May 2 Post

Hi again,

Be cautiously optimistic! On 4/19/17, CNBC announced that there has been a recent increase in smaller investors getting in to the stock market while the big institutional investors are reducing their holding in the equity market. For the past 30 years, this is another sign that the market is ‘topping off’. Small investors come at the end of a stock market rally and they are the last to leave; so the next time around, after getting previously ‘burned’ always miss the beginning of a market rally. By the way, I want to say a word about CNBC. In the 1980s first TV channel that created a 24/7 channel was called Financial News Network (FNN) which was very popular among finance professionals. Usually from 4am to 4pm Pacific Time, they only cover the financial markets with the ticker tape running on the screen.  

In 1991 under pressure due to scandals, FNN went off the air for the last time at 6 pm on May 21, 1991. CNBC immediately took over FNN's satellite transponder space, more than doubling its audience at one stroke. It branded its business day programming as "CNBC/FNN Daytime" until 1992. CNBC incorporated features of FNN's ticker into its ticker. While most of FNN's employees were fired, a few FNN anchors and reporters including Bill GriffethRon InsanaAllan Chernoff and Joe Kernen were retained. Sue Herera, who joined FNN at age 21 and very soon became an anchor, moved to NBC and the brand-new CNBC prior to the demise of FNN. Griffeth and Herera were later reunited at CNBC and co-anchored Power Lunch until 2011. CNBC adopted the "look", news style and stock ticker of FNN, so in a sense FNN's legacy continues in CNBC.(History of CNBC,CNBC,6/7/16).

Prior to December 2016, the market index was moving within a given range (17,900 and 18.500) for more than 18 months; and at that time, on several occasions, I wrote in my newsletters that when the market stays within a given range for 18 months, it is always followed by a big move to the upside. The market rally that started on 11/4/16 at 17,888 reached 21,115 on 5/1/17. Market runs on mass psychology. Prior to October 1987 I was following a market technician named Robert Prechter (who began his academic studies in psychology). He used a very mathematical theory called the Elliot Wave Theory. Elliot was an accountant by trade. According to that Theory there are 5 waves in a bull market (3 waves going up and 2 going down). In a bear market, there are 3 waves, 2 going down and one going up. Elliot discovered that the ‘golden ratio’ (1.618) applies to the study of universe as well as the study of financial markets. In 1987, Prechter predicted a new high in August 1987 and then a severe correction in September/October. In September, 1987, a friend of mine told me that his daughter just became a stock broker in NYC and I told her to get a different job as a ‘crash is coming’. Thereafter he used to tell his friends that I predicted the crash of 1987. However Prechter was wrong about the aftermath as he thought the bear market would last for decades and he did not see how Fed Chairman Greenspanbrought up the markets by pumping the money supply.

When the market passes a ‘psychological thresh hold’ (i.e.10000,20000 and so on), it is important to monitor how it will perform to make predictions about the future.  Usually crossing such a thresh hold, takes time. Market would go up, bump against it, drop down and so and then crosses it. We saw this with crossing the 20,000 level recently. At that time, 20,000 was considered as a ‘ceiling’. If the Dow can manage to stay above 20,000 for a long time with good volume, then we would be able to consider 20,000 as a ‘floor’ where the probability of the market staying above that is rather high. In a correct or a crash, all bets are off.  The week ending 4/28/17 was a classic example as the ‘market’ (Dow) keeps hitting the now ceiling of 21,100 but not being able to keep above that level-as it is said on Wall Street, ”it was testing the 21,000 level” . This does not mean that we will stay in this position for a long time. Usually the lowest drop is about 62%. Even though we have been above 20,000 since early February 2017, since 3/2/17, we have been on a slow descent.

