Friday, September 25, 2009

The Best Contrary Indicator We’ve Ever Seen


Every day our inbox contains at least one missive packed with seductively scientific jargon professing to predict the future of the stock market.

This jargon is known as technical analysis, and it is appealing to many investors thanks not so much to its proven worth, but to its relative air of exactitude and certainty, what with precise levels of “support” and “resistance” and the like, not to mention comforting equations of logic: “If the market does this, it will do that…but if the market does that, it will do this…”

Technical analysis also has a solid place in the history of our business. After all, as a chartist once pointed out to me, before the SEC came along and companies had to file regular earnings reports, about the only way anybody could look at what was going on at a business—aside from inside information—was to look at patterns of accumulation and distribution by those insiders via charts and “tape reading.”

And sometimes it really works.


In the early 1980s, while a junior number-cruncher in the Merrill Lynch oil group, a man came bursting into our offices one morning waving a chart-book opened to the page of a dull, overlooked company whose stock had suddenly come to life.

The man was Chuck Setty—a chart guy who worked with the legendary Bob Farrell—and the stock was Marathon Oil.

“What’s happening with Marathon?” Chuck asked my boss—who was one of the all-time great sell-side analysts, but a firm believer in the sanctity of data as opposed to charts and graphs and 50-Day Moving Averages.

“Nothing,” my boss said. “The stock is up a little. So what?”

“So this,” said Chuck, showing us a chart of the stock, which was solidly rising in an otherwise languid oil tape. He then circled with his pen a massive rise in volume running along the bottom of the chart. “Somebody is buying a lot of it,” he said.

That “somebody” turned out to have been an oil company by the name of Mobil.

A few days later, Mobil announced an $85 a share tender for control of Marathon, and I signed up for a course in technical analysis at The New School.

Hey, even Warren Buffett was into charting early in his career.

Over time, however, I have come to believe, like Buffett, that staring at charts often gets in the way of finding good, inexpensive businesses to buy—and bad, overpriced businesses to sell short.

In particular, wallowing in the day-to-day ups and downs of the market as a whole, the ups-and-downs of which only get magnified by the CNBC Talking Heads, has zero to do with getting prepared, as Buffett would have all good investors be, for those rare occasions when opportunity presents itself in individual stocks.

Indeed, such wallowing tends to reduce the likelihood that one will take advantage of those occasions.

Witness these actual excerpts from actual emails received during the course of one of the biggest stock market rallies in history:

March 16, 2009

The overall technical trend for the major equity market averages remains down, and there are no major bases in place yet. New lows for the averages were confirmed by new lows in the NYSE advance-decline line and consolidated tape on balance volume as well as by deterioration in our Volume Intensity (VIM) and VIGOR models.

March 31, 2009

Technically, SP500 futures' failure to hold 780 will target 767 (38.2% retracement)-764 (filling of gap) as next major support level (per P Dauber).

September 1, 2009

Technically stocks are doing damage here (breaking under 1015 support from last week, breaking under 1010 20day MA….recall JPMorgan’s M Krauss is looking for a close below 1013 to confirm pullback to ~980). 1000 on the sp500 being watched closely today….


All wrong, and all completely overlooking the fact that on any given day, there are stocks to buy and stocks to sell, regardless of whatever a market average is or is not doing.

But we here at NotMakingThisUp write not to bash chartists or their tea-leaves.

Indeed, whoever was paying Chuck Setty-like attention to the option activity in Perot Systems in the days leading up to Dell’s desperately uneconomic bid for that company would have seen something happening—thanks to what appears to have been some good old-fashioned inside information going around according to a newly reinvigorated SEC.

Whoever acted on those price and volume patterns in Perot Systems—like Chuck did, back in the Marathon Oil days—would have made some dough.

And making dough, rather than predictions, is what this business is about.

But instead of worrying about the 50-Day or the 200-Day or the Green Line crossing the Blue Line, we suggest a different market indicator.

In fact, based on past performance, we think we’ve stumbled across the best possible indicator of all: what the apparent knuckleheads in charge of handling cash flow at America’s largest companies do with their cash.

And what they do, it seems, is this: they throw it out the window.

Well, not in an actual physical sense, but they might as well, for they seem to buy their own stocks back at exactly the wrong time, and then they proceed to not buy their own stocks back at exactly the wrong time.

Here’s the story, courtesy of the indispensible StreetEvents:

S&P 500 stock buybacks hit record low

Standard & Poor's announced that S&P 500 stock buybacks have fallen to their lowest level since the first quarter of 1998 - when Standard & Poor's began tracking the data.

