November 2009 Archives

According to the National Retail Federation (NRF), the holiday shopping season is off to a lukewarm start.  While there were more shoppers in stores over the past three days, they spent less money than in the past.

The NRF found that 195 million people visited stores or websites over the Thanksgiving holiday and the associated weekend.  That is up from 172 million last year.  However, overall spending dropped to $343 from $373 last year.  Total spending over the weekend is estimated at $41.2 billion.

In comments accompanying the release of the data, the NRF said that consumers were seeking low prices and that big sellers over the first weekend of the holiday shopping season were lower cost items like small appliances, toys, and winter clothes.  Retailers "have their work cut out for them to keep people coming back through Christmas."

The destination of choice for shoppers seemed to be department stores.  Over the weekend, nearly half (49 percent) of all shoppers visited these stores, up 13 percent from last year.  Other places that people visited were electronic stores, clothing stores, and grocery stores.  The percentages of people visiting those stores were 29 percent, 23 percent, and 20 percent, respectively.

The most popular purchases were for clothing, books, and toys.  Sporting goods, personal care and beauty items, and gift cards saw increases in the percentages of people who purchased them from last year.

Analysts said that caution prevails among shoppers.  Whether it's online or in stores, the pie is unlikely to grow, they said.

It is important to remember that the kickoff weekend doesn't necessarily correlate with results from the rest of the holiday shopping season.  Last year, for example, sales for the weekend were off by one percent.  However, sales for the holiday season dropped by 6.3 percent according to MasterCard.

Despite this, retailers like to use the Thanksgiving weekend to get shoppers into their stores.  They're especially interested in getting shoppers to spend early so that they can book that revenue this year, with continued uncertainty over the consumer's willingness to spend.  There are signs that shoppers are sticking to lists and budgets.  So, stores are using discounts to lure them in.  However, unlike last year, when the near collapse of the financial system took retailers by surprise, this year, through tighter inventory control and planned discounts, retailers should be able to profit even from highly discounted items.

Analysts say that waiting until the last minute, which worked well for shoppers last year as retailers were desperate to clear out excess inventory, is unlikely to be a winning strategy this year.  Tighter inventory control will reduce the need for fire sale prices to move inventory, analysts said.

In an economy with double digit unemployment, it's unlikely that shoppers will really open up their wallets.  Thus, investors in retail stocks, which have seen a huge run up, should be as cautious as shoppers have been thus far this holiday season.

Charlie Rose recently interviewed Warren Buffett on his show.  The wide ranging interview covered topics ranging from Buffett's recent acquisition of Burlington Northern Santa Fe, the response to the financial crisis, the budget deficit, China's emergence as an economic power, tax policy, and more.

Here are some highlights.

On his purchase of the remainder of Burlington Northern Santa Fe that his holding company, Berkshire Hathaway, doesn't already own:

I felt it was an opportunity to buy a business that is going to be around for 100 or 200 years, that's interwoven with the American economy in a way that if the economy prospers, the business will prosper.  It is the most efficient way of moving goods in the country.  [I]t moves a ton of goods 470 miles on one gallon of diesel.  [A] train replaces 280 trucks on the road.  It emits far less into the atmosphere that's damaging than trucking.

On what he's seeking for in his investments:

Reasonable return is good enough, Charlie.  I mean, 50 years ago, I was looking for spectacular returns, but I can't...get them.  We have...eight to ten billion to invest every year.  [When] we're building things that are essential to society...they really don't have any choice...and we should get a decent return on that.  Enough to encourage us to keep putting money in the business, but we're not entitled to spectacular returns.

On cash as an investment:

[C]ash is always a bad investment.  I mean, when people say cash is king...that's crazy.  Cash [is] sure to go down in value over time.  You don't need to have excessive amounts of it around.

On the financial crisis of last year and its effects on the economy:

Because we're in a recession, there's not as much demand for money, and money isn't flowing to really dumb projects like it was a few years ago. But money is available now.  And the panic is gone.  But that panic that spilled over into the real economy last fall...has...left real scars on the American public psyche.  The American economy will come back.  It won't be tomorrow...and it won't be exactly the same.  Businesses will expand.

On China's growing economy and its potential to replace the United States as the world's largest economy:

They have four times as many people as we do...they will have a larger economy.  You know, they will grow faster than we will grow, but they're starting from a much lower base.  I mean, you know, I'll meet some guy in the street today whose net worth will be growing faster than mine on a percentage basis, but if I start with a big enough number, it will be a while before they catch me.

