Enlightened Economist

The 2 Hour Analysis with Fannie Mae

2009-11-02T12:08:00.007-06:00

Did it take 2 hours for investors to assimilate the potential upside in Fannie Mae thus creating a $.05 bid and $.10 ask in the January 2.50 Fannie Mae calls in early hour trading? Better yet, what potential upside am I even talking about? Some analysts believe the Fannie Mae equity is literally worth zero. So what drove the asking price (a 100% increase to the previous asking price of $.05) when the underlying Fannie Mae common shares were unchanged, as matter of fact down in early trading on November 2nd? As a holder of Fannie Mae calls, here is what I have to say.

Even though Fannie Mae is one of the most speculative plays out there considering its volatility and unusual volume trends, some very interesting news came out just last night and I believe the markets just picked up on that news, 2 hours after the opening bell, or when the asking price for those options doubled…

Recently, Fannie Mae got hammered down when an analyst downgraded the shares contending that it must be recapitalized to survive and even if it was rejuvenated, the amount FNM would owe would still be so great that still Fannie would not endure. However, just last night, there were some sparks. The Wall Street Journal stated how Goldman Sachs was attempting to buy near $1 billion of tax credits from Fannie Mae and that GS could gather other investors for the deal as well. I interpret that as ‘a lot more than $1 billion of tax credits’ could be picked up by GS and other investors. If such a deal was to happen, it would give a lot of needed relief to Fannie’s balance sheet. The only problem is that the government, being the controller of Fannie Mae, will not approve such a deal because it might not be in taxpayers’ interest and that it is enabling GS to cut its tax bill. My first thought is if the government owns Fannie Mae, doesn’t the ‘taxpayer’ theoretically own Fannie Mae therefore making it ridiculous for the government to block such a deal if it is good for Fannie Mae? Maybe it is too good for Goldman Sachs and therefore should not be approved because Wall Street is recovering better than Main Street? If that somewhat is the case, consider it absurd!

Anyways, back to these tax credits. Why would it be very good for Fannie if Goldman was to buy these besides the obvious point being that it would relieve Fannie of some financial distress? Well these ‘tax credits,’ or “low income housing tax credits” have been traded in a market where “observable transactions” have been curtailed. “There is decreased market demand for tax credit investments because there are fewer tax benefits derived from these investments by traditional investors, as these investors are currently projecting much lower levels of future profits than in previous years. This decreased demand has reduced the value of these investments.” – Page 23, Fannie Mae Form 10-Q for the quarterly period ended June 30, 2009

I think the 100% increase in the asking price for the January 2.50 calls is factoring in the probability that the government would approve such a deal and this decreased demand in ‘tax credits’ can very possibly be stabilized or increase if investors do want these tax credits. Goldman Sachs is expecting to win approval sometime this week, and if that is the case, Fannie could see significant upside. Keep in mind that FNM is again extremely volatile and is also reporting its 2009 3rd quarter results on November 4th – any surprises could send the stock flying. Also, I believe Goldman Sachs can convince the Obama Administration that this deal will benefit the ‘taxpayers’ as well.

Furthermore, Fannie Mae stated the following during their 2009 2nd quarter report: “Taking into account unrealized gains on available-for-sale securities during the second quarter and an adjustment to our deferred tax assets due to the new accounting guidance, the loss resulted in a net worth deficit of $10.6 billion as of June 30, 2009. As a result, on August 6, 2009, the Director of the Federal Housing Finance Agency (FHFA), which has been acting as our conservator since September 6, 2008, submitted a request for $10.7 billion from the U.S. Department of the Treasury on our behalf under the terms of the senior preferred stock purchase agreement between Fannie Mae and the Treasury in order to eliminate our net worth deficit. FHFA has requested that Treasury provide the funds on or prior to September 30, 2009.” This intertwines with the reason as to why Fannie Mae needs to be recapitalized.

But perhaps with Goldman (and other investors) seeking these tax credits and hopefully reaching a deal, it could offset the burden Fannie faces with its quest for $10.6 billion from the UST. And let us keep in mind that although many do argue government intervention has fueled this recent run-up in equities, we shall not forget the prosperity that comes with private capital.

I understand that Fannie Mae is a very non-ending, delicate, and tedious situation, that is why I encourage as much criticism and additional thought to this analysis as possible.

Las Vegas Sands Corp.

2009-10-28T20:33:00.003-05:00

Throughout the past week or so we have seen soft earnings from many of the large casino companies that have severally pulled down the whole sector. Wynn down ~16%, BYD ~33%, and LVS ~24% this past week. Even though LVS hasn't reported earnings yet for this quarter, the stock is still down 24% this week. Their earnings will be reported Thursday after the market closes. Analysts are expecting LVS to lose one penny per share, which shouldn't be too hard for them to beat.

"Analysts polled by Thomson Reuters expect Las Vegas Sands to lose one penny per share on $1.17 billion in revenue, compared with profit of 2 cents on revenue of $1.11 billion in the same period a year earlier."

It also seems that analysts are actually confident in this company, since it seems to have better management than other casino companies.

"ANALYST TAKE: Jeffrey Logsdon of BMO Capital Markets, who lifted his earnings expectations for Sands this month, told investors Sands would likely see strong performance in Macau.
Logsdon reaffirmed his "outperform" rating and said an improving economy and easing visa restrictions will likely bring even better results later."