According to Standard & Poor's Index Services, preliminary results show that S&P 500 issues spent $24.2 billion on stock repurchases during the second quarter of 2009, representing a 72% decline from the $87.9 billion spent during the second quarter of 2008, and an 86% decline from the record $172.0 billion spent on stock buybacks during the third quarter of 2007.

All this, of course, turns the old theory of technical analysis on its head: insiders should be buying not at the top, but at the bottom, and selling the opposite way. And in the old, pre-SEC, pre-Beat-the-Number-by-a-Penny days, pre-Dilutive-Stock-Option-Grants-Up-The-Wazoo, that might have been the case.

But not, apparently, any more. Nowadays, Bulls should keep a wary eye on corporate buybacks.

And Bears, it seems, should rejoice.


Jeff Matthews
I Am Not Making This Up


© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

Tuesday, September 22, 2009

So, What’d They Say?


So what, exactly, did FedEx say on the conference call last week?

Well, Fred Smith, the genius who started the whole thing, began the call with his standard overview of what’s happening and what he sees ahead.

In the previous quarter—ended in March—the best Smith could say was this (courtesy of the indispensible StreetEvents):

While the severe global recession continues to throttle somewhat FedEx's growth, we do see signs of stability as the rate of decline appears to have leveled off. In this regard, declines in FedEx Express International shipments appear to have bottomed and are at levels similar to last quarter. How long this bottoming out process will take and how strong the recovery will be remains of course uncertain. We believe however, the worst of the recession is likely behind us.

We remain optimistic about a turnaround beginning later in calendar 2009.

Three months later, the “bottoming out” and “rate of decline” has turned into something more positive:


Our financial performance was stronger than what we expected in June, thanks to a modestly improving global economy, strict cost management, and solid execution of our strategy. During the first quarter of FY '010, FedEx Ground and FedEx Freight noted positive month-over-month volume trends. Compared to the fourth quarter of fiscal year 2009, our International Priority volume at FedEx Express showed positive sequential trends.

These are encouraging signs of a more stable economy.

Still as many readers—particularly those who appear sat out the head-snapping stock market rally off the March lows—have pointed out in these virtual pages, champagne corks are not exactly blowing the lights out in Memphis.

Compared to last year, the numbers are still down—down $2 billion in revenue last quarter alone, thanks to the fact that volumes, while currently rising from the basement, have still not reached the ground floor yet, let alone the first or second floors.

And the business is still suffering from price declines “in a very competitive pricing environment.”

But FedEx was more willing this quarter than last to offer a view of the U.S., and it is one of recovery:

We are hopeful and confident as we move ahead. Forward-looking indicators such as new manufacturing orders, and the Conference Board's US leading economic index increased four consecutive months through July. In August, US factories saw their output rise for the first time since January 2008. At FedEx, we expect calendar third quarter GDP to grow about 3%, followed by roughly 4.9% growth in quarter four of calendar 2009. For calendar 2010, we believe US GDP will grow 2.9%.

More importantly, industrial production, a significant driver of FedEx's business, should improve more than 4% in 2010, a strong contrast to its 10% decline in 2009.


Here's hoping they're right.

And next up at NotMakingThisUp: The Best Contrary Indicator We’ve Ever Seen.



Jeff Matthews
I Am Not Making This Up

© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.



Tuesday, September 15, 2009

Pay Attention to FedEx, not the Fed


The most important data of the month—perhaps of the year—will be released this week.

The data will provide not only the most realistic fundamental snapshot of the U.S. economy at the moment, but a view of trends around the world.

The data are not, however, courtesy of the Federal Reserve or the Treasury Department. The data are courtesy of Federal Express (now FedEx, officially speaking), and consists of that company’s first fiscal quarter earnings and its outlook for the back half of this calendar year.

As we have pointed out in these virtual pages (see “No Haircut to the CPI Here,” from December 2005), the correlation of U.S. GDP to the index of air cargo activity is 70%.

Last week FedEx kindly provided a preview of things to come when the company pre-announced a shockingly good quarter—almost double prevailing estimates—“thanks to better-than-expected international priority volume” and cost controls.

At least one other company worth watching, Lubrizol, maker of fuel-additives—another highly economically sensitive business—joined the fray last night, raising 2009 earnings guidance thanks to “improving volume trends in the current quarter” and the ubiquitous cost controls.

Not for nothing, Lubrizol's new earnings will be an all-time record high, and more than 50% above 2007's previous high.

Coming after better news even from lowly homebuilders, we think there’s a trend—and that the trend is up-and-to-the-right.

Now, San Francisco Fed President Janet Yellen is not convinced: just yesterday she said the economic recovery would be—as nearly every economist in America is also expecting—“tepid.”

