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JakilaTheHun (99.93)

Ten Thoughts for 2011

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December 03, 2010 – Comments (16) | RELATED TICKERS: FXI , SLV , NFLX

Here are my ten thoughts on investing going into 2011:

 

(1) The Eurozone is a scary place to be.  The basic problem is that there are huge economic distortions that have resulted from the Euro.  What needs to happen is "price convergence"; prices are too high in the PIIGS and too low in the "Northern Block" of Germany, Netherlands, Finland, and Austria.  Unless Eurozone officials begin to recognize that the issue has absolutely nothing to do with sovereign debt (which is merely a symptom of the "price convergence" issue), then it's almost inevitable that there will eventually be a national bankruptcy.  As "cheap" as things look in the Eurozone, I'm still hesitant to invest there.

(2) China is about to see its bubble burst sometime in the next two to three years.  Official have no control over the "shadow banking" system, which will continue to pump money into the economy, in spite of economic signals that suggest there needs to be less money there.  All of this goes back to the Dollar peg, which has eroded purchasing power and has squeezed consumers, which is driving inflation.  It's also driving the asset bubbles there; it makes sense from a logical perspective if you are a consumer to buy hard assets so that your money does not lose value.  Yet, the Chinese economy does not need more real estate or gold. Nor does it need more manufacturing capacity.  There is massive oversupply to external economies and undersupply to the consumer space. I don't know how long it will take, but eventually, the house of cards will crumble.

(3) The United States is slowly recovering.  It is held back by the currency distortions in Asia and the Eurozone crisis; however, things in the domestic sphere are starting to look better.  Only problem is that aggregate demand is lagging behind everything else.  Businesses are now sitting on s@#$loads of cash, but won't invest that money, because they see nowhere to invest it. Until aggregate demand rises, this pattern could continue.  So my guess is that we continue to see recovery at slow pace, but the economy will recover all the same. 

(4) Latin America and South America are the two best "emerging market" areas to invest.  Latin American economies have actually been held back by the currency wars in East Asia.  The currency manipulations of the East Asian nation are starting to backfire and this benefits Latin America more in the future.

(5) US homebuilders are very cheap right now.  Who knows how long before we see "normalized" production again, but at the current prices, I see no reason not to sit around and wait on it.

(6) Small and regional banks will eventually prove to be a great investment, but it may take awhile, and one must be very careful about which banks they are buying.  But even if you want to play it safe, you can find well capitalized banks that are selling at or below tangible common equity and will probably benefit from higher interest rates in the future. 

(7) Public REITs with lots of cash and liquid assets could potentially benefit from some of the distressed debt coming due in the next few years.  The private RE companies' suffering will be the public REITs' gain.  

(8) Pain in Asia has the potential to filter out quite a ways.  Think Australia. And maybe Canada.

(9) If China's economy dramatically slows, gold, silver, and copper could all see negative price action.  China's gold buying in 2010 has increased five-fold from gold buying in 2009.  If this demand collapses, gold prices could drop considerably.  While this might only mean a 10% - 30%  drop in the price of gold, it could be much more harsh on vulnerable gold miners, particularly the major gold miners who have been purchasing new resources at inflated prices.  Silver miners are also a very scary bet right now and extraction costs are nowhere near the spot price. Of course, the bubble could continue to move on for another 6-24 months; but I think the risks are definitely starting to get higher and investors need to be more concerned about the downside.

(10) Don't forgot the rule of abnormal earnings.  "Abnormal earnings" is an economic term that implies that a "normal profit" exists and that if a firm is earning above that, it achieves "abnormal earnings."  Abnormal earnings entice new competitors to enter into an industry.  Unless there are significant barriers to entry, a firm will have difficulty maintaining those abnormal earnings for an extended period of time.  Investors might not be understanding the concept of "abnormal earnings" when applied to Netflix (NFLX).  NFLX has a competitive moat around the DVD-by-mail market; so it can protect its abnormal earnings in that sphere.  Unfortunately, that sphere is dying and it's now competiting in a sphere (streaming content) that theoretically has fewer barriers to entry.

 

Those are my thoughts.  Feel free to love them, hate them, or be indifferent to them. ;)

 

Disclosure:  I am investing in long, short, and option position in regards to most of these themes.  I own long-dated puts on NFLX. 

16 Comments – Post Your Own

#1) On December 04, 2010 at 1:10 AM, PaxtorReborn (29.60) wrote:

Jakila, you're a bank man, I've been meaning to ask you on your opinion (if you have one) about the Big Five Canadian banks.  In my opinion they are overvalued largely due to the Inflated Canadian housing prices, their oligolopy and the sense that Canadian banks are "more responsible" and a "model for the world".

I'm currently short TD and Royal Bank through long dated puts and long various USA small/mid sized banks.  