I also think that it is worthy to note that most scared investors have already pulled out of this stock during the weak when other casino stocks have provided poor earnings. This has pulled LVS down 25% before any news of earnings have been presented. To me this means that investors are expecting poor earnings and have already brought down the stock price to show that. I think that there is huge potential upside if LVS presents positive earnings tomorrow and a smaller downside if earnings are week b/c this is already reflected in the stock price.

In order to hedge your risk you could buy put options in other casino stocks while buying calls in LVS since bad earnings from LVS will drag down the rest of the sector as well.

Let me know what you think.

What Happened to the Armour?

2009-10-27T16:45:00.002-05:00

I will be very straight forward. This morning, Under Armour had reported its 2009 third quarter financial status, and quite frankly, I thought it was a great quarter. From Under Armour’s website came the following facts:

• Net Revenues Increased 16.2% to $269.5 Million
• Net Income Increased to $26.2 Million; Diluted EPS of $0.52
• Cash & Cash Equivalents Increased $53.2 Million Year-Over-Year to $93.4 Million at Quarter-End; No Borrowings Outstanding Under $200 Million Revolving Credit Facility
• Inventory Decreased 6.6% to $152.8 Million at Quarter-End
• Company Raises 2009 Net Revenues Outlook to $830 Million to $835 Million (+14% to +15% over 2008) from $810 Million
• Company Raises 2009 EPS Outlook to $0.85 to $0.87 (+10% to +13% over 2008) from $0.80 to $0.82

- http://investor.underarmour.com/releasedetail.cfm?ReleaseID=418803

This entire quarter, the street and other financial sources only talk about ‘top line growth’ – it is all about top line growth to see if the economy is healing, consumers are spending, and companies are doing better from not just slashing costs in whatever ways possible. Last quarter, cost cutting is what led many stocks to beat expectations and thus create an earnings rally. Under Armour’s top line growth of 16% was very interesting and bullish to me. Being a holder of call options in UA, I was not just very disappointed to see the stock sell off as much as 12% today, but puzzled as to how such downside could occur.

In several articles that I read today, reporters kept saying that Under Armour posted quarterly earnings that well beat Wall Street estimates and the company raised its full-year outlook, but the forecast implies a weaker-than-expected fourth quarter. How contradicting is that? They raised their outlook, but the forecast is expected to be weak? If I am missing something, I hope someone explains.

Taking this a step further, what I believe drove the stock price down was how Under Armour said that its personnel costs and selling, general, and administrative expenses would increase for 2009. However, the increase in expenses would be only from the low-teens, which was the previous outlook, to the mid-teens. Not to mention, the expenses are associated with an increase in funding for Under Armour’s performance incentive plan and for the continued expansion of their factory house outlet stores. How is that bad? To me, it signals growth.

So again, why would I hear “raised outlook, forecast implies weaker-than-expected outlook?” It makes absolutely no sense! One analyst said how revenue growth would slow in Q4 yet I cannot jump on that when every one of UA’s segments did well. What about the football season underway? That is worth estimating as Steven Louis told me. How could Nike soar on their quarter and Under Armour not? Nike’s first fiscal quarter of 2010 gross margins were 46.2% compared to 47.2% the same period one year ago. Under Armour, on the other hand, had gross margins for their third quarter for 2009 of 49.7% compared to 51% for the same quarter a year earlier. This decline in UA’s gross margins also seemed like a reason to bash the stock today. However, I do not see why considering that UA’s gross margins are more attractive than Nike’s. I think that is worth pointing out. And the last point I will make: the growth in the athletic apparel industry is in Under Armour. Consider the following results that derived from the Nike and Under Armour website, respectively:

- Revenue for Greater China during the first quarter was down 16 percent to $416 million compared to $496 million last year. Footwear revenue was down 17 percent to $218 million, apparel revenue declined 16 percent to $168 million, and equipment revenue decreased 16 percent to $29 million.

- Kevin Plank, Chairman and CEO of Under Armour, Inc., stated, "The strength and diversity of our growth platform enabled us to deliver meaningful top line growth during the quarter with all product categories up for the period.

Excuse the outrage, but I still believe there is much more upside in Under Armour opposed to Nike. Maybe, Nike should think about buying Under Armour? It is just a matter of time for UA to start crushing Nike’s toes.

Take-Two, Action!

2009-10-25T12:50:00.001-05:00

In a more recent post, I briefly discussed why M&A activity could pick up. Towards the end, I outlined some thoughts without going very in depth. One of those thoughts was regarding Take-Two Interactive, a multimedia/graphics software company that is most known for their Grand Theft Auto and NBA 2K franchises along with many other unique video games. I thought that the company was affordable (I still do) for larger companies such as Microsoft to pick up, especially considering that the Operating Income for Microsoft’s Entertainment and Devices Division grew by roughly 96% this quarter from the same quarter in 2008. Some sources have commented on how Electronic Arts or Activision Blizzard could be potential targets for a Microsoft, yet I feel that those companies have much larger enterprise values relative to Take-Two or THQ thus indicating it is very much possible to see ATVI or ERTS acquire Take-Two or THQ.

On Friday, out of the ordinary, I saw Take-Two Interactive surge 6.56% with an additional 1% or so in after hours trading. What fascinates me most is how there were more than 8 million shares traded, the most within one year (at the end of May and middle of July, about 6 million shares were traded on two separate days) and no new information seemed to have supported that move. This price action for Take-Two is not necessarily prevalent but most certainly unusual. Even if there were rumors of Take-Two putting itself up for sale or someone possibly attempting to acquire the firm, such rumors are still published. This reminds me of what recently happened with a Perot Systems employee who was charged by the SEC for buying more than 9,000 call options between the 4th and 18th of September, right before Dell announced that it was going to buy Perot. With Take-Two currently at $11.86 per share, the volume for the November $12.50 and $15.00 call options this last Friday of October 23 was more than 4,000 and 3,400 contracts, respectively. At the end of the day, I am just trying to understand where such unforeseen movement derives from.

