Guess who is assumed to live longer in the U.S. – Most Everyone!

As an investor, communicator and member of society, one of the largest impact news announcements of the year occurred last week, and it came and went almost unnoticed. Just because it sounds boring doesn’t mean it won’t wreak havoc on corporate balance sheets and even worse, state and local treasuries. Most people make fun of actuaries, and assume their data science is not all that important. In this case, it may cost us trillions.

After nearly 15 years of the same assumed mortality data for pension plans, the Society of Actuaries has released a new increase. Pension plans have taken on new liabilities and liquidity requirements. Both men and women are seeing two more years on average of expected life in 2014 in comparison to 2000. Expectations to live have moved to 86.6 from 84.6 and 88.8 from 86.4, respectively (of course women live longer).

But good news of life longevity aside, these additional two years pose major challenges for pension plan liability. The SOA projects liability growth to now run between 4% and 8% for typical pension plans.

Corporations are looking at an extra two years of funding required for defined benefit plans. Public companies with underfunded Pension Plans are in even deeper red, as retirees live longer. Asset managers are seeing unwanted higher risk and lower performance as earnings take haircuts to fund the new liabilities.

The pension industry, so focused on liability-based investing, now has a new twist and turn. Annuity-based lump-sum buyouts just got more expensive (with two extra years to fund), and yet still may be a better option for some corporate balance sheets. As portfolio managers look at stock prices, P/E multiples and a potential series of earnings underperformance, these liabilities need to be addressed and communicated head on. Additionally, asset managers need to consider the performance of the stocks they hold, and the performance requirements of their institutional clients.

These changes are predicted to take effect in early 2016, and plan sponsors will be seeking to make necessary funding, investment, and lump-sum strategic decisions.

Innovation anyone?

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The Sandy effect, the election, the market

I am watching with amazement as nothing ever really changes in the investment commentary landscape. The economy is improving and at a better clip than most of the street is willing to admit. That may be because much of Wall Street is still licking its wounds from their backing of Romney/Ryan.

The election was a mandate. The president, love him or hate him, trounced his competitor. The game was simple, win Electoral College votes. He did by a land slide. Don’t go looking at other stats. The reason the campaigns focused on swing states, all but ignoring states like  CA, NY, IL and other states as well as making no attempt to get out the vote there is simple; it was not the game. The game was all or nothing Electoral College, and Obama won by a landslide.

Next is Sandy. Perhaps too many analysts live on the upper east side where they were unaffected. Much of the general population and even the moneyed east coast were trounced by the hurricane, hunkered down before it, sitting in the dark after and then slammed with cold and snow again a few days after the power came back. This series of events bodes poorly for firms like Groupon (GRPN), NasdaqGS and Nordstrom (JWN) NYSE and even worse for truly mass firms like McDonald’s Corp. (MCD) NYSE. What a shock that people can’t drive, are focused on flashlights and candles and not on a discount on their next facial! Even the mighty Apple Inc. (AAPL) NasdaqGS had its stores close, suffered from lack of web access (by those of us with no power) in the hard hit areas. That meant no app store, iTunes or ordering new Macs or iPads.

The news from Europe is reported like its new, but in reality it has had few material changes except the passage of time and some honest and not so honest attempts at solving their crisis. They will kick the can down the road for another few years. Europe and the US Government need to be refinancing like the private sector, and large caps should be issuing bonds also at historical low interest rates. Once more cash is on the books, sooner or later, and I know we have been waiting a long time, our good old friend inflation will solve many of our public problems, and companies will tap the equity markets when interest rates are not so attractive sparking that part of banking. China Friday showed further signs that the country’s economy is recovering. Inflation rose a less-than-expected 1.9%, while industrial production increased 9.2% yoy, another monthly improvement.

Hopefully, Congress and the administration will do the right things, increase the Social Security cut off to $200,000, raise the retirement age for Social Security gradually, fix the larger issues with Obamacare without throwing the baby out with the bath water, and right-size by prioritizing our defense spending (without hurting our troops or global position). Last, we have to fix global warming, I can’t take these storms. Out in Rockaway NY, the first solar power generators brought in is from Greenpeace, not FEMA or the city. Flood zones, stronger storms, we had our warnings and multiple catastrophes. Let’s go Washington and the states, let’s get it together and take a global leadership position on climate change. It is costing us too much time, human capital and money not to deal with this proactively. I has seen much suffering and that alone should be our compelling reason for handling climate change.