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#2) On December 04, 2010 at 1:24 AM, jgknot (30.98) wrote:

reg NFLX,

it is indeed scary at around 50 forward PE. sure for correction.

but i never short the thing because of

1.possibility of a takeover, with all BIG guys holding loads of cash

2.increasing subscribers.. for 10 bucks, easy switch over from cable to netflix (like i did)

3.business model solid and evolving..(streaming and all the content deals)

4.no credible competitor as of today, even if one comes they have to price it below netflix, which  only the BIG guys can do for that margin. 

with the bluray's and high def TV's, disc's may stay for a while so until amazon comes with a solid plan, i sit tight

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#3) On December 04, 2010 at 1:44 AM, JakilaTheHun (99.93) wrote:

Paxtor,

Haven't done any research on the Canadian banks with the exception of RBC (which I wouldn't recommend shorting due to the very high capital levels and internat'l exposure).  

I've looked at some of the Aussie banks and I have a similar thesis on some of those banks as you have on the Canadian banks.  Australia and Canada both have very resource-dependent economies, which is why they are doing so ridiculously well right now, but that also may be one of the reasons the housing markets in both nations seem inflated.

Your thesis might be right; I've just not looked at the valuations for the Canadian banks enough to know.  I agree with you, though, that there is a misconception that they are "more responsible."  In actuality, they've merely not had the issues with the housing market that we've had and they might be more dependent on China than the US (which is what a lot of people are missing).  

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#4) On December 04, 2010 at 1:50 AM, JakilaTheHun (99.93) wrote:

jgknot,

The possibility of a takeover is virtually nil at this price.  No company is foolish enough to buy them at over $200. 

As far as competition needing to 'price below Netflix', I disagree.  Someone could come in and price above Netflix and offer greater content and squeeze Netflix that way, as well.  When you get right down to it, the streaming service only covers a small portion of overall movies, TV shows, etc.  I'd pay $20 per month for a service that allowed me to stream about 4X - 5X as much content as NFLX. 

 

I think it's an excellent short at this point.  The only question is whether one can obtain the shares, because it's very heavily shorted at this point.  The puts are priced very high, as well, so there's obviously a large contingent of people betting against the price right now. That's probably the biggest risk if you are going short/buying puts.  

Still, even if it's a "crowded trade" betting against it, I just don't see how the economics of this can work out.  NFLX isn't earning anywhere remotely close to what the stock price implies their future earnings should be.Even if no competition ever moves in (which seems unlikely), they still might not be able to earn enough to justify the stock price.  So ... I don't see how the stock price makes sense on any level. 

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#5) On December 04, 2010 at 12:13 PM, dbjella (< 20) wrote:

Can you further explain what you mean by the following?

sovereign debt (which is merely a symptom of the "price convergence" issue), 

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#6) On December 04, 2010 at 12:49 PM, JakilaTheHun (99.93) wrote:

When each nation went off their national currencies, those old currencies were pegged to the Euro, and the Euro became the sole currency. 

If one currency was overvalued relatived to the intrinsic value of the assets of a country, then prices would need to fall to reach equilibrium.  Conversely, if one currency was undervalued relative to intrinsic value, prices would need to rise. 

German, Austria, the Netherlands, Finland, and even Belgium have been the primary beneficiaries here.  Prices are too low, which has been a major benefit for German exporters, who have been able to export more cheaply, all the while borrowing at much lower rates due to the structure of the Euro. 

Meanwhile, Spain, Portugal, Ireland, and Greece have all suffered severely.  Prices were too high, so their exporters have had to deal with an artificially strong currency, that hurt exports.  As exports fall, so does GDP, and the economy weakens. 

In a system where each nation has its own currency, this is not that big of an issue, because if prices are too high, the underlying currency can adjust to new market conditions.  As such, exporters will gain an advantage, which will help improve the economy.  

Unfortunately, that's not how it works under the Euro.  As the prices in Spain fall, the currency (the Euro) does not fall proportionately to the fall in Spanish prices. As the economy weakens, governmental revenues fall,as well.  Once again, this might not be a problem in a place like the US, because interest rates would fall, as well, which would help lower government borrowing expenses. In Spain, though, interest rates rise, because they are forced to pay all their debts in an artificially strong currency. 

So basically, there are underlying market forces trying to push towards certain results, but the Euro prevents those forces from working as they normally would.  Instead, the weakness in the PIIGS nations results in higher interest rates in the PIIGS, but lower interest rates in the "Northern Block".  The PIIGS see their exports continue to suffer, while the "Northern Block" continues to benefit in spite of market forces saying the reverse should occur.

The only way to fix the issue would be to come up with some mechanism that allowed for price convergence to occur, such as taxing the current account surplus nations and redistributing it to the current account deficit nations until the distortions were minimized. Or possibly by changing the borrowing structure, so that all the Eurozone nations borrow from the ECB at the same rate, rather than holding their own debt auctions.