Just last week, the NPD Group, a market research firm that gives information on consumer trends said that video game software sales grew by 5% in September. After six straight months of declines, this was the first positive reading. The sector was not too fond of this data point because analysts were expecting 15% growth but potential still exists. For the same month, video game console sales did very well. Sony PlayStation 3 sales were up 134% from the previous month, Wii sales were up 67% for the same period, and Xbox 360 sales grew by roughly 63.7% again for the same period. Even though these sales stemmed from lower costs, if one buys a system, that person will buy some games. In conclusion, what attracts my attention was this movement in Take-Two. So starting this week, I will continue to follow the sector, just with a closer eye on it and we will see where it takes us.

Going With Dell over Hewlett-Packard

2009-10-23T10:45:00.003-05:00

For sometime, I have been holding on to Hewlett-Packard January 55 calls hoping that as the economy turns around and PC sales begin to pick up, HPQ would make its move towards that 55 strike (currently trading at $48.30). However, I decided to swipe out of my position in HPQ call contracts for Dell, despite the financial media just bashing on this company. Here is why:

After analyzing HPQ, IBM, DELL, and AAPL, I found some interesting results. Right off the bat, Apple does not amuse me. Allow me to take the contrarian approach on this one: AAPL is extremely overbought and to add, most analysts and individual investors are just TOO optimistic with Apple. The option contracts I was looking at were extremely over valued relative to its peers. Don’t get me wrong, Apple has great ‘innovative’ products, but they can only go for so long. What about Buffet’s ‘economic moat’ theory on this one? I still consider it, do others?

Ok, so now that Apple is gone, let us compare HPQ, IBM, and DELL. Looking at January calls that are roughly out of the money by 13%, 15%, and 12%, respectively, HPQ calls have the lowest premium demanded, followed by Dell, then IBM. With IBM also having the lowest probability of outperforming the S&P 500 index relative to HPQ and DELL not to mention the lowest 1 year volatility average (meaning the equity is less likely to move a lot thus leaving the option contracts less appealing), I will forget IBM.

Here we have it, HPQ or DELL? Personally, I have a Dell laptop and just love the computers, but that is beyond the point. DELL has a higher probability of outperforming the market by roughly 2%. The volatility is much higher than HPQ suggesting that Dell will more likely reach its strike faster than HPQ will. Year to Date, Dell has been outperforming HPQ by a near 2000 basis points. So with this all said, with the option contracts that are both out of the money by almost the same amount (considering intraday movements) with the same expiration, the premium for Dell is only $.07 more, or $7.00 per contract. I believe that is well worth it. By January, I look forward to discussing the movements both HPQ and Dell will have, going on the assumption that Dell will continue to outperform HPQ. Earlier this morning, Microsoft acknowledged strength in its Windows 7 product and PC demand is believed to have stabilized and expected to grow as businesses and people upgrade to newer computers. Of course there are other macro issues that could be figured into these assumptions but in the end, I believe Dell will flourish in terms of share price movement relative to Hewlett.

Thoughts and criticism are always appreciated.

The Wave of Mergers NOW

2009-10-11T17:58:00.002-05:00

It is this Monday, October 12th that marks the day, or week where I believe many companies can be acquired. We have seen M&A activity pick up with Disney’s bid for Marvel, a well run company that has strong fundamentals and a nice probability of outperforming the markets. We have also witnessed Kraft bidding for Cadbury, Dell making an offer to Perot, as well as Affiliated Comp. Services becoming a target for Xerox. Keep in mind that of these four acquirers, two are components of the Dow Jones Industrial Average. Thus a key question that comes to mind after considering the recent M&A activity is what Dow Components will be the next acquirers and who will be the targets?

Over the last 12 to 15 months we have seen endless companies hoard cash as a result of the economic crisis, lacking credit, and everything else that had caused such a spooky environment. But now that the markets have been fighting back with the help of some leading economic indicators, stabilizing home prices, available credit, and companies reporting better numbers than expected, with equities on the move, rising valuations are more likely than dubious. Therefore, many companies might almost feel obligated to make acquisitions now so they could avoid paying even more of a premium at some later point in time.

This week, October 12th – 16th, we will see many companies report: Charles Schwab, CSX, Intel, Citigroup, JP Morgan, Google, and GE just to name a few. With such a key earnings week approaching and the Dow recently hitting new highs for the year, not to mention the strong momentum and millions of investors that are so eager to jump back in, we easily have the fuel to push the Dow above that psychological 10,000 mark. If that occurs, the markets can continue to rise. Clearly there are some concerns such as a weak dollar and a federal tax credit to first time home owners that is near expiration to name a few, but on the contrary, everyone expects some ‘pullback’ but that might not even be warranted! If this week gives us a great optimistic read on the consumer and the general economy, why does the market have to pull back?