The private sector has created a lot of jobs, housing is coming back. The federal government has few people on the payroll today that when Obama took office. I was privileged to work with a great economist 2004-9 who also listened to other really smart people. He taught me that as demand decreases deflation and all heck breaks loose. Once demand returns, profitability comes first, and then jobs, then growth. We have been waiting now for going on five years for this to occur. It has been anything but a straight line. But we are living the turbulence of our times, not reading about it in a history book. I believe in the US and the free market. The S&P 500 will be above 1500 one year from today. We will look back on this time in 20 years and praise the slow progress.

I am buying more US equities, counting on congress and the administration to handle the fiscal cliff and move forward. The economy will inch its way forward, albeit with plenty of ups and down regardless of government actions. If you’re a trader, there is lots of vol to play, if you are an investor, set your course and keep your eye on the prize.

Disclaimer: Mr. Corn is long AAPL and MCD and may take positions in the other stocks mentioned.

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Earnings Risk

Over the years I have posted about earning several times.

Among my client list is a fund of funds which does not like earnings risk. As a longer-term investor, I usually do not mind if a company misses analyst estimates assuming it is continuing on its path forward increasing the big three: revenue, earnings and margins. It will usually recoup and grow its stock price over time, but not always within a quarter. Their idea of not taking earnings risk is simply to sell the entire position before earnings and simply buy it back the next day or week depending upon the news and stock performance.

The past few earning seasons the market has grown less and less forgiving. The criteria for earnings announcements are increasing and the bar is higher. This especially holds true for higher profile companies and growth firms. Now, the market wants a company to beat for earnings, beat for revenue, and now announce increases in annual and next quarter estimates. It’s not just increases. The increases have to be above analyst estimates, not just the company’s own estimates. Firms that do not meet these criteria can get hammered within seconds of announcing earnings.

This is the risk that is defined by my client. This is the risk I need to consider each day during earnings season for all of my clients. Keep in mind that institutional clients are not taxable so turnover is not a consideration. Others will bring up transactions costs, but frankly at a penny or so per share, this has never been a real consideration.

The real consideration is a simple risk/reward equation. Every day I have firms in different sectors with the ultimate idiosyncratic risk, earnings. Why the ultimate? I do not use options so “cheap” insurance is not available within my investment process. Besides, as one hedges risk, opportunity is equally diminished.

Yesterday it was International Business Machines Corporation (IBM NYSE) which lost 3.53% and Intuitive Surgical, Inc. (ISRG NasdaqGS) which rose 7.15% its day after earnings.

As reported on MarketWatch:

IBM said it earned $3.07 billion, or $2.61 a share, on revenue of $24.7 billion, compared with earnings of $2.86 billion, or $2.31 a share, on $24.6 billion in sales in the same period a year ago. Excluding one-time items, IBM would have earned $3.3 billion, or $2.78 a share.

Analysts surveyed by FactSet Research had forecast earnings of $2.66 a share on $24.8 billion in sales for the quarter ended March 31.

Among its main business areas, IBM said software sales rose 5% from a year ago, to $5.6 billion, but its services business, which makes up the majority of the IBM’s revenue, rose just 1% to $14.6 billion. The company also said the value of its backlog of services contracts was down 2% from a year ago to $139 billion.

Hardware sales fell 7% to $3.7 billion.

IBM raised its earnings estimates for its entire fiscal year, and now expects to earn at least $14.27 a share, up from an earlier forecast of at least $14.16 a share.

Excluding one-time items, IBM raised its full-year profit forecast to at least $15 a share from $14.85 a share. Analysts had earlier estimated IBM would earn $14.93 a share for its fiscal year.

