Blue Light Special

Today's Heard on the Street column tells you everything you need to know about the current market.

Sears Holdings may be struggling as a department-store operator, but it is proving an astute hedge fund under billionaire investor Edward S. Lampert.

The retailer, controlled by Mr. Lampert, earned more than half its net income in the fiscal third quarter ended Oct. 28 from investments in exotic derivatives designed to mirror the performance of company stocks. Those investments helped triple net income, to $196 million, or $1.27 a share, despite weak sales at its Sears and Kmart stores....

The company turned an investment in derivatives in other companies' shares into a $101 million after-tax profit during the quarter. A spokesman for the Hoffman Estates, Ill., retailer declined to disclose the company or companies whose shares were represented by the derivatives.

In a statement, the company said the investments involve "substantial risks," adding that future results "may be positively or negatively materially affected based on the timing, magnitude and performance of these investments."

The financial derivatives used by Sears, known as "total-return swaps," are agreements that take on the big risks of highly leveraged investments in equities or other assets without actually buying them or assuming debt to purchase them, said David Krein, president of New York structured-investment adviser DTB Capital Group. Total-return swaps also can boost the liquidity of an investment, carry tax benefits, and have the advantage of gains that can be recorded as profit on a balance sheet, whether realized or unrealized.

Note the analysts falling all over themselves to praise the "strategy". But if Lampert loses the formula, and suddenly the whole thing goes gunnybag, those same analysts will be the ones Tsk-Tsking from their front row seats, rationalizing their sugar coated strong buy ratings (of course if it gets really ugly they'll just change firms).

By the way, our nearby Kmart is one of the old style versions... and just a horrid shopping experience. A retail ghost town. For the 4 or 5 people shopping there it is a last resort, like when you just need to whip in there real quick to buy a toothbrush or some batteries.

Beats circling around and around Wal-Mart or Target hoping to find a parking space.

Don't Believe Everything You Read

I'm probably the only person in the world with such peculiar pet peeves, so just a short comment on this recent article: Retail investors missed most of recent rally.

As equity markets rise, individuals are lured into buying more shares or adding extra dollars to mutual funds invested in stocks. By the time they've invested, the smart money -- corporations with insight into the health of their own businesses -- has usually stopped buying equities and gone elsewhere...

With the Dow Jones Industrial Average breaching 12,000 points for the first time ever Wednesday, this unhappy cycle may have begun again...

Retail investors "are starting to participate, but they didn't begin until nine days ago,"...

Not to pick on this reporter, nor the fella quoted above, but does anybody really believe individual investors suddenly woke from a coma only nine days ago?

Do you know how many $Trillions "retail" folks have parked in equity mutual funds, hedge funds, and ETF's (not to mention indirectly through pensions)?

A few Billion going to and fro in any given month is just noise.

In contrast, if memory serves, back in 2002, we saw $65 Billion exiting funds for several months in a row... and about the same amount pouring into bonds. Now that was a sentiment indicator.

Looking a Little Ragged

I've had a running commentary for a few weeks now about the market's persistent strength. During this recent leg of the rally we have seen selling pressure pre-market, and/or in the early going, overrun by strength all the way into the close. It's only one factor, and it is certainly simplistic, yet it is still an important gauge of the underlying bid.

In contrast, markets that are topping out will typically start with a gap higher and then fade through the rest of the session as the true believers continue to hope they've caught the bottom.

Last week (charts below) we still saw persistent buying in the Dow and S&P (think esp about Friday's rebound following the CAT imposion), but the Nazz definitely looked tired. And the closely watched Semi's threw up a caution flag.

It will be interesting to see the reaction to this week's news.

Achilles Heel

This may be hard to believe, but during the 70's, 80's, and into the early 90's, WalMart's stock was a juggernaut.

It was automatic. You bought it high, bought more on dips, and dollar cost averaged the rest of the time. An honest to goodness no brainer. This was a stock you could confidently recommend to Grandma; a rock solid core holding for every client. No questions asked.


In early '93 I was watching Paul Kangas on the Nightly Business Report. He was doing one of those interviews with a money manager who would come back to the show from time to time. In his previous appearance the money manager mentioned they liked WalMart. Paul pointed out it had done well since his last visit, and asked if investors should still be buying.

"No. We've sold our entire position."

I spewed whatever it was I was drinking all over the living room. The cameraman fainted. Paul Kangas looked at the guy as if he just cussed in church.

You don't SELL WalMart... you BUY WalMart!

Mr. Kangas is a consummate professional, thus he quickly regained his composure and asked his guest to explain.

"Paul, WalMart has been growing an average of 25% per year since the company went public. Their sales are quickly approaching $100 billion. We did the math and found if WalMart continues to grow at 25%, their sales will equal the GDP of the United States of America by the year 2000. Frankly, we just don't think that's gonna happen."