On the deficit:

[Congress], once the economy is rolling again...they've got to raise taxes now that income will go up as the recession ends anyway.  They're going to have to close the gap between expenditures.  The gap between [expenditures and revenue] is wider as a percentage of GDP than we've seen except in wartime.  If we have a gap of two, 2.5 percent and we have sort of normal growth, then debt as a percentage of GDP doesn't grow.  So, the country gets more valuable over time and we have more productive capacity and all.  So we can handle more debt, but...it should be proportional to...the wealth and earnings of the country.

On taxation and marginal tax rates:

I don't...like [a value added tax because]...it's regressive and you know, we don't need any more regressive taxes in the United States.  And I worked with the rich people...even when the top rate was 70 percent.  I worked with them when capital gains rates were 39.6 percent and not one of them said, you know, it's 1:00, and instead of working this afternoon I think I'll go to the movies because my marginal rate is so high.  I mean, if anything, they worked harder.

[T]axation is a way where you get to the excesses of what the market system produces and where you take care of the people who get the short straws

On income inequality:

[Y]ou want a prosperous country so you want a whole bunch of rich people, but you also want everybody to do reasonably well in something as prosperous as we have.  We have $45,000 of per capita GDP in the United States...but we've got almost 60 million people living in households where...the top income is $21,000 or less.  But a prosperous country should not just be prosperous for the people like me.  I'm prosperous because of the society around me.

There's a lot more, and it's well worth listening to the entire interview.  Consider this -- every year, Buffett auctions off a chance to have lunch with him, with the proceeds going to charity.  Earlier this year, that lunch cost the winner $1.68 million.

You'd get a chance to chat with Buffett for about an hour at that lunch.

If you don't have the coin to buy that lunch, you can watch the interview with Charlie Rose for $1.68 million less.

By now, you're sick of the financial press talking about Black Friday.  This is, of course, the day after Thanksgiving.  The name of the day supposedly came about because that is the day when retailers go from being in the red to being in the black for the year.

Of course, that's nonsense.  Most retailers now have earnings, not losses, in the quarters before Black Friday.

Another thing you'll hear is how critical Black Friday is for retailers.  Without strong sales on this day, you'll hear, the holiday shopping season will be weak.

According to some analysts, sales are probably meeting or exceeding expectations.  The National Retail Federation said that heavy promotions drove strong consumer traffic.  There are reports of individuals waiting as long as 20 hours in order to take advantage of discounts.

And traffic at malls run by Taubman Centers was up by about ten percent versus last year, the company said.

However, the lines were driven by customers seeking deep discounts.  Obviously, deep discounts yield lower profits for retailers.  While we likely won't see the discounts that we saw last year, where companies like Saks cut their prices by as much as 60 percent and offered extra points to its most loyal customers.

Still, for all the hype about Black Friday, the day isn't even the most busy shopping day.  That day is usually the last Saturday before Christmas.  And an analysis done for the Washington Post by a retail analyst found that there's very little correlation between Black Friday sales and the overall holiday season.

So, investors would be well advised to not listen to the hype about Black Friday.  It's one day in a long holiday shopping season, and a lot can happen between now and Christmas.

Many investors probably thought that the global financial crisis that the world suffered through during the end of last year and early this year had been solved.  Others warned that there was another shoe to drop.

The Dubai crisis, which analysts at Bank of America said may escalate into a "major sovereign default," serves as a reminder that while a total collapse of the world's financial system has been averted, many risks remain.

"One cannot rule out -- as a tail risk -- a case where this would escalate into a major sovereign default problem, which would then resonate across global emerging markets in the same way that Argentina did in the early 2000s or Russia in the late 1990s," Bank of America analysts wrote in a report to clients.  They added that Dubai defaulting on its debt would be a "major step back" in the recovery from the global financial crisis and would result in a "sudden stop of capital flows into emerging markets."

Dubai borrowed $80 billion over a four year period to build itself into a tourism and financial hub.  It was known for "outrageous" construction projects which even prompted AskMen to compile a list of the Top Ten Outrageous Dubai Construction Projects.

However, just like a real estate speculator in Las Vegas, Dubai has been pounded by the downturn in real estate.  It has suffered through a 50 percent drop in real estate prices from their 2008 peak.  By comparison, Las Vegas, the worst housing market in the United States, had a 55 percent price drop.  However, unlike Dubai, that drop came over a 37 month period versus a single year.

