And I mean really freak out. That was huge money to me back then. Connection to my on-line accounts was through a 14.4 baud modem. And a single, 12 inch screen served as my window to the financial world. I shake my head in amazement at how the tools and access have changed, and that I even lasted this long.

As I was updating my account tracking this morning for end of quarter results, I was thinking back to those early days and comparing my capital base today with what I started with 12 years ago. I've grown my capital 11.5x over 12 years, after tax, and after draw down for living expenses. What is that? A 1153% return? The number is so big that even I get confused trying to turn it into a percentage. That's about a 23.5% annual (after-tax, after living expenses) return on capital. Over these 12 years, the S&P 500 has gone up 40.7%. That's about a 3% annual return (pre-tax and no living expense draw down). I crushed the overall market's performance, by at least 20 percentage points a year, over a 12 year period, significantly more if I throw back into the pot all the taxes and living expenses (which I unfortunately didn't track).

This morning I'm filled with a tremendous sense of satisfaction. A peaceful calm has come over me. I survived:

• The Russian debt crises
• The dot.bomb debacle
• Two huge recessions
• 9/11
  
• A moron's presidency (George W Bush)
• Two wars
• A doubting wife
• A heart attack (seriously, they hurt)
• The collapse of our nation's financial industry
• and, the Real Estate bubble of a lifetime

I got here by an ever changing approach to trading:

• Shorting lock-up releases
• Mo-mo investing
• Russell Index front running
• IBD 100 front running
• Aero specialization
• Day-trading the stochastics of SSO and SDS
  
• The lazy man carry trade

I don't have a clue what's in store for the next 12 years. But I really hope to be sitting behind a computer then too and reflecting on those 12 as being just as successful as the previous 12. And if I can get though the next 12 without another heart attack, I'll be especially grateful. Trading's a tough business. It's immensely stressful, at times. But I wouldn't trade it for anything else in the world. I love what I do.

Today's a day of celebration. I'm taking the day off. I'm celebrating 12 years of survival through stressful times and coming out the other end alive and significantly better off financially. I'm going to do something fun. I'm going to find something to trade, something other than a security.

I'll probably go trade silly bands with my neighbor's 5 year old child.
_________________________________________________________________

I wish the 13th year (2011) had been better. But given the fact that it was the unlucky 13th year,  and I am extremely superstitious,  it makes common sense that the year wasn't great. It wasn't bad, but nothing to write home about.  It was largely a continuation of The Lazy Man Carry Trade.  Leveraged up to my eyeballs,  I sat in high yielding,  leveraged,  equity and debt,  closed-end funds.  AWP, CHW, CSQ, EAD, ETG, ETO, EVT, HIX, HYT, IGR, MVO, UTF, UTG were my main investment vehicles.   Paying only 1.25% on money borrowed,  I banked dividend payouts of 7 - 10%.  So,  this carry trade made sense.

And I made my share of decent trades other than just sitting back to collect dividends.  I booked some major gains by bailing on a large slice of my MVO position near its peak on the year.  And I traded in and out of more than a few names to scalp gains here and there.

But,  I failed badly on two fronts.  I failed to accurately read the overall market trend.   The market hit its high in the spring,  and I didn't trim.  In late summer,  when problems erupted over the budget debate in Washington DC,  I stubbornly rode my positions down and gave back serious gains.  While I added some into the fall weakness,  it wasn't near enough.

One of the worse issues I faced though was a failure in investment thesis.  I thought 2011 would be the year that interest rates would rise,  that inflation picked up,  and that equities would start a major move higher.  I therefore trimmed back on debt positions,  added greatly to real estate positions,  and layered on interest rate hedges.   I got killed when bonds rose,  real estate tanked,  and interest rates fell through the floor.   I wound up with major losses in TBT and AWP.  And I missed the run in my debt funds.

I did have luck on my side.  My savior,  pulling my year out of the fire,  was a little jewel of a micro-cap in which I have 10% of my capital parked - EDAC.  Its a nice little company in the Aero industry.  I have followed this industry closely for years,  trading in and out of names like LMIA, TGI, CVU, DCO, TDG and EDAC.  My EDAC position though has been a LT hold.  I've been in the stock for years,  and it paid in spades in 2011.  EDAC moved from $4 to $11,  banking me serious coin.  Sometimes,  it really does pay to have lady luck in your corner.

Still,  it wasn't a bad year.  I wound up making a 1% return on my capital.  Not allotting for taxes and draw-downs,  my real pre-tax return was in the 10% range.  For the year,  the market was flat,  and the average hedge fund lost about 4.5%.  So,  I was 10% above the mkt,  and 15% higher than the average hedge fund.  So,  not a bad year,  but not my norm either.