You may disagree with Yellen, as we do. Or you may disagree with us, as many, many investors, and most economists, do.

But whoever you disagree with, be sure to listen to FedEx: they know a lot more about the real world than we here at NotMakingThisUp, and they probably know a bit more than Ms. Yellen.

After all, along with their counterparts in Atlanta, they basically help make the economy run, whether it’s on the downswing or the upswing.

To hear which way things are swinging, and how tepidly they may iu fact be swinging, dial in at 8:30 a.m., Eastern Standard Time, Thursday morning.


Jeff Matthews
I Am Not Making This Up

© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.


Wednesday, September 09, 2009

Lampert Speaks…But Where’s His General Grant?


There were, until the financial crisis, two main schools of thought on Sears Holdings in the hedge fund community.

One school consisted of those hedge funds that made early, and profitable, bets that Eddie Lampert would turn Sears into a Berkshire Hathaway of the new millennium.


This school held the view that there was enormous value in Sears; that Eddie Lampert would find a way to unlock that value; that short-term earnings were meaningless; and that anyone who focused on the dilapidated nature of Sears (and K-Mart’s) stores; on the aging and coupon-clutching customer base; and the resulting, lousy comp-store sales, was missing the vast potential in Sears’ real estate portfolio.

Students of this school never actually shopped at Sears, although they may have visited the stores once in a while—like when Eddie launched a new initiative, for example (see “Wal-Mart 9, Sears Holdings Corp 2” from June 30, 2005).
And they probably wouldn’t have been caught dead in a K-Mart.

But they made a lot of money in the stock.

The other school of thought on Sears Holdings consisted of hedge funds which, for the most part, had invested in retailers over the years; knew a good store from a bad store when they saw it; and couldn’t believe the gap between what they saw with their own eyes whenever they walked into a Sears or a K-Mart versus what Sears’ hyperventilating stock price was suggesting might be going on inside those stores.

That school of thought was short Sears’ stock—and quite painfully, for several years.

Then Lehman came along, consumer spending collapsed, and the Great Leveling began in American business, separating good companies from the bad, retailers included.

And Sears Holdings especially.

Even the imprimatur of the great Eddie Lampert —and we do mean ‘great,’ with not a bit of sarcasm—combined with a billion dollars worth of share repurchases, could not hold up the stock.

Of course, as the crisis took hold and the formerly unprofitable school of thought that regarded Sears as a deteriorating pile of rotting stores—Eddie Lampert or no Eddie Lampert—began to take hold, well, the piling-on began by Wall Street’s Finest and the fickle press.

Even Barron’s—which had once published a $300-plus a share value for the business—recently jumped in, with a cover story titled “Washed Out.”

Thus it was that this weekend, in an uncharacteristic move, Lampert himself finally spoke out, in a public letter to the pilers-on at Barron’s, defending his company:

To the Editor:
The Barron's Aug. 24 article that discusses Sears and ESL Partners was misleading, inaccurate, and poorly researched. Without responding to each inaccuracy, I want to correct some of the more important misstatements and address the overall negative bias in the presentation of facts.


What exactly did Barron’s say to provoke the unusual response from the famously secretive, non-blog-publishing hedge fund manager?

Barron’s merely:

a) Recapped the bad news that has come out under the ticker “SHLD” recently—lousy sales, shuttered stores, and uncharacteristically dour reports by Wall Street’s Finest—and;

b) Called out the use of one-time “special charges” and reliance on “Adjusted EBITDA”—a notoriously misleading measure of business health in a capital-intensive business like department store retailing—as a performance metric, and;

c) Speculated that Lampert and his investors are “backed into a blind alley” with “no escape,” thanks to cost-cutting that “has been so extreme,” according to Barron’s, “that it can no longer generate the cash flow to mount a turnaround”—a legitimate concern given that the balance sheet was cleared of $5 billion in cash spent on share buybacks from 2005 to 2008 at stock prices well above the current price—and;

d) Predicted “Sears stock could fall by as much as 50% as the problems drag on,” and;

3) Declared that “The agonies of Sears are of vital importance to the investors in Lampert's hedge fund,” suggesting gruesome consequences for the hedge fund king.


So how did that hedge fund king respond to Barron’s?

Quite lamely, we think.

While first admitting “the performance of the company is not where I would like it to be,” Lampert writes:

“The executive team and associates of Sears have all been hard at work in attempting to change this performance in an environment that has been less than friendly to the entire retail industry. At the same time, contrary to the theme of the article, we have made some important progress in 2009.”

Let’s ignore Lampert’s nobody-else-did-well-either kick-off and focus on exactly what those signs of “important progress” might be.