There are so many saying and theories on Wall Street. Some strongly believe in the saying, “Sell in May and go away”. These traders sell in May and buy back in late Fall when (at times), the market is low. However if you did that in 2009 (one of the best years for the market), the opportunity cost would have been greater than 12% in 3 months! This is why I want you to have at least 50% in cash at all times. You cannot maximize your gains but that should not be your objective. There is another saying on Wall Street, “If you try to make a killing in the market, the market will kill you”. Slow and steady wins the race! September is the worst month for the market and all the crashes took place in October. Personally I have noticed that if we have a severe correction prior to September, even early Fall could be bullish for the market.

Ford- As you can see from our scoreboard, our historic gain on Ford is diminishing and it is getting closer to our average cost. Usually, when our prices go below the average cost, I suggest that you buy more to further reduce the average cost. “Plant the seeds now to reap the harvest later”. I remember 8/24/15 very well. The first hour of the market, it was brutal brining down most stocks. Ford was one of those stocks that got hit badly. However within minutes, tremendous amount of orders came from Europe that Ford rose so sharply, the market automatic circuit breakers went in to effect to stop trading for a few minutes! Times have changed since then. The Federal Reserve had 2 interest rates hikes and have promised much more in the future. Already loan losses in the auto industry have begun to rise.

Given interest rates close to 0 and since we had the global market in a major slump, most Americans have been buying expansive gas guzzlers. Now it is very likely the trend will shift in the future. To make matters worse, auto makers might have to give cash incentives to draw in customers that would cut in to their bottom line; which is not good for the stock price. Auto makers too shifted their small car production to Mexico while keeping the gas guzzlers in the US. When consumers shift from gas guzzlers to small cars again (as they have done in the past), US employees would be the first to lose their jobs. This time around if Ford goes below our average cost, we should be cautious in buying more but that does not mean we should not do it.

In a rising environment, to be in a bond mutual fund is suicidal. If you want to hold bonds, buy the actual bond where you get 100% of your capital; short term is better than long term. A couple of years ago, when the credit market was headed for a total disaster, Carl Icahn (one of the best on Wall Street), commented that investors were taking an unnecessary risk by going for junk bonds that were generating a 0.5% more than the rest. With investment grade you can get more than the treasuries but less riskier than the junk bonds. Consider investment grade corporate bonds. They are not important as treasuries to the global market and not exciting as the high yield market, so they are easy to overlook. Sitting in the middle of the risk spectrum, investment grade bonds could be the perfect compromise for an unsettled time.

Unlike treasuries or junk bonds investment grade bonds are positioned to perform reasonable well under most scenarios. If developed economies remain stuck in a new normal of low growth, inflation and interest rates, junk bonds could be the biggest beneficiaries. As it stands, investors are having hard time quitting junk bonds. Over the past 12 months, junk bonds returned 13.9% according to Bloomberg Barclays Indices data, versus 3.5% investment grade bonds and -0.2% for US Treasuries. The tax reform risk cuts both ways; if the tax deduction for interest expense is eliminated that could ultimately lead companies to carry less debt, but the process of getting from here to there is highly destructive.(Sam Goldfarb, “Current Yield”/Barron’s, 5/1/17).

 GE- Thomas Edison may have co-founded General Electric, but that doesn't mean the massive conglomerate isn't interested in selling its consumer-lighting division, according to a report from The Wall Street Journal. Sources tell the Journal that the company is interviewing investment banks about possibly selling the massive division, which the sources say could go for $500 million. The deal would not include Current, GE's commercial LED lighting company. As the Journal notes, the sale would be likely be less about the money and more about continuing GE's retreat from the consumer sector in favor of business-facing ventures. The most recent big move in this direction was the conglomerate selling its appliances division to Haier Group, a Chinese company, last year. A GE representative told CNBC that the company doesn't comment on rumors.(Mack Hogan,CNBC,4/5/17).

