Watching China

We would like to take a moment to thank this week's advertisers on Shanghaiist:

• Sherpa - The one name to remember when you don't feel like eating out but are too lazy to cook!
• Witopia.net - Can't stand the Great Fire Wall anymore? Sign up for your own VPN now.
• David Leadbetter Golf Academy - Get started in golf or take your game to the next level with some of China’s best golf instructors.
• Go Kunming - Your one stop resource for news, events, travel, business and lifestyle in Kunming.

Advertise on Shanghaiist and reach 300,000 unique readers each month at rates that are cheaper than any of the English-language magazines in town! Check out our online media kit and get in touch with us at advertising AT shanghaiist DOT com.

Today's WSJ had an interesting, stunning, disturbing or frightening (depending on your mood or interpretation) graphic comparing the last three major market slumps of the past 100 years:

The thing I found most interesting about the above is the fact that there were often multi-year bull runs during the past two protracted bear markets prior to this one, because when we look back on history we often think of past bear markets a one big slump, and assume that if we're in the midst of a multi-year bull market than we simply can't be in bear one. A theory that is blown out of the water when we look back and see that the markets went on a bull run from '34 - '37 (similar trends were seen in the 70s and during the early part of the depression), despite the fact that the country was in the midst of the great depression. The obvious implication is that we may look back on the current era and realize that the bull run of '03 - '07 was nothing more than a brief "bull-blip" during what was primarily a bear market.

In Elliott Wave terms the S&P 500 is in wave 3 of 3 down. I will attempt to explain this in terms those not familiar with Elliott Wave can understand. Here goes:

Wave 3's are long and strong and unrelenting. They can be in either direction. When wave 3 is headed up, everyone is waiting for a pullback to get in. That pullback never occurs.

If you are looking for a reason why stocks are plunging, here's one major reason.

Today, again at 2 PM (eastern time) announcements re: settlement of the massive Lehman Bros. credit default swaps will occur. According to one trading desk source of mine, the equity markets are far more concerned on this point than are the debt markets. Earlier this week, the settlement of Fannie (FNM) and Freddie (FRE) CDS' were announced.

The bad news is that Hank Paulson seems to have run out of ideas. The good news is that, with no bright ideas of his own, he's turning to the bright ideas of Gordon Brown: first direct equity injections into troubled banks, and now a blanket government guarantee on bank debt, as well as insuring all deposits.

I like this idea, because it's more likely to bring down Libor than any other plan I've heard. TED's at 446bp this morning: banks simply aren't lending to each other at the benchmark 3-month maturity. And one of the reasons is that three months from now takes us into January, which is after a big upcoming funding crunch:

Vipal Monga today mentions something I was unaware of: The Lehman CDS auction today is not the end of the story when it comes to settling those trades. All it does is set the price: Settlement doesn't happen until October 21, the week after next. In other words, to the degree that there's nervousness over counterparties being unable to meet their CDS obligations, it's going to remain through not only this weekend but also the weekend afterwards.

In fact, the actual settlement price is one of the few things we already know, more or less: It's going to come in somewhere between 10 cents and 20 cents on the dollar. The huge list of things we don't know, by contrast, is going to remain unknown until after October 21. Michael Edwards has a good column up at Seeking Alpha today:

Prices of Treasury securities are registering mixed changes in overnight trading. “Mixed changes” in this environment is somewhat puzzling and even a bit troublesome.

The U.S. market has always represented the ultimate safe haven venue, yet this morning according to my screen at about 700AM New York time, the yield on the 2 year note was actually several basis points higher than where it closed late yesterday. Indeed, the yield on every Treasury issue is higher than the level at which it finished in late trading yesterday.

In an interview with CNBC this morning, "adventure investor" Jim Rogers spoke about the current crisis, saying that eventually the banks and businesses that are sound will take over access from those that are unsound, "and then we will start over."

Asked why markets have not responded to government efforts, Rogers said, 

It all looks so easy on paper, but in real time, using real money, making strategic investment choices is hard. Especially during a banking crisis that threatens the broader global economy.

Each January, we offer an historical chart of how the major asset classes fared on a calendar year basis, starting with the recently ended year and going back several years. Here's what we published this past January--see table at end of post. Looking at this history leaves the impression that one can easily sidestep danger and favor the winners over time. In fact, looking at the past and managing portfolios in real time are equivalent only in the sense that both are focused on investing. But one and only one is immensely difficult, and the reason has as much to do with managing emotions as it does with informed financial analysis.

On Thursday I doubled my original position in Canadian oil integrated oil and gas firm Husky Energy (HUSKF.PK). I bought Husky at $33.85 where it was trading at a P/E ratio of 7.0 and a dividend yield of 5.9%. This purchase likely brought Husky up to about a 6-7% weighting in my non-registered portfolio.

Buying oil when the U.S., and possibly the world is going into a recession has its risks, but I believe most of those risks are already priced into this stock. At a 5.9% yield, I am not concerned about Husky's one to two year forward earnings outlook. With its low pay out ratio the company should be able to maintain the dividend if oil stays at reasonable levels.

