TMFDeej (99.47)

Chicken producers are starting to crack / A theory that is whack / A big fat zero for Indymac / Back to the crack

July 11, 2008 – Comments (12)

A funny thing happened on the way to the meltdown in restaurant stocks caused by higher meat prices, a higher minimum wage, and a slowdown in consumer spending that I predicted...the entire stock market imploded.  Many of my real-life chicken producer and restaurant shorts were up around 30% in only a matter of a couple of weeks despite the fact that my thesis has yet to play out.  To quote Monty Python and the Holy Grail, Let's not bicker and argue about who killed who, or in this case about what reasons they are down...30% is 30%.  After going back and forth on the issue several times, late last week and early this week I began to close them all out, in real-life not in CAPS. 

Why did I do so you ask when my thesis has yet to entirely play out?  My spider sense was tingling.  OK, not really.  For one, 30% in a couple of weeks on a short is nothing to sneeze at.  It's not like we're talking about long-term buy-and-hold investments here.  Furthermore, while the price of beef is well above its year ago levels the price of chicken is still well below what it was at this point last year.

Chicken is still cheap because chicken producers have been extremely stubborn and have refused to cut production...until now.  I'm thanking my lucky stars that I covered my chicken producer shorts a couple of days ago because they exploded to the upside yesterday.  Whew.  The stubborn chicken producers are finally starting to crack they are finally starting to cut production.  Yesterday Department of Agriculture reported that the total of fertile eggs intended for incubators dropped by 4%.  This means that the number of chickens added to producer inventories will likely drop in the next couple of months.  This is the weakest this report has been in a whopping seven years and it means that producers are finally starting to understand that they're all doomed if they don't start to cut production.  Chicken prices for you, I, and restaurants will start to increase later this year. 

I have a feeling that we may end up seeing a number of restaurant stocks, particularly those that sell a great deal of chicken, beat analysts' second quarter estimates because chicken prices are still low and the stimulus checks are floating around out there.  If any restaurants get a big pop after their Q2 earnings are announced in July or August I may decide to short them again.  I have absolutely no doubt that high chicken prices and slowing consumer spending are coming, it's a matter of when, not if.

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Argus published a really interesting note on the "Rule of 20" yesterday.  For those of you who aren't familiar with it, basically the Rule of 20 states that the forward P/E ratio of the S&P 500 should be close to the number 20 minus the yield of the 10-year treasury note.  This rule has worked fairly well for the past four decades.  Any time the forward P/E ratio got ahead of this, the market generally corrected.  The current consensus forward P/E of the S&P 500 is approximately 14.5, while the rule of 20 (20- 4.0) is 16.  According to the theory, this indicates that stocks are a good value right now and that this might be a good entry point. 

While this is very interesting, I personally think that forward P/E ratios are a bunch of carp because they're only as good as analysts' earnings estimates.  In this case we may very well find that analysts are being way too optimistic about what earnings will look like.  Moreover, I expect interest rates to eventually rise some time next year.  If I was forced to guess, I personally would say that we are still far from the bottom in the S&P, but this theory at least makes for interesting discussion.

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As a former Indymac (IMB) shareholder who rode a tiny, dip my toe in the water sort of position down from $10 to $5 before learning the error of my ways and just how messed up the economy and housing market truely are, I got a good chuckle out of this piece of news: IndyMac’s new price target: $0.  Friedman Billings Ramsay recently cut its price target on IMB from $1 to $0.  HAHAHAHAHAHAH. Apparently the second largest independent mortgage originator in the country has no money left and no one is willing to give it any.

Man I am still staying the heck away from financials right now.  I keep telling myself that there are eventually going to be some good deals in this area like when Peter Lynch bought S&Ls by the handful back when they melted down, but I don't think that we're there yet.

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Refiners are getting crushed because they cannot make any money at a time when the price of oil is going parabolic, foreign refiners are increasing capacity, and people in the U.S. are cutting back on the number of miles that they drive.  Note to the government, the answer to the horrific crack spreads that refiners are seeing is not increased production capacity.  Basic economics tells us that when something is too cheap, the answer is not adding more of it to the market, yet this is exactly what the government is trying to encourage by introducing a 50% tax credit for refiners who increase their capacity by at least 5% (see article: Oil refiners' tax credit linked to plant expansion).  Stay far away from refiner stocks, I know that they have been crushed and that a new refinery hasn't been built in the U.S. since 1790, but this is not the bottom for them.

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Quick hits that illustrate what rough shape the economy is currently in:

-  U.S. sees 9.8% spike in '09 electric bills. Yuck.  Is your employer going to give you a 10% raise in '09?  I doubt it.  Here's yet another thing that already stressed consumers are going to have to pay more for in the future.  Companies and stores that sell discretionary items are in big trouble.

-  Six months, 343,000 lost homes. Yuck.  Despite what some people think, to meit appears as though the housing meltdown is getting worse, not better.

-  Cruelest summer for teen jobs since 1958.  Yuck "June employment for teenagers drops nearly 40% below 2007 levels as companies cut extra positions. Summer hiring for teens at lowest pace in 50 years."  This ties back into what I was saying yesterday about staying away from teen clothing retailers.  They are going to report some dismal results later this year.

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I leave you with this oldie, but goodie.  I love this video.  There must be some sort of subliminal message in this song because once I hear it I can't get it out of my head for days.

Deej