At the end of the day, I believe there is still a lot of room for consolidation throughout a broad array of sectors and synergies to be created if such acquisitions occur. How about Under Armour being taken over by Nike, Activision or Microsoft bidding at Take-Two Interactive, or a Merck or Pfizer picking up a Cell Therapeutics or some other biotech? Just some thoughts…

3/6/09 - 6469.95: Bottom in Dow

2009-03-11T23:02:00.005-05:00

That’s right, I’m going all-out optimistic and calling it. I haven’t been writing about the stock market, but I am an investor, so I think I’ll start right now. The market is inarguably oversold; I will attribute the last 10% or so downward to a combination of unnecessary government interference and the DOOM AND GLOOM media. If not for those two factors, we probably would have held at the 50% retracement support level.

I’m a technician, but I also take strongly into account the fundamental economic environment. From that perspective, the pieces of the puzzle here, especially looking through my perpetual lens of optimism, seem to be fitting together in the shape of a market bottom.

Tuesday’s rally was significant for a number of reasons. First, it was lead by news of profitability coming from the leper colony that is the financial sector, and from Citigroup of all companies. I don’t think I need to explain any further why this is so significant in the face of the unbridled pessimism surrounding the financials, and the entire economy for that matter.

Second, promising news came down that the up-tick rule will be restored. This is crucial in the current market environment. (If you aren’t familiar with the rule read here: Uptick Rule) If reinstated as promised, this will do wonders for the stock market (and limit profits for short sellers, but I’m making the bull case here).

On to the technicals, here is a 6 month daily chart of the Dow, with three of my choice indicators:

Now that’s a pretty picture. MACD and stochastics extremely bullish, and with the 20 day moving average in sight at approximately 7,200 there is some serious short term uptrend potential here.

Let’s now take a step back to look at the weekly 5 year chart of the Dow:

Of course, this isn’t as good looking a chart but I see that short term uptrend turning into some serious long term upward motion if that 20 day moving average is broken. On the 5 year weekly, the stochastics are starting to turn up, with a bulling crossover in our sights. Also, the MACD is turning back towards positive territory. Although maybe premature, these would be leading indicators of a bullish reversal.

What really catches my eye on this chart, however, is what appears to be a text book first half of a head and shoulders reversal. Putting this all together, if the 20 day moving average is breached to the upside, I would look for an upward trend to about 9,000 followed by a pull back, for the second shoulder, to about 8,000 before we start our long term climb back to our pre-2008 glory.

For those of you who shun technical analysis and think that these are just wild guesses, I won’t waste either one of our time explaining the reasoning and actual forces behind these chart patters or movements in oscillators, as there is a myriad amount of literature on the subject. Instead, I will make a fundamental case for the prediction:

The short term rally, as I’m calling from the 6 month chart (assuming the 20dma is broken), can be attributed to strength coming from the financials as well as the positive legislative changes expected. A short term rally would in turn relieve the media’s DOOM AND GLOOM attack on equities, which would in turn alleviate much of the downward pressure from panic selling and zero confidence. How does the second shoulder correction fit in to this fundamental analysis? I believe that this long term rally will briefly correct downward because there are still some credit/liquidity issues stemming from contagious fear that need to be flushed out by some economic optimism:

On Tuesday, the day of the rally, an article was posted on CNBC.com entitled “New Red Flag for Markets: Credit is Tightening Again." The takeaway was that Libor rates, the “Ted Spread” (the difference between 3 month Libor and 3 month T-bill rates), 2 year credit default swap rates, and the Commercial Mortgage-Backed Security index, are all currently indicating an increase in the reluctance to lend; credit is tightening up again. David Lutz of Stifel Nicolaus says, “"With those four things showing more and more strain, there's a disconnect with equities rallying the way they are. If they keep trading this way it's definitely an indication that there could be another leg down in stocks."

Couple that info with the other two key takeaways from the article:

“To be sure, the credit indicators are nowhere near the depths of September 2008 or so when lending all but dried up completely.”

“"After several months of swift declines and an environment where global central banks continue to cut short-term interest rates, any increase in Libor rates is a troubling reminder of the tension in credit markets," says Greg McBride, senior financial analyst for Bankrate.com. "The equity markets have effectively been behind the curve of what the credit markets have seen and experienced first-hand."”

And what I put all this information together as saying, in conjunction with the fundamental support I gave for a near term rally, is that we will have our short term rally, and a good sized one at that (I’m sticking with 9,000 if the 20dma is surpassed), based on a snowball effect of positive sentiment and flood of capital reentering the market, correct down to 8,000 because of credit worries, and then resume our long term upward ascent as everyone in the world realizes that the economy was never really that bad. This will be accompanied by a beautiful symphony of markups by all the companies that wrote off everything in sight and all types of good news. (This is supported by a statistic that I cannot find the source again, Kudlow presented it a few days ago, that compared to the financial crisis of the 90’s, companies are writing down twice the amount of assets compared to actual bad debt).

Pretty upbeat isn’t it? Are you feeling the sun emerging from behind the clouds yet? Well, I for one, sure hope this all comes true, and I really hate to say it but it is all largely reliant on the government not doing anything stupid. If all goes as planned and as they say, and Geithner really provides solid incentives for investors to by the “toxic” assets off the banks’ books, etc. and the Dow breaks that all-important 20 day moving average, I think that we stand a darn good chance at the nation-boosting rise back up to equity prosperity.

Low Oil or High Oil? What Can This Mean?

2009-03-11T22:21:00.002-05:00

I figured it would only be a matter of time for oil to trend upwards from its strong correction that took place from mid July 2008 to mid January 2009. Keep in mind many OPEC nations were not exactly content with having millions of fuel abusers get such a break at the pumps over the last few months. Also, is it possible that such goals to create jobs via alternative energy sources in America were put on hold, or better yet, lost emphasis because oil was so low?