As is, market forces aren't allowed to operate normally and thus redistribute wealth from the PIIGS to the Northern Block.  In fact, the recent "bailouts" have actually exacerbated the issue by imposing harsh austerity terms on Ireland (and eventually Portugal and Spain in all likelihood). 

You might wonder why austerity won't work, but it's really quite simple:

(1) Raising taxes causes underlying asset values to fall

(2) Lowering government spending causes the cash flows for properties to fall, which also lowers the underlying asset values

So basically, nominal prices are too high relative to intrinsic values,and Germany has decided to "fix" this issue by lowering the intrinsic values of Irish assets even more, so that assets are even more overpriced than they were before. 

 

The only thing that shocks me is that none of the PIIGS have really revolted against this system yet.  So far, they've bought into the austerity programs, that are almost surely destined to fail, because they don't address the price anomoly issue. 

Since there will be more downward pressure on prices, all that will happen is that the troubled banks will become more troubled.  It fixes nothing. 

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#7) On December 04, 2010 at 1:03 PM, TMFBabo (100.00) wrote:

What are your thoughts on natural gas? I posed this question to UL on his blunt man thread, but I value your opinion very highly and I'm curious to see what you think.  Here's the short version of my case for natural gas:

1. Too many producers are operating at far above breakeven

2. Hedges unfavorable to the producers will eventually start to roll off

3. It's the only commodity that hasn't run up.  Seriously, everything else is much higher than before: coal, gold, silver, copper, iron ore, coal, sugar, coffee, etc.

4. Oil/natural gas ratio is at a historically high number (I've heard "all-time" but I haven't researched to confirm).  This is a number with actual utility, since 5000-6000 mcf of natural gas and 1 barrel of oil produce roughly the same amount of energy

5. The increased supply is not a "new normal" - some producers drill despite bad economics because of land lease issues

Agree or disagree? I'm not asking for natural gas prices to go to the moon, but I think $5 to $6 is a much more appropriate range right now per mcf.

I still don't like most natural gas producers like I don't like most dry bulk shippers, but I have a few plays in mind.  

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#8) On December 04, 2010 at 1:18 PM, JakilaTheHun (99.93) wrote:

Babo, 

I'm sort of neutral on natural gas producers right now.  Admittedly, I don't feel like I know the industry well enough so that I'm capable of making "good calls" except when there are obvious misvaluations.  I think that was the case in early '10 (I bought into WES in particular), but now ... I'm not so sure.

 

The first thing I would say is that I would not buy into natural gas itself.  While I do think the prices will probably rise a slight bit from here in the next few years, the technology continues to improve so much that prices might continue to fall over the long-term.  We keep finding more and more natural gas here in the US, so greater supply keeps prices down.

That's why I've really only been investing in companies involved with the whole natural gas cycle (seismic companies, producers, distributors, etc) in some form. I've completely stayed away from the underlying commodity.

Oil/gas ratio is pretty meaningless if you ask me.  Oil is becoming more difficult to find and expensive to extract.  Natural gas is becoming easier to find; even if some of the processes are "more difficult" to use, the more we use them, the better the technology becomes. 

 

I think there probably are a few good plays in the sector still; just don't feel like they are the type of plays that I'm knowledgeable enough to find.  Don't know if that was a useful analysis or not.

 

 

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#9) On December 04, 2010 at 1:42 PM, TMFBabo (100.00) wrote:

I'm sort of neutral on natural gas producers right now.

That sums up your thoughts, I'd say.  That's a lot better than "I'm bearish." 

I agree on not buying into commodities - I much prefer to buy companies, since you buy into companies with wonderful management or potentially undervalued plays (distressed, special situation, etc)

I think the oil/gas ratio actually does have interesting implications.  If this is the "new normal" for natural gas, there are places where natural gas is more economically viable than other sources of energy given the price.  Heating oil vs. natural gas is a good one, as is a natural gas power plant. 

I believe things like that would cause more demand for natural gas as long as it's the correct thing to do in terms of energy efficiency.  I'm a newbie at this energy stuff, but the only way to learn is to dig in and win (and lose) with a few companies.  I do believe there are more situations that I haven't heard/thought of before.

My preferred method of playing natural gas involves buying into companies that are distressed versus others and you can buy assets cheaper than otherwise.  If you're paying $1.00 per mcf vs. $3.00 per mcf (just random numbers), the former play is potentially more undervalued.  It's also more likely to be distressed in some way, but there are companies that are trading at much bigger discounts relative to their peers.  These companies often come with warts (dilutive recapitalization, debt fears, whatever). 