Chevron-Our $147 price target on Chevron (ticker: CVX) is derived from a discounted-cash-flow model, supported by a sum-of-the-parts and dividend-discount-model analysis. We hosted investor meetings last week with Chevron Chief Executive John Watson. The message was consistent with that from the company’s March analyst meeting: the cash cycle is improving; capital expenditure is being tightly controlled; production growth will accelerate, driven by Australian liquefied natural gas (LNG); and Permian will be a key growth contributor. Chevron’s capital spending falls to $19.8 billion in 2017 versus a peak of $41.9 billion in 2013, as the company’s major capital projects reach completion. Spending in 2017 includes about $2 billion for the final phases of the Gorgon and Wheatstone projects, which will be essentially completed this year; thus the go-forward capital spend rate is about $18 billion a year. The company is guiding for total capital expenditures to range between $17 billion-$22 billion in 2018-2020, and Watson commented that it is unlikely the company would reach the high end of that range. At the March analyst meeting, Chevron raised its guidance range for Permian production to 325-450 thousand barrels per day equivalent (kbde) by 2020, with potential for 700 kbde in the middle of the next decade. The depth of Chevron’s Permian drilling inventory provides for decades of activity -- which is not efficient from a net present value (NPV) standpoint. The company indicated that it had identified about 150,000 acres that it could use as bargaining chips, and could ultimately lease or joint venture this acreage to other operators. We expect that the company will be active in swaps to block up its acreage to allow for longer laterals.(Jason Gammel and Marc Kofler, Barron’s, 4/11/17)

IBM- IBM disappointed Wall Street with their earnings and revenue figures last month and the market punished them mercilessly with a 7% decline in the share price. In time, IBM will come around but no one can bet on the time frame. Investors get rewarded for being patient.

 Alcoa- Buy Alcoa Before It Gets Bought. Alcoa trades at a 31% discount to our estimated 2017 private market value of $49 per share, similar to the 30% discount post-fourth quarter. We recommend purchase as Alcoa’s (ticker: AA) discount to the PMV is material and could close by a merger transaction with Rio Tinto (RIO) or another metals player. Low cost bauxite/alumina assets and a capable management team give us confidence in the standalone company, and we model a near 10% free-cash-flow yield in 2017-2018 excluding environmental/asset retirement obligation (ARO) payments. Given recent moves in commodity prices, the filing of Alcoa’s 2016 10K, and ahead of the March results, we update our model. We continue value of bauxite and alumina (including Ma’aden interests) based on a 10% discount to Alumina (AWCMY), and Aluminum plus one-half of Cast Products based on a 10% discount to Century Aluminum (CENX) enterprise value (EV)/ton. The discounts reflect Alumina’s potential takeover premium and Century’s potential upside from lower U.S. corporate taxes. These proxies account for over 85% of our segment value. We are increasing 2017 adjusted earnings before interest, taxes, depreciation and amortization (Ebitda) before special items increases to $2.10 billion from $1.95 billion, while 2018 Ebitda increases more modestly, to $2.030 billion from $1.997 billion, with 2019 Ebitda barely higher at $2.010 billion. Improved aluminum pricing is the major upside drive. Spot prices have improved from late January’s $1,800 to the current $1,950, reflecting in part Chinese environmental/pollutions constraints tightening supply and raising marginal cost plus a more inflationary backdrop. Our Aluminum segment Ebitda increases by over $150 million in 2017 and just over $10 million in 2018, as the forward curve has flattened. Catalysts to Unlock Value could be nearer now that Arconic has sold its Alcoa stake down to 7.1%, selling 23.4 million at about $38 per share on Feb. 15. Rumors on March 30 through said that bankers were working with Rio Tinto on a potential bid for Alcoa, although there has been no company comment or news since. Ample cash flow in 2017 will be used to pay down debt and capital expenditure, with growth capital expenditure of $150 million versus a prior sub-$100 million earlier view. Alcoa will also consider shoring up its pension deficit before considering capital return. (Justin Bergner, Barron’s, 4/10/17).

Have a wonderful month.