With oil low, dozens of nations whose export markets rely solely on oil become distressed. To fix this issue, OPEC decides to cut production. Back in December of 2008, OPEC cut production slightly over 2 million barrels per day. Another production cut of near 1 million barrels per day in the near future is the speculation and those repercussions of such supply cuts can take time opposed to trading speculation that can dictate the price of oil per barrel by the immediate second. However, once the production cuts start to assimilate, oil can trend higher. Now there is a bigger picture to this issue.

With oil potentially undervalued, two things can happen of many: 1) a correction can potentially benefit dozens of countries thus shifting their Gini Coefficient closer to 0 (assuming that an oil producing nation as a whole benefits from oil revenues and not just the cream of the crop/dictating political organizations) and 2) it encourages the United States to focus more on producing alternative energy in America thus creating jobs in such relevant sectors.

In one of my research reports I wrote at DePaul University a few months ago, I outlined several bullish strategies on how to capitalize on the assumption that the securities markets were fairly ignoring the correction in oil prices simply because the financial sector pushed the oil sector out of the lime light. If the correction in oil prices helped such companies like JetBlue and FedEx, such upside would be realized in the underlying stock and the put options to protect against any downside would expire worthless. Albeit the underlying stock of JetBlue and FedEx ‘inefficiently’ trending downward with the rest of the market, a January 2010 put option on JetBlue and FedEx with strike prices of $5.00 @ 1.75 and $60.00 @ 10.90, would have experienced a 54% and 132% return, respectively. With such substantial upside present in the positions as of March 10, 2009 (the increased value in the put options would exceed the loss from the underlying equities), it would make most sense to sell the put options prior to their expiration date.

With that said, similar strategies can now be applied to such solar stocks. If oil prices are trending upwards, perhaps it would make sense to start buying numerous solar stocks, or the call options depending on how bullish you are. If the Obama Administration wants to emphasize alternative energy, why would this not make sense? I understand that the ‘infrastructure spending’ part of the Stimulus Package did not help companies like Caterpillar outperform because such an allocation to a hefty project does not happen over one night. This is why it makes sense to buy put options on such related stocks to perhaps compensate for the downside because the markets are so volatile and again, repercussions can take time (known as a Protective Put strategy if one is going long Stock A and buying the put options to Stock A). Bottom line is that I am still optimistic and based on several sectors out there, including solar, I believe the moment to start getting the toes wet might just be now.

The Truth of the Labor Market

2009-02-22T10:41:00.002-06:00

As I mentioned in my previous post, a more thorough explanation of the American Labor market is needed. Well, here you have it:

The labor market is like any other market; prices, in this case wages, are set by the forces of supply and demand. For any particular job function, there are a certain number of people in the world who are qualified to perform it (supply). For most job functions, there are a certain number of businesses/employers in the world who require a person to fill the position (demand).

(Now, I started off by talking about the American labor market, so why now am I talking about the global labor market? Because we live in a globalized economy in which, with exception of those nations that enforce protectionist policy, businesses are free to move across borders in pursuit of the most favorable operating conditions.)

So when ABC Inc. needs a new XYZ7000 machine operator they list the job opening. The XYZ7000 just happens to be the newest most technologically advanced piece of machinery there is so there are only 5 people in the area, seeking employment, that have the training and qualifications to run the XYZ7000. Well, if ABC Inc. is the only company in town, they only have to offer a wage superior to that of 1 of the 5 people's next best offer, in this case let's say manual labor at $7/hour. ABC Inc. offers $10/hour and John, one of the five, is hired. Well, if Bill is willing to take the position for $8/hour, he will get the position instead and the equilibrium wage for an XYZ7000 machine operator is $8/hour; where supply equals demand. Now, if 9 more firms all purchase the XYZ7000 and need operators for it the case is completely different. Now the 10 firms will be willing to pay per hour up to the cost of their best alternative, let's say having 30 workers do what the machine does by hand. We have said, for our example, that manual labor is worth $7/hour; 30 workers = $210/hour. Now John gets a raise to $200/hour just to retain him from getting hired by one of the other firms for that rate. Bill, being the the shrewdest negotiator, gets hired by one of the other five firms for $209/hour. As we see from the above example, supply and demand dictate wages. (I apologize to anyone already well versed in the concept.)

What's my point? The ones complaining not having/getting a job are those who have skill sets for which there is a far greater supply than there is for demand. What's the answer? Guess what, 9 times out of 10, if you don't have/can't get a job then you are not willing to work for the wage you deserve. Don't get outraged, just understand- when supply outnumbers demand, it's the demand that decides what you're worth. That's so unfair! You cold hearted son of a gun! This is the usual response. Unfortunately for everyone with this mindset, this is not a subjective matter. If you demand $34/hour for your manual labor on an assembly line and workers in Mexico can and will perform the same task at the same quality for $5/hour don't be surprised when your employer hops the border for more favorable labor costs.

This is what minimum wages do; make businesses leave in favor of better conditions, or when in response the government implements protectionist policies to try to stop that process the companies just get squeezed to death.

I hope this helps a bit to clarify why people "can't get work"; because they are asking too much for their skills relative to the supply of that particular type of labor. This doesn't even get into tax policies and disincentives to work which will be heavily covered soon. If you would like any points clarified or expounded upon please respond and let me know, I don't want to sound like a textbook, especially for those already familiar with this concept. Also, please feel free to criticize.

Please, just let markets work!