Bank of America said that 'in a best-case scenario, this will remain limited to a Dubai corporate sector problem, with either some bailout from UAE authorities or a market-friendly debt restructuring."  They estimated that Dubai's external debt is 103 percent of its GDP.

Not surprisingly, stocks plunged on the news.  The Dow was off as much as 233 points before recovering to close down by 154 points, or 1.5 percent at 10,310.  The S&P 500 fell 1.7 percent to 1,091.  And the Nasdaq dropped by 1.7 percent to 2,138.

For the week, the Dow dropped by 0.1 percent.  The S&P 500 was actually up by 0.01 percent for the week.  And the Nasdaq closed the week down by 0.4 percent.

Investors will need to watch what happens with Dubai and its debt issues over the weekend.  A positive resolution, or signs of one, will likely cause a rally. On the other hand, if the problems drag on, it is likely that stocks will react negatively to the news.

The dining room table wasn't the only table full of things for investors to feast on.  On Wednesday, investors got a feast of economic data.  Data was released on consumer sentiment, initial jobless claims, new home sales, personal income, and durable goods.

Initial unemployment claims for the week were down by 35,000 to 466,000.  This was the lowest level in more than a year and the best report since September of 2008.  Continuing claims also dropped by 190,000, down to 5.42 million.  The last time there were fewer initial claims was the week of September 13, 2008, when 459,000 filed initial claims for unemployment.

Only one state, Florida, reported an increase of more than 1,000 claims.  That was countered by the 22 states that reported a drop of more than 1,000 claims.  The list of states that had a decrease of more than 1,000 claims was led by California, where nearly 8,000 fewer claims were filed than in the week before.  However, that positive news was tempered by news that a shorter workweek drove down California's claims.

Analysts had expected initial unemployment claims to drop to 500,000, so the news was much better than expected.  Estimates ranged from 460,000 to to 512,000, so the actual number came in close to the most optimistic estimate for initial claims.

The unemployment data, according to analysts, shows an improving trend.  Employers are shedding jobs at a slower rate but they have not yet returned to increasing their headcount.

Personal incomes gave investors an additional helping of positive economic news.  The government reported that personal income increased by 0.2 percent and personal spending increased by 0.7 percent.  The savings rate declined to 4.4 percent, down from 4.6 percent in September.

Analysts had expected personal income to increase by 0.1 percent and personal spending to increase by 0.5 percent.  Thus, the increase in both spending and income was better than expected, and a positive sign for the economy.

New home sales also increased, with sales increasing by 6.2 percent to an annual rate of 430,000.  That pace was the highest rate of new home sales since September 2008.  Analysts had expected that new home sales would climb to 402,000, with estimates ranging from 350,000 to 425,000.  Thus, the actual number of new homes sold climbed above even the most optimistic estimates.

Some of the increase in sales may have come as home buyers hurried to take advantage of the $8,000 tax credit for first time home buyers that was set to expire at the end of November.  However, that credit has since been extended.  It is possible that the sales that were pulled forward will cause sales to drop in the next few months.

However, as has been the case recently, the good economic news was tempered.  First, durable goods orders plunged unexpectedly by 0.6 percent.  This was the second decrease in three months.  Excluding the volatile transportation sector, orders dropped by 1.3 percent.  Without defense related goods, durable goods orders rose by 0.4 percent.

The report was seen by analysts as reflecting a reluctance on the part of companies to make capital investments.  Companies are hesitant to spend money on new equipment because they are concerned that high unemployment levels will cause consumers to pull back on spending.

Thus, the drop in the University of Michigan's consumer sentiment index, which showed a decrease to 67.4 from the prior month's 70.6, is a cause for concern.  According to the director of the survey, ""Consumers cite their deteriorating finances as well as their uncertainty about future job and income prospects more than ever before, and this has made them very cautious spenders."

The survey revealed that consumers are extremely pessimistic about their income.  Only nine percent of the respondents reported an increase in their personal incomes, and 38 percent said that a cut in their income was their biggest concern.  What is even more concerning is that very few respondents anticipate income gains and those that are expect small gains.

This naturally had a serious impact on planned spending.  When asked about the purchase of durable goods such as furniture, appliances, and home electronics, 39 percent said they will postpone their purchase of these items.  That was only beat by the 47 percent who said this in the November 2008 survey, which was the worst on record.

The consumer sentiment index caused analysts to say that the consumer is a long way away from being a major contributor to growth in the economy.  It is likely that until the labor market improves, consumer spending, which accounts for 70 percent of the economy, will remain weak. That means we will see a weaker than normal recovery.