It was one of those rare moments that offer crystal clear clarity. Anyone watching instantly knew he was right.


A few weeks later WalMart came out with a warning that same-store sales would fall dramatically. More warnings would follow. Of course the stock was priced for perfection- and owned by everyone and their grandmother, so the sickening slide was an absolute house of pain for several years.

I was reminded of that story today while listening to a very bullish market strategist. He not only expects double digit profit growth in 07, but found no reason we couldn't continue at the same clip for the forseeable future (if you're uber bullish for 07 you can't allow for a slower rate of growth in 08 because we all know the market is a discounting mechanism).

The Achilles Heel of this market, ironically, is the simple law of large numbers.

Revergence to the mean.

The US economy is somewhere in the neighborhood of $13 Trillion, and has been growing about 3% per year during the recovery. Meanwhile, profits are up double digits umpteen quarters in a row.

We currently enjoy full employment, relatively low interest rates, high productivity, and historic corporate profit margins that are the envy of the world. The US economy has also benefitted from a staggering amount of deficit spending since the recession that followed the popping of the bubble.

It sounds great because it is great. In fact, it is phenomenal.

Until you do the math.

Tilting At Windmills

Notice how many bears are shaking their fist at this market? Notice how many bulls are expecting a selloff? (They think a haircut would be healthy, setting the stage for a strong 4th quarter rally: the proverbial pause that refreshes.)

Among the bears, a lot of smart folks think this move is nothing more than a "head fake", or "sucker's bet", fueled by a "short squeeze".

If you peruse the following charts you'll notice they all have something in common: a weak opening followed by a strong finish. With the exception of last Wednesday (when the media went nuts over a plane flying into a NY highrise), this market has absorbed the initial wave of selling and then continued its march higher.






If this is a headfake or short squeeze we'll get a hint of trouble to come once we see that pattern reversed: exhuberant buying at the open followed by distribution.

Maybe then we'll begin to see the bulls shaking their hoof at the market.

Chart of the Day

Something for everyone from Chart of the Day...

The Dow made another record high today. So how does the current stock market rally rank? To answer this question and to provide some perspective, all major market rallies of the last 106 years are plotted on today's chart. Each dot represents a major stock market rally as measured by the Dow. So what does this chart show? As it stands right now, the current Dow rally would be classified as long in duration (1010 trading days) but slightly weak in magnitude (64%). Stay tuned...

Bank of America Offers Free Online Trading

First Citiwide Change Bank

Narrator: "When you do only one thing, you do it better"

Customer #1: I needed to take the bus, but all I had was a five-dollar
bill. I stopped by First Citiwide, and they were able to give me four
singles and four quarters.

Narrator: "At First Citiwide Change Bank, We just make change"

Bank Representative: We will work with the customer to give that
customer the change that he or she needs. If you come to us with a
twenty-dollar bill, we can give you two tens, we can give you four
fives - we can give you a ten and two fives. We will work with you.

Customer #2: I went to my First Citiwide branch to change a fifty. I
guess I was in kind of a hurry, and I asked for a twenty, a ten, and
two fives. Their computers picked up my mistake right away, and I got
the correct change.

Narrator: "Correct Change"

Bank Representative: We have been in this business a long time. With
our experience, we're gonna have ideas for change combinations that
probably haven't occurred to you. If you have a fifty-dollar bill, we
can give you fifty singles. [Narrator: "We can give you fifty singles"]
We can give you forty-nine singles and ten dimes. We can give you
twenty-five twos. Come talk to us. [Narrator: "We can give you
twenty-five twos"] We are not going to give you change that you don't
want. If you come to us with a hundred-dollar bill, we're not going to
give you two-thousand nickels.. [Narrator: "We're not going to give you
two thousand nickels"] - unless that meets your particular change
needs. We will give you.. the change.. equal to.. the amount of
money.. that you want change for!

Narrator: "At First Citiwide Change Bank, Our business is making change"

Bank Representative: That's what we do.

But seriously folks, Bank of America's strategy is an astute move on several levels. Most importantly: they can build their brokerage organically (for which they hope to cross sell other services) a lot cheaper than spending $Billions for an existing platform (which has been done over and over again with lousy results).

As an aside, I found it amusing to see the online trading firms react in the same exact fashion as my industry did back when those same online trading barbarians were at the gate.

"I don't see pricing as the battleground. I see functionality as the battleground," says Jarrett Lilien, president of New York-based E*Trade Financial. He considers the industry's prices already low, so brokerages must compete by providing better services, such as advanced order types that automatically sell stocks at predetermined price points.