Still, buying assets at 33 cents on the dollar (or even less) post recapitalization (bankruptcy risk down tremendously) is an interesting way to create value for yourself.  The low upside potential here is that the company becomes fairly valued relative to its peers, or at least that the gap narrows a bit.  That's a potential double or triple even if natural gas stays depressed, as long as the new leaner company can improve operations.

You could argue that you could do this in any industry and it's true.  I like natural gas in particular because there's also a high upside case: natural gas prices go up and you make money that way too.  It's more likely for a beaten down commodity to go up than it is for one that's already run up.  

I intend to go through other commodities and repeat the same exercise: buying assets on the cheap.  I saw a silver mining company a while back that has assets in the ground for 1/5 what other assets in the ground are worth.  Companies that don't produce obviously don't attract the same valuations per oz that producers do, but comparing apples to apples (silver in the ground vs. silver in the ground), I saw a mispricing. 

These companies often come with debt fears when their assets are 20 cents on the dollar relative to peers, but I've seen that these fears push stock prices down much further than they should go, given the circumstances.  

You know, my comment here is more a bull case for special situations than it is for natural gas.  

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#10) On December 04, 2010 at 1:44 PM, lemoneater (79.15) wrote:

Jakila, another helpful blog. My natural gas investment is SE which operates pipelines. I wonder why we don't look more to natural gas as a possible energy solution. What makes oil the dominant energy fuel here, anyway? 

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#11) On December 04, 2010 at 4:15 PM, walt373 (99.79) wrote:

I think the major differences between oil and natural gas are...

First, transporting oil is way easier and so it is more of a global commodity. You need to liquify natural gas in order to transport it (LNG) so it's not as easy or economical. Because of this, you will see oil responding to demand from all over the world (like China and India), but natural gas demand is more local. Most commodities have risen due to Chinese demand, and this is partly why natural gas has not.

Second, most cars don't run on natural gas. They can, but you need to have natural gas engines or something, or install devices that allow you to use natural gas instead of gasoline.

So nat gas and oil are not really subsititutes for each other in equivalent amounts of energy. Natural gas has some pros over oil but oil is more useful in general right now.

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#12) On December 04, 2010 at 5:18 PM, jgknot (30.98) wrote:

iam not bullish on NFLX, but cautious to short.

may be 200 is a little more on the high end at this point.

 i see you short at around 155 , which means you see the price well below that. so what is your price?

you said you will give 20 bucks for 5X content, me too, but is there one available from anyone else now..no.

only an amazon, microsoft or sony likes can make it happen..

but they may just buy NFLX too, say it go to 150 and they buy for 200. 

hulu is charging 8 bucks for some tv shows with ads too, netflix may take that route too, to increase revenue, few little ads in their content. 

with xbox already in the living rooms, more content delivery by MS would be great , so they may go for buying at a premium, to improve their entertainment business , to compete with apple 

e coffee table (gates talked about) / epad to compete with ipad to  see your contents or use it to see it on TV

In the future apple, msft, google, are going to dominate, so they are going to gooble up as much and whenever they can.

if groupon was talked for 3-6 billion and got rejected , i see netflix easily above 10B, as it gets you to reach targeted audience.

its all about strategy..right things need to move at right time.

 P.S. Iam not a good script writer or an editor

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#13) On December 05, 2010 at 1:30 AM, Morijo (28.01) wrote:

Don't know if you follow this fellow Walayat but I've beem pretty impressed the past two years at how he has read the situation

He agrees with you that austerity won't work in Europe and ranks countries on both their debt default risk and contagion risk.  http://www.marketoracle.co.uk/Article24619.html

I get the impression he is not keen on what the US is doing but agrees it is better than austerity

 http://www.marketoracle.co.uk/Article24281.html

 I also agree with you on Canadian housing prices (being Canadian). Canada is in lala land but sure to reach earth .

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#14) On December 05, 2010 at 2:00 AM, JakilaTheHun (99.93) wrote:

Morijo,

Interesting stuff. 

I'm not particularly keen on what the US is doing either, but I believe it's very widely misunderstood.  I'd also argue that, flawed as it may be, it's better than what the European nations are doing.

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#15) On December 05, 2010 at 3:38 AM, IgnoreTheCrowd (< 20) wrote:

(5) US homebuilders are very cheap right now.  Who knows how long before we see "normalized" production again, but at the current prices, I see no reason not to sit around and wait on it.

 

Strongly agree with you on this one. Do you have any specific companies in your mind that are well positioned than others in the sector?

I personally like MDC, TOL, PHM, DHI, MHO,  MTH at this moment for long term.

Really would like to hear your detailed opinions on homebuilders.

+1 rec.

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#16) On December 06, 2010 at 11:15 AM, jgknot (30.98) wrote:

well, as i know the only way i can get you is by making the morgan stanley guys raise the nflx estimates..so i made it happen.

ha..ha.. 

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