2009-02-21T14:20:00.000-06:00

Forget the intro; I’ll just cut right to the chase. Businesses that cannot survive without government aid should not survive. It’s really that easy. People that cannot afford to live in a house should not live in that house. Again, it’s really that simple. Forget the $800 billion pork-barreled-up-the-whazoo ‘stimulus’ bill. Taking the tax dollars of those businesses that make prudent decisions and operate with sustainability in mind, and using them to give as a hand out to the irresponsible businesses who either knowingly or ignorantly took blatant risks in the name of short term results is the epitome of inequity. Taking the tax dollars of those homeowners who break their backs and sacrifice everything discretionary in order to pay their mortgage on time every month to spend them on keeping the irresponsible people who bought houses they knew they couldn’t afford, or who would rather spend their income on a new BMW lease, in their houses is unfathomably sickening. Businesses: if you take risks, assume the responsibility for the result. American citizens: if you bought more than you can afford; assume the responsibility for your decisions. The government is not some generous bad parent who rewards blatantly irresponsible behavior by eating the loss so you don’t have to. Unfortunately, that’s exactly what this ‘stimulus plan’ garbage is. It’s also what all these ‘our top priority is keeping people in their houses’ programs are. This is atrocious. Seriously, what kind of message does this send to the youth of our nation? “Do whatever the hell you want son, live far above your means, max out your credit, bet on the long shots, because in the end you will reap the rewards and someone else will cover all the losses.”

Before you start posting enraged comments, obviously there are those businesses that made prudent decisions and are still facing bankruptcy. There are obviously homeowners that didn’t buy above their means, but rather lost their jobs or something similar and are now facing foreclosure. Well, unfortunately there will always be these outlier cases, no matter what the economic environment. What about everyone losing their jobs? We are in a contraction period in the business cycle. No one thinks anything out of tune with the labor market when it’s easier to find a job than your car keys. During times of major economic growth when firms all balloon up their employee base getting a job is quite easy; competition for those positions is not too bad. But when growth turns into contraction, and these same firms proportionately reduce their labor costs everyone is so shocked at the heartlessness of ‘Corporate America’. Only the best candidates get the jobs, all those non-top performers who got hired during the growth phase are no longer sustainable. This is what happens in a downturn. It is exactly the opposite of what happens in an upturn; but no one is paying attention when times are good. I’m going to need to supplement this with a subsequent post outlining the serious problems with the American labor market.

So what about those businesses that didn’t take any risks but are still getting beat down and out? When John Doe opened up his (whatever) business, how would he have known that the economy was about to tank and demand for his (whatever) would seriously decrease or disappear? It is this type of mentality that’s the problem. There is risk involved with starting a business. There is risk involved with operating a business. There is a business cycle; it is well documented. Just because someone is ignorant of history and economics does not mean that they should be excused from the consequences of their actions. Telling the judge, “But how was I supposed to know that in China pedestrians always have the right of way?” will not get you out of Chinese prison for vehicular manslaughter. In economics, just the same as in the judicial system, ignorance of the law is no excuse.

Opening or running a business does not guarantee success. Seeking or getting a job does not guarantee you indefinite employment. Investing your retirement money in a mutual or index fund does not guarantee you positive returns. This is how the world works. If you do not have the foresight to see the downturn coming, and/or have not adequately prepared for the lean years, your business will and should fail. If you are living near, at, or above your means and have not adequately prepared for the lean years, you will and should lose your house and assets. If you are not the most qualified for your job position, and/or are being paid more than the equilibrium wage for that position, you will and should lose your job. I’m not some heartless bourgeois; this is simply the real world, this is reality.

It is only after this reality is realized and accepted that we will stop trying to ‘fix’ the inevitable, with more misappropriated tax dollars which in turn only delay and exaggerate it, and embrace this correction as a much needed consolidation period from which increased efficiency, growth, and prosperity will emerge.

Blog Update

2009-02-15T10:58:00.002-06:00

Readers,

I extend my sincerest apologies for the lapse in postings since just prior to the election. Much has happened and their is much going on that needs desperately to be understood through the clarifying lenses of logic and economics. Propaganda, misinformation and unfathomable falsities are being ratified by the media as fact and truth. Within the week posts shall resume, and in constant frequency.

I highly encourage checking back regularly and posting questions or comments in response to postings. I have invited a few guest writers to author pieces to augment those which I shall present, and through doing so I hope to stimulate a continual dialogue between authors and readers. Anyone wishing to be a guest author can either respond to a post with their own enlightened insights or, if they so wish, email me a draft of what they would like published.

Also, I have a large backlog of topics I wish to cover; but if anyone has suggestions please do not at all hesitate to email them to me, either abstract of specific all are welcome.

I hope all are off to an industrious new year and I look forward to reestablishing your readership.

Please check back regularly; new posts on the way.

Best regards,

Steven Louis

The Real Cause of the "Oil Pressure" Pt. 2

2008-06-14T06:27:00.012-05:00

In my previous post I identified and discussed a depreciating U.S. Dollar as the initial cause of the soaring price of oil and gasoline. The common criticism received in response to my previous argument is that it does not account for the entire price movement, and also that there is a divergence at times from the inverse correlation of the value of the USD and the price of crude. The explanation I previously provided was not incorrect, it was simply only the beginning of the story.