The first sign of progress, according to Lampert, is an amended credit facility. We do not make this up.

To healthy retailers, of course, an amended credit facility is not so much a sign of “progress” as a sign the company won’t be filing Chapter 11 any time soon. We think it should be dismissed out of hand as filler.

The second sign of progress, Lampert says, was an increase in “adjusted Ebitda” of 9% in the first six months of 2009, when “most of our major competitors saw a decrease in their Ebitda performance.”

Unfortunately, this assertion that Sears outperformed peers in one measure of its fundamentals is hard to refute without exact knowledge of a) who Lampert considers to be Sears’ “major competitors,” and b) what goes into Lampert’s own calculations of “Adjusted Ebitda.”

According to our Bloomberg, for example, Sears’ EBITDA in the first half of the current year did not grow: it declined, to $465 million from $636 million the previous year.

Furthermore, Wal-Mart, which has been taking market share from Sears almost since the day Sam Walton opened his first store, and certainly has to be Lampert’s company’s single most important “major competitor,” did not show an EBITDA decrease during the first half of the current year—it showed a slight increase.

Worse, for Lampert anyway, is that while Sears was bleeding $162 million of negative cash flow from operations in that same period, and spending a bit under $200 million on top of that for capital spending, Wal-Mart was gushing $13.469 billion in positive cash flow, and spending $9 billion—yes, $9 billion—of that money on new stores, new fixtures, and new technology...i
.e. the very stuff that has made Wal-Mart what it is today: Eddie Lampert’s worst nightmare.

Moving on to the third of Lampert’s “signs of progress”—and we aren’t making this one up, either—the Sears Chairman points out that Sears stock jumped 70% year-to-date, “outperforming all of our large competitors.”

Besides being absolutely meaningless—short-term stock price moves tell an outsider precisely nothing about the long-term health of a business—this data point, like Lampert’s EBITDA calculation, looks far less impressive when you move the goalposts back to the end zone, where they were before he shifted them to a better-looking spot on the field.

Lampert surely knows—he does run one of the most successful hedge funds in America—that in almost any stock market rally of the type we’ve enjoyed thus far in 2009 (i.e. the sharp, short-covering-off-a-panic-low variety), the lowest quality stocks always move up the furthest, for the simple reason that they already moved down the furthest.

Just ask the short-sellers in AIG.

More telling to the underlying business than a short-term dead-cat stock bounce, of course, is a time-frame that encompasses the entire financial crisis. Had Lampert chosen to brag about the last twelve months, in that case, the comparison wouldn’t look so perky: Wal-Mart, Target and Costco shares were recently down 15 to 20% over that timeframe.

Sears was down 31%.


“Okay, wise-guy,” the discriminating reader might say (and we have very discriminating readers here at NotMakingThisUp), “what would you do with Sears that the great Eddie Lampert is not?”

The answer to that is easier said than done, but the turnaround of any institution as large and storied as Sears has nothing to do with short-term moves in stock price, “adjusted EBITDA” or amended credit facilities.

Rather, it is about something Lampert did not address in his letter—not even once. It is about one person.

The person who runs the business.

And by way of explaining what we mean by that, we harken back to a simpler but more dangerous time, just 22 years before the 1886 founding of the R.W. Sears Watch Company in Minneapolis: the American Civil War.

During that Civil War (or the War Between the States, if you prefer), the North had suffered a series of overcautious generals, most of them with political ambitions, who could not bring themselves to fight until pushed into battle by the inexperienced Commander in Chief (Abraham Lincoln) and his incompetent General-in-Chief (Henry Halleck).

The end result was, in all cases but Antietam (or Sharpsburg, if you prefer that), disaster for the Northern Army of the Potomac.

It wasn’t until Lincoln finally selected Ulysses S. Grant—a fighter without political ambitions who had captured Vicksburg following one of the riskiest and most underrated maneuvers of the war—as his General-in-Chief, and gave Grant complete control over all Northern armies in the field, that the tide shifted to such an extent that Confederate General Robert E. Lee—the best general the U.S. ever produced—was eventually forced to concede to Grant at Appomattox.

And in much the same way that Lincoln and Halleck tinkered aimlessly until that war had almost been lost (or won, if you prefer that) before turning everything over to General Grant, Eddie Lampert, in all his years as Chairman of Sears Holdings, seems to have avoided making any single individual responsible for the retail battles being fought every day in the real world—i.e. in the communities where shoppers right now are making up their minds whether to go to a Sears, or a Wal-Mart, or a Costco.

But that’s exactly what Sears Holdings needs: it needs a General Grant.

And it needs one sooner, not later.



Jeff Matthews
I Am Not Making This Up


© 2009 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.