For its part, Charles Schwab said it had no plans "at this time" to change its price structure. "Knowing there is no free lunch, consumers look carefully at the whole picture— rates on their cash, trading costs, quality of services and investment advice, etc.," founder and CEO Charles R. Schwab said in a statement on Oct. 11.

North Korea May Have Conducted Another Nuclear Test

Update: 8:21PM
Should have mentioned I got that wire story (below) via Drudge. The latest: Japan's announcement of a second test was apparently triggered by a 6.0 earthquake. [Earthquake sets off Nuke Alarms? Sounds like the plot for a movie.]

Per Reuters:

N.Korea may have conducted another nuclear test: NHKTue Oct 10, 2006 7:42 PM ET

TOKYO (Reuters) - North Korea appears to have conducted another nuclear test, Japanese national broadcaster NHK said on Wednesday.

Japanese government sources had information that there was a tremor in North Korea this morning and they were checking on the possibility of a nuclear test, NHK said.

Defying warnings from its neighbors, the United States and the U.N. Security Council, North Korea announced on Monday that it had conducted its first-ever nuclear test. Pyongyang had earlier said a U.S. "threat of nuclear war and sanctions" had forced its hand.

Not that this has anything to do with the financial markets (since none seem to care), but it sure seems like NK's Kim wants to get some attention.

PS Wish I had saved the piece, but I read somewhere after the first test, which apparently registered as a relatively small explosion, that it may have been small due to it's design to sit atop a rocket. I believe it was the folks at Stratfor wondering if it was a test of a "weapon" vs. "device". A weapon would have to be smaller and more rugged, while a device can be any size required to get the hoped for test result (big bang). The implication that they have successfully tested a "weapon" would seem serious in my non-expert opinion.

Dow 36,000? Nope, Dow One Billion.

By now everyone is familiar with the parallels between the charts of the Nikkei and the US markets after the "Y2K Bubble" popped (as you shall see, we're using quotes for good reason). For quite some time it appeared we were bound to follow Japan into our own deflationary ring of hell. But as our markets refused to roll over, at some point it became clear, no matter how we adjusted the timelines, that the whole thesis was invalid.



More recently, this chart from Birinyi Associates (via Captain Kirk) has gained currency among investors, as it would happily suggest we are merely in the middle innings of a great bull run.

However, sadly, we must reject this comforting image due to a variety of technical factors which we uncovered during our own computer runs of the data.

In fact, you might be surprised to find Birinyi Associates understated the outcome by a factor of 80,000!


It is those technical factors that led FinancialRx to what we believe may prove to be the most significant development in finance since the invention of compound interest.

Ironically, this simple model has resided under our noses for 10 years now.

Witness: The next two charts compares the Dow Jones Industrial Average with the cumulative earnings of Tiger Woods since he turned Pro. (Second chart courtesy Golf Digest Magazine.)




As you can clearly see both bear an uncanny resemblence, right down to the 2000-2002 dip in the Dow, which of course encompasses Tiger's adoption of a new swing. Other mini-corrections correlate to Tiger falling in love, Tiger changing caddies (which we have previously mistaken for the "Asia Crisis" and then the "LTCM Debacle"), and so on.

With the help of the supercomputers and staff at the Bureau of Labor Statistics, we have backtested, adjusted the model to smooth for seasonality, added birth/death adjustments, tweaked the confidence interval, and rounded up all numbers in each sequence, in order to obtain the perception that our projections are correct.

Other than normal future revisions and changes in calculation methodologies, the only thing that could possibly derail such an obvious outcome would be... well... Tiger Woods.

Bottom line: Dow One Billion by 2010.


Naturally, certain naysayers will raise questions:

Inverted Yield Curve? Don't make me tired.

Korean peninsula hanging over Japan like a Nuclear Sword of Damocles? Mixed metaphors are not an investing strategy.

Runaway twin deficits in an asset based economy? Makes me bullish just thinking about it.

Sevin Rosen Scraps Fund: VC Business All Risk and No Return

There was a time when a fool and his money were soon parted, but now it happens to everybody. - Adlai Stevenson

This weekend's NY Times reports Venture Capital firm Sevin Rosen is offering a refund.

“The traditional venture model seems to us to be broken,” Steve Dow, a general partner at Sevin Rosen Funds, said in an interview.

Sevin Rosen, a 25-year-old firm that is among the most respected in the industry, was in the process of closing its 10th fund and had received commitments from investors for $250 million to $300 million, Mr. Dow said. But in a letter sent to those investors yesterday, Sevin Rosen said it had decided to abort that process.

“We have decided to take the radical step of returning the commitments you have given us for Fund X,” the firm wrote.

Explaining its decision, Sevin Rosen, which has offices in Dallas and Silicon Valley, said that too much money had flooded the venture business and too many companies were being given financing in every conceivable sector.