Once the USD started its firm trend downward oil instantly responded with a firm upward trend for reasons I explained in the prior post. The value of the dollar, however, is not the sole input leading to oil pricing, or the pricing of any commodity, albeit a very important one. The decline in the dollar simply served as a catalyst for the progression of simple economically explainable events that followed. Observe:

As oil prices started their steady climb upwards (because of the dollar), buyers and sellers shifted their positions because their actions are based on their predictions of future values. Individual investors, speculators, professional hedgers and even, to a slightly lesser degree, consumers base their purchasing decisions on where they think prices will be in the future. On the demand side, individual investors and large speculators will only buy, and will buy aggressively, when they believe prices will be higher in the future so that they may sell their investment for a profit. On the buy side (without getting too technical), professional hedgers are employed to buy the commodities that their employer uses as an input for their business at the lowest possible price so profit margins can be maximized. An average American who owns a car as his primary mode of transportation wants to minimize his cost at the pump by buying at the lowest possible price.
For all these circumstances a simple analogy can be used: If you want to buy a dozen apples and you think the price will be lower tomorrow, you will most likely wait to buy. But if conversely you believe that the price of apples will be higher tomorrow you will buy today. If you believe that the price will be significantly higher tomorrow, and continue to rise, you will be inclined to not only purchase the dozen apples you wanted, but as many applies as you can possibly afford, regardless if you intend to eat them or sell them, so you can lock in the lowest price possible.

This causes a shift to the right in the demand curve:

(If this graph is completely foreign to you I highly recommend doing a quick search on basic economics- Econweb provides an excellent explanation of the law of Supply & Demand)

This shift is caused because the expectations of higher prices are creating demand that didn't previously exist. As the graph illustrates, this shift in the demand curve, D1 -> D2, sets the equilibrium price higher, A -> B. These resulting higher prices lead to a further shift in the demand curve which in turn causes higher prices, and so on and so on until something intervenes stopping the cycle. This is only the effect from the demand side.

The response from the supply side when higher prices are expected is the exact opposite. While the buyers all want to act as quickly as possible to buy before the price rises, the sellers want to do nothing at all. If you own the stand selling apples and you know that you can sell the same apples for significantly more money tomorrow you will hold them off the market until tomorrow, and if you believe that the prices will continue to rise significantly you will continue to hold your goods off the market until you believe that the price has peaked.

This causes a shift to the left in the supply curve:

This shift is caused by suppliers holding their supply off the market, S1 -> S2. This causes the equilibrium price to rise from point A to point B. Again, this increase in price leads to a further shift in the supply curve which in turn creates even higher prices as the trend solidifies.

Independently, in each of these circumstances we would see higher prices on increased quantity demanded or decreased quantity supplied respectfully. But in the case of oil prices we are seeing a combination of the two creating this massive hoarding effect, shifting both the demand curve right, D1 -> D2, and the supply curve left, S1 -> S2, causing the price to move upwards significantly, p1 -> p3, while quantity supplied remains the same; q1:
This cycle of higher prices followed by shifts in the supply and demand curves causing higher prices is self perpetuating. Once this cycle is started by something, such as a consistently depreciation USD, it becomes self fulfilling and strengthens as the trend becomes visibly solid. This cycle has been moving at an abnormally fast pace because of the introduction of oil ETFs.

ETFs, or exchange traded funds, track the price of a index such as the S&P500 or in this case a commodity. In 2006, the first oil-tracking ETF was released called the United States Oil Fund traded on the Amex. To put it simply, you can trade shares of this ETF through your normal stock broker, either on the long side or short, each share effectively equivalent to one barrel of light sweet crude oil. However, the buyers of these shares are only really purchasing risk and will never actually take possession of any oil. Today, all it takes to open a brokerage account with a discount broker is a couple hundred dollars, or less, maybe a signature or two, and you are up and running. This is a far cry from the barrier of entry into the futures market where you previously needed to be for any direct exposure to oil.

Now that anyone can effectively buy a barrel of oil with $(insert current price/barrel) and a few clicks, the market is flooded with new demand who previously had no access to buying. This is not only strongly facilitating the hoarding effect that we discussed, but is also creating its own shift in the demand curve in an overwhelmingly over exuberant dot com bubble-esque fashion.

The factors that I have explained in these two posts combined with a myriad of other price drivers: increasing demand, oil being a non-renewable resource, environmental protection, anti-business legislation, a volatile world political climate, etc. are a recipe for short term energy-inflation disaster which is having, and will have, serious consequences.

All this doom and gloom!! I probably have you thinking at this point that I am advocating the immediate abandonment of oil and "going green" with solar, wind, and the like. On the contrary, I have a long term positive outlook on the whole mess. Just the same way that the weakening of the dollar catalyzed the upsurge in oil prices, it can also spark the long fall back down. Everything that I described in this post and the last works the exact opposite to the downside. The dollar gaining 30% of its value back would almost immediately drop oil prices almost by the same amount. This would spark the shifts back to the left in the demand curve and in the same snowball effect way that the prices went up, all the factors would start to combine moving them right back down. I obviously agree that we, as a nation, should be working to become independent of foreign oil, and eventually transition completely to sustainable and renewable resources, but until then the pricing of oil just needs to get back under control. This is not the end of the world, the fed just needs to start supporting the greenback instead of just paying it lip service and then we can enjoy the ride back down.

The Real Cause of the "Oil Pressure"

2008-05-13T23:28:00.016-05:00

The recent upturn in gasoline prices at the pump have caused widespread concern among consumers. This in turn has caught the attention of the presidential candidates. Although I agree that the current price of oil, and subsequently gasoline, is far above where it should be, I understand the true driver of these prices. Many of my posts leading up to the election in November will analyze each candidate's claims, rants and proposed actions one by one. I will start today by explaining the true economic causes of our current gasoline prices.

