Chiru: Don't Be Too Quick to Believe It

By Dr. Duru written for One-Twenty

February 27, 2008

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{Content note: stock specific commentary in the latter half of this missive}

Chiru! I have found a third animal to serve as a mascot for 2008. I started with turtles and swans. Now I have a diminutive, rare Tibetan antelope that has re-entered the spotlight after photographer Liu Weiqing recently admitted to faking a photograph showing the chiru peacefully co-existing with China's new high-speed train.

Qinghai-Tibet Railway opening green passageway for wild animals

The photo is wistfully named "Qinghai-Tibet Railway opening green passageway for wild animals." This train has opened up a route between Tibet and China and caused concerns that it could wipe out the chiru. This photo presented hope that the chiru would survive just fine. I do not just like the name "chiru" because it is similar to my own name "Duru." This story of the faked photograph has dropped at a time in which I find myself mired in deeper and deeper disbelief at the action and events swirling in the stock market.

So to start the metaphor, think of the little chiru as us, the retail investor, the American consumer. The speeding train high above the life of main street is all that is bad with the economy and the financial markets. It is a speeding train to somewhere we know not. All we want to do is graze, take care of our families, and put in a good day's work. But this train roars from above at periodic intervals, seemingly random intervals. Its rumble from afar swells those of us who care with fear, its appearance sends all of us scrambling for cover, and its passing replenishes the hopeful amongst us with relief that the terror has passed. Can we figure out a way to peacefully coexist with this train (wreck)? Many efforts have been underway, but I caution do not be too quick to believe them.

The stock market has swooned 4 times in the past year from the on-going credit crunch and on fears of recession. Each roar of the train has left us hopeful that we have finally seen the worst of things. This year, we found out that things could actually get worse. Here is a small sample of the things we have been encouraged to believe in order to quell any unrest in the populace:
  1. Oil can crawl over $100, gas prices creep toward $3.50 and $4.00 a gallon, and the economy will continue to absorb the costs of keeping oil-rich countries, uh, rich.
  2. The Federal government can afford to drop checks from helicopters to encourage more spending (uh, debt)
  3. The Federal Reserve can keep dropping interest rates from helicopters as long as it wants and until the market stops fearing recession
  4. The dollar can continue its 6-year "orderly decline" for as long as needed to encourage U.S. exports and international growth of U.S. corporations
  5. Higher food prices are a net benefit to the global economy since it enriches the agricultural economy
  6. None of the above will lead to notably higher inflation expectations...and neither will soaring commodity prices. If all else fails, slower economic growth will bring prices under control
  7. Housing deflation will not impact the rest of the economy, much less the global economy (oops - I think this one is finally debunked!)
  8. Bailing out two near-bankrupt bond insurers will save the entire stock market, nay, the global economy (check out this interesting exclusive interview on CNBC with Jospeh Brown, the CEO of MBIA - he seems genuinely shellshocked that his company has become the center of all we hold financially holy. The most interesting part starts at 6:00 where Mr. Brown says MBIA is done dabbling in derivatives and calls this credit crisis the worst in the past quarter century.)
  9. Recycled oil money and continued generosity from China will save our financial institutions from ruin
  10. The various ratings agencies can still develop models to inform us on how much risk exists in the financial markets
  11. Stagflation is "impossible" or at least not very likely...ever
  12. The market always rises on a wall of worry (if we could rely on that old adage, the S&P should be at least 1700 by now off the current cacophony of worries)
  13. Even if the U.S. gets bogged down on the frontlines of financial stagnation, the rest of the world can continue the fight without skipping a beat (Hong Kong's Financial Secretary John Tsang recently expressed his concern about both inflation and a global economic slowdown)
  14. If all else fails, Warren Buffet has enough money to helicopter relief worldwide
Chiru, chiru, chiru on each and every one! The list could be longer. I am sure you get the point. Everytime you hear someone declare the impossibility or low likelihood of some calamity resulting from the above, I encourage you to evoke a chiru and add a dash of Taleb with an eye to the prevailing trends!

Despite the headline turmoil, the market is doing its best to hang in there. We are chopping and churning around last year's lows waiting around for some good news to really propel us back out of this new bear market. The most interesting of the hopeful news is that this summer the banks, brokerages, and homebuilders could actually find out they over-estimated their write-offs on bad debt. I am not ready to believe it, much less put any hope in it. John Markman writes an excellent article called "Why Wall Street rescues are failing" that suggests that the only way out of our mess is to inflate the currency, that is, print our way back to solvency and try as best as we can to cope with the inevitable scourge of inflation. I gulped real hard on that one!

Anyway, let's get on with a review of some of the action and do a status check on some of my recent picks and recommendations (see disclaimer here).

First some good news:

Casual dining restauranteur Brinker International (EAT) is up 10% since I mentioned it and picked it up (Darden (DRI) still would have been the better move!). Best Buy (BBY) has already recovered the gap down from its earnings warning (I never did nibble some more on the shares).

I was just remarking to Trader Mike that I was shocked to find that IBM was already back to flat for the year. I was pondering what implications this might have for big cap tech and the rest of the market. Wouldn't you know that IBM goes on later that day to announce a big share repurchase plan that sends its stock soaring almost 4% on the day? This move was also credited with sweeping up the rest of the market into a buying frenzy. It makes little sense to me, but hey, I am sure bulls will take anything excuse they can get.