That did however,  drag down my historical 23.5% annual return coming into year 13.  It now sits around the 21% range.  BUT,  that's after-tax,  after draw down for living expenses.  So,  its normal for me to be making 30%+ returns.  So from that perspective,  2011 was not a good year.  

My taxable income was significantly higher than my return on capital because I was still booking gains carried from 2009 when I returned north of 60%.  And I had major living expense draws to pay college bills for a child,  continued to furnish our new home,  paid expenses on a property swap,  and pulled off a more than minor kitchen upgrade project.  So,  all in all,  I'll take a 1% growth on my capital after all those costs,  and in a year where the overall market was flat.  I should have done better though.

A look at returns around the world in 2011:



2011 is in the history books.  It's on to year 14 ... and better times ahead.

Think you pay 15% tax on LT Capital Gains? Pfffttt, think again.

Mitt Romney's disclosure of his massive income and sub 15% federal income tax rate has opened eyes to the inequity in our income tax code.  How did Mitt pay so little in income taxes?  The 15% tax on LT Capital Gains helped.  That,  teamed with having most of his income classified as "carried interest" which gets the 15% LT Capital Gain tax treatment. But about that 15% rate,  it doesn't apply to you. It's not for minions. It's only reserved for the super-rich, like Mitt.  The LT Capital Gain rate you pay is likely 40% higher than what Mitt pays.  Don't believe me?  Read on.

Let's just cut to the chase.  If you have appreciable LT Cap Gains,  and your taxable income is between $150 and $464 K,  then it's highly likely that you are caught in Alternative Minimum Tax (AMT) hell.  And that's where the lies about the 15% tax on LT Capital Gains begin.  If you're in AMT,  you're paying 21-22% on your LT Capital Gains.  Yes,  I know,  you'll read in IRS literature that the 15% rate applies in AMT.  And it's also likely that you'll find more than a few naive CPAs around who will advise the same.  But that's just not the case.

The culprit is the AMT exemption.  It acts as a credit that reduces the AMT tax owed.  But,  if you're married filing a joint return,  for example,  your $72,450 exemption starts phasing out once your income exceeds $150 K.  For every dollar of income,  you lose 25 cents of the exemption.  It's the increase in taxes by virtue of losing a portion of this exemption that causes the tax on your LT Cap Gains to rise above the 15% rate.  In other words,  by having those LT Cap Gains,  you're losing some of the exemption, and that causes your AMT tax to rise.  The math is more clearly explained here. And there's more information here about the exemption amounts and where the phase-outs start,  based on your filing status.

And if you still don't believe me,  then there's an easy way to test it.  Plug your return into TurboxTax.  Override and change the LT Cap Gains number and watch how it impacts the tax you owe.  If your income is between $150 and $464 K,  and you're in AMT,  then you're going to find that changing your LT Gains by $1,000 causes your tax bill to ramp by about $220.

The bottom line is this,  you can find yourself in a situation where both you and Mitt own stock in Apple.  You both bought and sold the stock at the same time,  recognizing the very same gains on each share sold.  Although your total taxable income is but a very small fraction of Mitt's,  your federal income tax on that Apple gain is 40% higher than what the super rich Mitt Romney had to pay.   Direct your thank you notes for this inequitable situation to your representatives in Congress.

There's a trade to be made here though.  It's likely that our tax rates will change appreciably in 2013.  Capital Gains tax will likely go up and investors left and right will rush the exit at YE 2012 to lock in the supposed 15% rate.  That forced selling should send the market lower.  And it will be an excellent time to buy.

But here's the important point.  Don't be a sucker and necessarily join the crowd in the selling spree.  Chances are good that the Cap Gains rates will only be raised to 20%.  And as this article indicates,  that would actually represent a tax cut for many,  especially if other changes wind up reducing the impact of AMT.   So,  pay close attention to your own personal tax situation,  and the change made not only to LT Cap Gains rates,  but also to how AMT is determined.

Why is this situation so unfair?  Well,  look at the statistics of who gets trapped in AMT.   Spend 5 minutes looking at this excel spreadsheet of data (latest release 2008) from the IRS.  Here are the stunning facts about how AMT winds up screwing the middle class,  to the benefit of the super-wealthy:



Bottom Line? The vast majority of AMT tax is paid by Americans with income between $200 - $500 K. And the vast majority of that arises from the 21-22% tax rates slapped on Capital Gains while in AMT. Meanwhile, the super-wealthy slide by,  paying little in AMT and only 15% on their LT Cap Gains.

Like I said, send your thank you notes to Congress. I'm only the message delivery boy. My message should be clear though ... You're getting screwed. And the Mitt Romney's of the world are laughing all the way to the bank.

World Mkts

Economy