The consensus belief among Americans is that the cause of current gasoline prices is "America's addiction to oil," suggesting that our demand is increasing faster than the supply. This belief is fed by almost every member of the media as well as countless politicians, including the current presidential candidates. Some even elaborate to saying that world's demand for oil, mostly coming from China, is causing a shortage and responsible for the current price levels. Members of the democratic party take the topic a step further and accuse the oil companies of gouging and price manipulation. They in turn use this as an excuse to propose ridiculous taxes on the oil companies, but I will get to that in a subsequent post.

The increase in global demand for oil is an undeniable reality. That being said, this demand increase has relatively little to do with the recent surge in prices. The true driver of the recent oil prices is very simple: the value of the U.S. dollar. This is also true of the rest of the commodities that have seen recent surges, including food. There is only slight simplification needed to make this phenomenon readily understandable for everyday Americans that are not familiar with futures markets.

The prices of commodities, including oil, are denominated in U.S. dollars. Meaning that if you wanted to purchase a barrel of oil, a bushel of corn, or an ounce of gold you would need to pay for it with American currency. It is simple to see then, that when all else is held constant, if the value of the dollar decreases, then the number of dollars you would need to spend to purchase that same barrel, bushel, or ounce would increase by that same amount. This is the concept of inflation. (For those wondering why the CPI, the federal government's primary inflation yardstick, only registered a .3% rise in March while oil saw about a 4.5% rise over the same period, I will explain this dislocation and the problems with that indicator in a subsequent post.)

Take a look at the following charts:

On top is a weekly price chart of the U.S. Dollar Index over the past 2 1/4 years- it tracks the value of the dollar. The lower chart reflects the continuation-adjusted weekly price of the Light Sweet Crude futures contract- the price of oil. It doesn't take an economist to see the obvious inverse correlation between the two. You can see the same inverse relation between the recent chart of the dollar and the prices of most commodities.

This is not at all to say that the weak dollar is the only thing influencing the current pricing of oil. I am simply showing the fact that it is the single largest and most important factor. Now that you see the cause and effect relationship between the value of the dollar and the price of oil we can translate this into gasoline prices.

Shifts in the pricing of crude oil are almost immediately translated into identical moves in the price of refined gasoline on the wholesale end. These shifts then take anywhere from a few days to several weeks to fully reflect in the retail price of gas at the pump. This is because when the retailer, a gas station, receives a new shipment to replenish their supply at a higher price they must sell that gas at a proportionately higher price to maintain their margins. In most cases the gas station will then sell the remainder of that shipment for that price and not make major adjustments in price until they receive their next shipment, hence the price lag at the pump.

With this supply chain in mind, starting with the price of crude oil, let us now make a few calculations. First take a look at the same charts of the dollar and crude oil, respectively, extended monthly over the last 10 years:

Focus your attention to the points highlighted by the red line and the circled areas. This was the end of 2002 and just before oil prices began their long climb up from $30 to $125. Notice that this coincides with the point at which the dollar started its slide from 105 to almost 70. So now let us evaluate the price of oil and gasoline if the dollar was not allowed to depreciate 33%. Take the current price of oil at $125 a barrel and multiply it by .67 to remove the effect of the weak dollar and we arrive at $83.75- the price of oil as dictated by supply and demand. We can then take the national average gas price at the pump of $3.72 and use the same calculation to arrive at $2.49. Granted these prices are still historically high, except when compared to the oil crisis of the early 80's, but the prices we just arrived at are what they would be if the Fed did not allow and perpetuate weak dollar policy. (The dollar and the actions of the Federal Reserve will be recurring topics that I will elaborate on in future posts, I will not go into detail here because the focus of this post is the simple relationship between gasoline prices and the value of the dollar as has been illustrated.)

In conclusion, my goal in this post was to make the reader aware of the real primary driver of current gasoline prices. The main importance being that not one of the 3 presidential candidates has put much, if any, emphasis on strengthening our dollar as a means to getting energy prices back down to acceptable levels. The gas tax holiday, more taxes on oil companies, taking away drilling subsidies, carbon emission caps, none of these proposals or gimmicks will have any real positive effect on long term prices, and some of these will lead to higher prices. My next post will tackle the subject of taxes on oil companies and will build off of some of the ideas we have just covered. The takeaway: as Larry Kudlow states repeatedly, "The candidate that gets to the strong dollar first will get it right and take the presidency."

Welcome to Enlightened Economist

2008-05-13T19:36:00.003-05:00

First and foremost this blog will be used to cut through the vast confusion caused by politicians, political candidates, and anyone else that deems themself an authority on the subject of economic-based politics. There will be very few times that I will ever feel the need to comment or offer my opinion on social or moral issues except in the context of economic discussion. I hope to provide an absolutely spin-free insight into the actual causes and effects of economic legislation in addition to a very concise analysis of the global economic climate. I fully encourage any reader that ever disagrees with me to reply to the respective post with a constructive argument. I also highly encourage any reader to elaborate on any of my posts if they feel that I have overlooked or oversimplified something. All questions are always welcomed as well.

Please bookmark the Enlightened Economist and check back regularly for new entries. I guarantee that any regular reader of my blog will grasp a far firmer understanding of economic concepts and in turn be a more cognizant voter, a more productive citizen, and maybe even a more successful investor. Enjoy!