Fluor (bad news for me, good news for bulls)
I have mentioned Fluor several times before. I allowed my first successful short from the broken triangle pattern to convince me that I could anticipate the next pattern. I justified a new short based on a weak rally into resistance. FLR managed to shuffle right on up another 8%. If I had waited on confirmation of the potential weakness, I would be sitting here with zero loss ahead of Thursday's earnings report! Lesson learned. The stock is now starting to look bullish with a potential W-bottom in the works and a high-volume peek above both the 50 and 200 day-moving averages.

Now the rest of the news...

Foster Wheeler (FWLT)
Speaking of infrastructure plays...FWLT had a steep post-earnings swoon of 15% that looks like it could continue lower for a bit more. FWLT missed high analyst expectations had a bunch of company-specific issues: a contract dispute, unfavorable product mix, and tariff problems. The CEO Raymond Milchovich tried to defend his company's honor on Jim Cramer's Mad Money show. Click here for the video. He convinced me that longer-term this company seems OK, but I doubt he did much to cure the current nervousness.

Oil service stocks
FWLT's drop was notable given the company is a heavy player in infrastructure. Infrastructure was supposed to be a place you could hide from recession and enjoy safety in global growth. In a similar orbit, we have oil service stocks. Even with oil itching to reach for $110 and beyond, I have watched many (most?) of the oil service stocks get crushed after earnings this quarter. Victims include Schlumberger (SLB), Diamond Offshore (DO), Oceanerring (OII), National Oilwell Varco (NOV), Smith International (SII), and Baker Hughes (BHI). Helix Energy Solutions (HLX) is on deck this week. It may pay to be last because over the past week or more, the market has been scooping up the shares of these companies. Still, this action makes one wonder...

Google (GOOG)
Any of you who have followed "One-Twenty" knows I cannot help but check in on Google from time-to-time as a market tell. You also know that my recent opinion on GOOG turned very negative. It proved timely ahead of its last earnings call that proved disastrous. The past week of action represents a continuation of that selling. Suddenly, GOOG has done something it has never done in its brief history as a public company: It has now wiped out a full year of gains. GOOG sits at prices from the beginning of 2007 and is down some 35% from all-time highs set just 4 months ago.

I will not bore you with the news this time that has encouraged the latest selling frenzy. The chart is all you need here. The current steep two-month downtrend has been just as ferocious on the way down as GOOG's two-month ascent last September to October was intoxicating. The roundtrip has finished and GOOG has officially been dethroned from the stratosphere of "immortal" stocks. Despite all the recent pain, GOOG's maximum historical one-day decline remains less the 10%. I will bet you two Talebs and raise you another that GOOG will suffer a double-digit one-day decline in the near future. What is the risk here? Well, GOOG's management does not issue forward-looking guidance on the business. Until recently, analysts have chosen to remain outright giddy on GOOG's prospects. This means that if the economy continues to slow and the bear market deepens, we get an increased likelihood that the three months between earnings announcements will generate a sharp divergence in analysts' expectations from reality. Do not doubt the power of such a sentiment shift. I believe on Tuesday several analysts were scrambling to bring their target prices down in huge chunks, like $100 (drops of 10 - 15%). GOOG's risks are actually increasing, not decreasing with price. But you will see many people remark wit astonishment that GOOG has gotten so cheap - hop on a chiru and remember that the definition of "cheap" depends on a bunch of analyst estimates of future earnings growth that is not informed by any forward guidance from GOOG.


Dryships (DRYS)
Over the past two days DRYS has moved counter to the nice market rally. It was down -3% on Monday and -6.5% on Tuesday. I wrote earlier that I thought the stock might correct back to support at the converging 50 and 200 DMAs. That is almost another 10% away at this point. But I was not thinking about the prospects for DRYS to swoon in the face of an otherwise strong stock market. This is one to watch since it will move far and long whether up or down. I switched from a net long to a net short position. This recent weakness is suspicious. The immediate key will the direction of the break from the 2 week trading range.

Solar stocks
Finally, here is one that surprised me. I have scoffed often and liberally at all the hype around solar stocks over the past year. Much of this skepticism was generated from previous work experience I had in the industry back in 2001. Solar is simply not replacing fossil fuels in a major way anytime soon. Besides, we should all know how all bubbles end. This past weekend, I finally decided to do some updated research. I quickly discovered that Germany has been the primary accelerator of the solar industry. For example, the Green Party has put in place some very favorable price breaks to consumers who install solar panels and sell electricity back into the grid. The Spanish and CHinese govenrments are ramping up. Japan has long been an ardent supporter given its lack of domestic energy souhces. So, as long as governments continue to subsidize solar with the hopes and expectations of creating economically viable industries in the near-future, I suppose solar should do just fine. In the short-term, an investor only needs to worry about the relative productivity and profitability amongst the various players. But if these governments ever pull back their significant solar supports...look out. I encourage you to do your own research if you want to get involved here. It seems to me that the component suppliers are a better way to go than the panel markers. Or even fully integrated players.

Be careful out there...and chiru!

DR. DURU®, 2008