Regular readers will remember that back in early October, we highlighted a report from Citibank which recommended buying shares of Tiffany & Co.  The logic behind that report was that the company was well positioned to take advantage of weakness on the part of its competitors.  It was a contrarian bet, as most analysts said that consumers would be on a budget and seeking practical items.

This morning, the company reported its third quarter earnings.  The company reported that in the third quarter, it had sales of $598 million, down by three percent from the year ago period.  Earnings from continuing operations were $43 million, or $0.34 per share.

More importantly for investors, the company raised its earnings guidance for the year.  The company had previously guided investors to expect $1.65 to $1.75 per share.  With its third quarter earnings release, investors were told to expect earnings of $1.88 to $1.98 a share.

On top of that, the company reported that cash and equivalents more than doubled, increasing from $160 million to $375 million.  This cash gives the company the chance to move in on weakened competitors and to fund expansion of its operations.

Analysts had expected the company to report earnings of $0.23 a share on revenue of $576 million, so Tiffany beat both figures handily.

The stock, not surprisingly, surged in trading before the market opened.  The stock jumped to $44.45, an increase of 6.3 percent.

If the results coming from Tiffany are any indication of what's in store for retailers, the horrible holiday shopping results expected may not actually materialize.

As you know, last Friday was the options expiration date for the month of November.  That means that some positions were closed out or called away, and those positions had to be replaced.

In what is an unusual development, three positions we held were called away.  Our positions in Ford, Mylan Laboratories, and Qualcomm were called away.  This was unusual because about two thirds of all options expire worthless, so to have three positions called away is unusual.  Nevertheless, we'll book the income from the options as well as the capital gains and call it a day.

We took the money that we gained from having these positions called away to beef up our position in Johnson & Johnson.  As you'll recall, this stock was one of the ones we highlighted in our post on a do it yourself income fund.  We also increased our position in ABB, which you'll recall was something we entered as a play on a smart grid and a push by companies to improve the efficiency of their processes.

Then, in order to generate more income from our portfolio, we sold covered calls.  We sold calls on our positions in ABB, GE, and Johnson & Johnson.  ABB's $20 December calls were sold at $0.30.  The price we got for GE's $17 December calls was $0.16.  And we were paid $0.15 for our $65 December call for Johnson & Johnson.

Hopefully, this month, our calls will expire worthless.  If not, then we will replace our positions with new ones.  In any case, as regular readers know, much of our trading gets done around the options expiration date for the month.  If our positions get called away, we need to replace them.  If they don't, then we need to roll them over.

This morning, investors got some good news on the economy.  Both GDP in the third quarter showed growth and housing prices continued to show improvement.

The Commerce Department reported that its second analysis of third quarter GDP showed growth of 2.8 percent.  That was down from the initial estimate of 3.5 percent, as new data collected by the Commerce Department showed that growth was not as strong as the preliminary data indicated.

The increase in GDP, according to the Commerce Department, was driven by an increase in personal consumption, exports, and residential investment.  These were partially offset by an increase in exports, a drop in state and local government spending, and a deceleration in the pace of federal government spending.

The revised growth in GDP exactly matched the consensus estimate.  Estimates ranged from a gain of 2.4 percent to a gain of 3.5 percent.  Consumer spending accounted for 2.1 percent of the gain in the economy.  That is important, as consumer spending is so critical and the fact that it's increasing despite high levels of unemployment is a positive sign for the economy.

The Case-Shiller home price index showed that home prices increased for the second quarter in a row in the third quarter and that it increased its rate of gain.  In the third quarter, home prices were down by 8.9 percent from the year ago period.  That is much better than the 14.7 percent drop in the second quarter and the 19.0 percent drop seen in the first quarter.

Housing prices increased by 3.1 percent in the third quarter, the same as in the second quarter.  "We have seen broad improvement in home prices for most of the past six months.  However, the gains in the most recent month are more modest than during the seasonally strong summer months," the release accompanying the data said.

Economists had expected that pricing would drop by slightly less than the actual data, so the news on the pricing front was not as positive as expected.  However, the improvement in the pace of declines was viewed as positive news.

As you know, housing dragged the economy into the worst recession since the Great Depression and it needs to recover before the economy returns to strong growth.  Analysts said that the latest data shows that the worst of the housing market declines are likely over but they caution that we are not out of the woods.

The National Association of Realtors reported today that existing home sales jumped by 10.1 percent, to a seasonally adjusted annual rate of 6.1 million units.  That is 23.5 percent higher than the October 2008 figure of 4.9 million homes, and is the highest number of sales since February of 2007.