But excess of capital is only part of the problem, the firm said. In its letter, it bemoaned what it described as “a terribly weak exit environment,” a reference to the dearth of initial public offerings and to a market for acquisitions at valuations that it considers too low to deliver the kind of returns that venture investors expect.

At a time when young companies like YouTube and Facebook are said to be entertaining acquisition offers in the $1 billion neighborhood, that pronouncement may seem surprising. But Mr. Dow said those “megadeals” were rare and were not enough to sustain an entire industry.

“While good returns from any given firm’s portfolio is certainly a possibility, the statistics have clearly shifted in an unfavorable direction,” the firm wrote. “The venture environment has changed so that overall returns for the entire industry are way too low and even the upper-quartile returns have dropped to insufficient levels.”

VC funds, PE funds, Hedge Funds. Sevin Rosen is telling us the world is afloat in liquidity. But it's not really an issue of doing an IPO at the back end. It's the inflated price too many investors are willing to pay on the front end.

If you can't get a good entry point, figuring out a good exit point becomes moot.

Gone are the days when VC's got in on the ground floor. There's been a Katrina-like surge lifting the big boats, small boats, flotsam, jetsam and rubber duckies. So much so we find ourselves reading Google might buy YouTube for $1.6 Billion (of course they're using Google Monopoly Money).

The markets have a lot of smart folks scratching their heads these days. In the future we'll look back and wonder, "What we're they thinking?!"

Who Wants to Be a Millionaire?

Received the email below recently. This is probably the 10th iteration of this sort of scam I've received over the past 5-6 years. I'm assuming people fall for this sort of thing if they keep sending these(??).

Barrister & Solicitors,
Coles Chambers,
Suite 6, 3rd Floor,
118 Lord Lurgard Street, Lagos Island.
P.O.Box 75519,
Victoria Island, Lagos, Nigeria.

Hello Friend.

Before I start, I must first apologize for this unsolicited mail to you.I am aware that this is certainly an unconventional approach to establishing a relationship, but you will realize the reason for my action after going through this email.

I am Barrister Thomas Cole, a solicitor at law. I am the personal attorney to Late Richard Burson. I got your impressive information after a Conscious search for a reliable and matured mind that has all it takes to execute this project. I was elated when I saw your address, and I picked a keen interest with confidence to solicit for your help in executing this opportunity. However, I was moved to contact you based on the present situation of this opportunity, which I may say, is a God given offer.

There was a foreigner who lived here in NIGERIA some time ago; he is called Richard Burson by name, until his death. I was his Personal Attorney, unfortunately Richard Burson died with his wife and their two kids in a Local Plane Crash at Kano State, which enroute from sokoto to Abuja (the capital city of Nigeria), all occupants in the Plane lost their lives, unfortunately on this same flight were other dignitaries like the former Nigeria Sports Minister and a host of others.
The following websites could be referenced: Please go through the website.

http://www.usafricaonline.com/ngrkanocrash.html
http://news.bbc.co.uk/1/hi/world/africa/1968616.stm

Owing to his death, his bank called on me for a meeting as regards his Account Balance with the bank, being h is attorney till the time of his death, I was told to come up with any of his relatives to come and claim the money, I tried all I could to trace his family, but all my efforts proved abortive.

Since January this year till date, the bank has been asking me to look for his family because they realize that a lot of people have been trying to claim the money as his next of kin, but after verification, It is found out that those people are not really his next of kin, because they cannot provide any legal evidence to prove that they are his relative.Hence, I have decided to use you as his next of kin to claim the money as it happens that none of his relatives will ever appear to claim the funds, besides I have all his documented memo in my possession, which will back you up before the bank as his next of kin .

I have the logistics to make your name to be that you are the rightful next of kin to the deceased and as well as the beneficiary of the funds. The amount involved is $US28.5Million Dollars. As regards to that, I will like you to furnish me with the following information, which I will use to secure the legal documents.
(1). FULL NAMES
(2). COMPLETE CONTACT ADDRESS
(3). CONTACT PHONE NUMBER
(4). FAX NUMBER
(5). OCCUPATION
(6). AGE
(7). Sex

As soon as I receive your information, I will forward an application for account closures to which you will submit to the concerned bank as his next of kin. Be rest assured that, there is no risk involved as I have rerfected and made the necessary arrangements to back you up in claiming the funds. I will want you to regard this deal as being highly confidential because this busines as transaction demands a high level of secrecy as the bank does not know that I am involved in the deal.if interested in the transaction and to enable me feed you with more information, then do all you can to furnish me with all the needed informations stated above.

Thanks for your anticipated co-operation as I await your reply. Reply
through my alternative email thomascole4@XXXX.com
Best Regards,
Thomas Cole Esq.