For the first time since March 2003, the Dow Jones Industrial Average broke 8000 at the open of the US markets. However just as quickly as stocks dropped 600 points, it recovered more than half of its losses in the first 15 minutes of trading and actually moved into positive territory 35 minutes into the trading session. The capitulation followed by the major short squeeze suggests that we may have seen a near term bottom. This type of volatility drove the VIX index to a record high of 70.

Currency Traders Waiting for the Buying Opportunity

Interestingly enough, we have not seen much of a reaction in the currency market. This suggests that the capitulation is only in stocks and traders are waiting for the bounce to get in. The day is early so many things can change and equities could sell off again, but for the time being, it appears that the buyers of EUR/USD, GBP/USD and USD/JPY are sitting on the sidelines waiting to get in. If stocks start bottoming out, carry trades could actually bounce today. No one will want to be short carry ahead of the G7 and G20 meeting this weekend – we expect a bounce.

Yesterday, sort of early in the day I sold the rest of [[SDS]] when the market was about flat. I also sold another stock (not so widely held) along with it as a partial offset to being wrong on the sale, and for the tax loss.

The cash level is now very high but still,anyone who has used inverse products during the bear market has probably come to view them quite fondly as either a crutch, emotional support or an old friend (lol). So I sent an old friend packing yesterday with the market down 37% from its high.

The big news this week has been Bank of America's (BAC) dividend cut and the continued financial meltdown. On Wednesday, Merrill Lynch lowered their 2008 profit forecast on General Electric Co. (GE) to $1.96 and cut its price target to $23. Murmurings on the street are that GE could join BAC and cut its dividend, which is currently over 5% - high by historical standards.

Even when the sky appears to be at its darkest, there are those still stand tall! Albeit, their numbers are not what we have seen in past weeks, but here are a few select companies that recently raised their cash dividends:

• Teekay (TK): Boosts Quarterly Dividend 15% to $0.316/Share (5.60%)
• Acme United (ACU): Increases Quarterly Dividend 25% to $0.05/Share (5.60%)
• First Financial Northwest (FFNW): Raises Quarterly Dividend to $0.085/Share (3.51%)
• United Technologies (UTX): Boosts Dividend 20.3% to $0.385/Share (2.85%)
• Apogee Enterprises (APOG): Ups Quarterly Dividend 10% to $0.0815/Share (2.86%)

This is the Age of the Bailout. And everybody knows how bailouts work: The government steps in and makes whole any holders of fixed income instruments, be they bonds or deposits or even subordinated debt. That's what happened with Bear Stearns, after all: anybody who wrote credit protection on Bear while it was spiralling into insolvency wound up making a fortune.

Except, the moral hazard trade -- buying banks' bonds, basically -- hasn't worked this time. WaMu's bondholders suffered default, as did Lehman's. In Iceland, even depositors might end up losing money. And I think there's a fair chance that the stock market's action Thursday was related to precisely this effect.

One of the components of every stock analysis I have done at my blog has always been to show the effects of dividend reinvestment over a ten year period of time. The results are truly amazing as the dividend income with reinvestment almost always outpaces the dividend income without reinvestment.

The main pro of re-investing your dividends is that you get the power of compounding in your favor. You are essentially getting “free shares” by investing the total dividend income into more stock. If you have also picked a solid stock that tends to increase the payments to stockholders every year you are essentially turbo charging your portfolio for the long run and should expect to receive even faster annual dividend raises.

Another reason for re-investing dividends is that one could dollar cost average their dividend income into more stock by spreading their purchases over a period of time, which also decreases risk.

The past decade was definitely a good time to be re-investing your dividends in Realty Income (O).

As anticipated in yesterday’s morning post, we did not break 9,500 on the morning rally.

September month-end short interest numbers were released after the close yesterday, and unsurprisingly, the decline in short interest in the Financial sector was huge.  The SEC and Chairman Cox implemented the "No Short" rule to "protect the integrity and quality of the securities market and strengthen investor confidence."  While it was probably wrong to implement the ban in the first place, it's infinitely more wrong to implement the ban and then eliminate it before their goal was attained. 

Over the last few weeks, when the ban was in place, shorts clearly covered as shown in the chart below.  Yesterday, when the "No Short" ban was lifted before the "integrity and quality of the securities market" was protected and "investor confidence" was strengthened, all those shorts that covered were given the all clear to rush back in.  There's rational thought coming from the short community, and irrational thought coming from the SEC.

Internet advertising revenues for the first six months of 2008 were $11.5 billion, setting a new half-year record that represents a 15.2% increase over the first half of 2007, according to recently released data from The Interactive Advertising Bureau [IAB] and PricewaterhouseCoopers.

The IAB Internet Advertising Revenue Report also shows a Q2 increase of 12.8% over the same period in 2007 and shows a slight decline of 0.3% from the first quarter.

In "well duh" news, recent comments by Treasury Secretary Henry Paulson suggests that the U.S. is considering implementing a bank recapitalization that is very similar to the British one, namely the exchange of cash infusions for preferred shares:

(From the FT): "The US could soon follow the UK down the path of using public money to recapitalise weakened financial institutions in return for preference shares.