The gain in sales took analysts by surprise.  Analysts had expected existing home sales to climb to an annual rate of 5.7 million, with estimates ranging from 5.2 to six million.  So, the actual figure came in even higher than the most optimistic analyst.

The increase took even the National Association of Realtors by surprise.  The normally overly optimistic organization said that the gains may have been driven in part by the anticipated expiration of the $8,000 tax credit for first time home buyers.  Now that the credit has been extended and expanded, the organization said, "a measurable decline should be anticipated in December and early next year before another surge in spring and early summer."

As you know, the downturn in the housing market helped start the economy on the path towards the worst recession since the Great Depression.  A recovery in the housing market would go a long way towards pushing the economy back into growth.

Analysts say that the housing market is showing signs of a rebound.  The jump in existing home sales was called a sign that there is a lot of demand in the housing market.  Barclay's Capital called the gain "impressive" and said that "the housing market recovery will be a durable one."

The National Association of Realtors concurred.  "Existing home sales have already bottomed. Home prices are almost there. We are seeing a less of a decline in house values," the organization's chief economist said.

Cabot Money Management said that the home sales numbers were a sign that it was a "relief" that the "tax benefits going into the housing market are working."  They added that "everything is about housing and jobs right now."

So, the week opened up on a good economic note, and stocks will likely move up.  Stocks of home building companies like D.R. Horton and KB Homes are likely to jump.  Now the question is whether the rest of the week's economic data on GDP, consumer confidence, durable goods, consumer spending, new home sales, and jobs.  It is a short week with the Thanksgiving holiday, but it's going to be full of economic data that will move markets.

This week's issue of Barron's cover story is titled 10 Terrific Dividend Stocks.  It talks about how the market's recent drop has made it possible for investors to purchase "high quality dividend paying and dividend growing stocks" at a discount.

That got us thinking.  With money market yields miniscule -- the average money market account is yielding just 0.31 percent -- why not use those dividend stocks to create an income fund on your own?  Of course, unlike a money market account, the principal amount will fluctuate, as the stocks in that portfolio will change in value.  But if you're looking to generate income from your stocks and not as concerned about day to day fluctuations in the price, then you can use high quality dividend stocks as a proxy for a money market account.

What we did here is look at the companies that Barron's listed as its ten best dividend stocks, and we also looked at the additional ten that they provided.  We wanted to make sure that anyone putting this together would get income every month.  That meant we had to make sure we had stocks paying their first dividend in January, February, and March.  Then the cycle would repeat throughout the year and investors will get receive dividend income every month.

This would mean that we need a minimum of three stocks.  However, in order to diversify our portfolio, we chose six.  These are all high quality companies who can easily pay their dividends from the cash flows they generate.

We took the list of 20 that Barron's generated and we narrowed it down further.  We used several criteria to make this happen.  First, we wanted to make sure we had a portfolio that would generate income every month.  Then, in order to keep us from overpaying for the stocks we selected, we chose stocks with lower price earnings ratios when possible.  We also wanted some diversification.  For example, three of the top yielding stocks are telephone companies, so we scratched one from our list.

When we were done, the stocks we selected were AT&T, Verizon, Merck, Chevron Texaco, Lockheed Martin, and Johnson & Johnson.  These stocks all yield at least 3.1 percent, so investors purchasing these stocks will get a yield that's ten times higher than that of a money market account.  Of course, in order to get that additional yield, investors are accepting the risk that they may lose money on the underlying investment.

Verizon and Merck pay out on a January cycle.  AT&T and Chevron Texaco pay out on a February cycle.  And Lockheed Martin and Johnson & Johnson pay out on a March cycle.  That means every month, investors will get a two dividends from their stocks.  These stocks are also reasonably prices, with Johnson & Johnson's 12.7 price earnings ratio the highest among the group.  The average for the S&P 500 is close to 20 times earnings.

Furthermore, investors can boost their income from these stocks by selling covered calls on them.  This allows them to generate even more income from their positions.

All in all, this self created and managed income portfolio will allow investors to generate income from their stocks through dividends and covered calls.  These are also solid, secure companies that can cover their dividends and who will likely raise them in the future.  Investors looking for a relatively safe and low cost method to generate income may want to look into this.

NOTE:  THIS DOES NOT CONSTITUTE A RECOMMENDATION TO PURCHASE ANY OF THESE EQUITIES.  INVESTORS SHOULD DO THEIR OWN RESEARCH BEFORE PURCHASING ANY STOCK.