Intuitive Surgical ISRG posted a 38% jump in first-quarter profit to $144 million, or $3.50 a share, from $104 million, or $2.59 a share, in the same 2011 period. Sales rose 28% to $495 million. The report exceeded Wall Street’s forecast for a profit of $3.15 a share on $477 million in sales, according to FactSet. Intuitive Surgical said it sold 140 da Vinci surgical systems during the quarter ended March 31. The 3-D technology system allows surgeons to operate while seated using robotic arms that probe a patient’s body. They sell for $1.1 million to $2.3 million. This prompted a handful of analysts to raise their price targets on the stock. Intuitive Surgical also raised its 2012 view for revenue and procedures using the Da Vinci.

Both firms “beat and raised” which used to be the golden duo. However, IBM posted flat YOY revenues and the street also didn’t like its revenue mix, versus ISRG which was more of a straight line pointing up. Of course market cap and revenue can’t be compared with these two firms, and my position size was actually over 4x for ISRG. This is based on growth rate, commitment to the sector and that I have been trimming IBM since February as its stock price growth rate slowed versus XLK, a primary hedge. ISRG has held a primary position within my healthcare book and continue to outperform XLV its primary hedge.

There is no perfect hedge within equities for equities. Each hedge is imperfect and brings its own challenges. No stock can be shorted to protect against another stock’s earnings. Not within a sector, industry or supply chain. Each day brings new risks which are magnified during the season. Position size, selling into earnings, the number of positions within the sector and industry are all calculations within a portfolio’s risk profile. Earning season is exciting. The key is to calculate when it is optimal to maintain, reduce or increase your risk profile.

Mr. Corn is CIO of E5A Funds LLC and through investment strategies under his supervision, he is long both IBM and ISRG.

 

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QQQ and SPY: A case for Mean Reversion

There are times when investors explore mid-term market moves seeking clues for where ETFs are not behaving at their historical norm. Right now one needs to look no further than two of our three main US broad market gauges; the S&P 500 as measured by its tracking ETF SPY NYSEArca and the NASDQ as measured by its tracking ETF QQQ NasdqGM.

I deploy ETFs for quick exposure to a sector, region, or asset class and use them extensively for that purpose as added beta or a hedge. As an example I am usually long or short USO and CRUD in addition to my other single stock energy investments. The price of oil has been so range bound, this trade has been a source of alpha for months. But right now lets examine much larger and more liquid opportunities.

Since the market bottom in March of 2009 and through in and out of sample tests, QQQs generally out-perform SPY. The QQQs are presumed to be comprised of faster growing technology and mid- and small-capitalization firms. This composition of index constituents tends to produce more outliers which move the index faster with slightly more volatility. In a flat or up year one tends to be paid for that volatility with greater returns. Since the market’s bottom in March of 2009 the outperformance of the QQQ to SPY is over 20% on an absolute basis. The question is: are there times to best capture the out-performance?

In Q411, on price return, the SPY well out-paced the QQQ in what may be a set up for mean reversion.

As analysts reduce their estimates for S&P 500 companies, some estimates are being raised for these QQQ-based technology and smaller firms. This dispersion of estimates can add to the probability of positive outliers in the underlying index in this earnings season. Chalk it up to the perception of entrepreneurism, growing markets, or reduced costs, the QQQs have the potential to outpace the SPY.

Since the calendar has turned, the QQQs have taken an early lead. YTD the QQQs are trouncing the SPY. Measuring on a three month or even one month basis from today, the opposite remains true. Does this spell opportunity to have returns revert to their historical norms? Have the indexes begun their march back to their historic mean? If so, is long QQQ and short SPY a solid market neutral alpha trade? Or perhaps can my long-only readers simply over weight their QQQ position to their SPY and still benefit?

The charts show a disparity from historical norms. If accurate, the two week outperformance will continue until the QQQs return to their leading position. But readers beware, perhaps three months is not a long enough timeframe for mean reversion to be material enough for a targeted trade. At least for now, I am slightly longer QQQ than SPY.
Disclaimer: Mr. Corn is CIO of E5A Funds LLC. He manages a global long/short and designs funds of ETFs. In his long/short he may be long or short broad market ETFs such as QQQ and SPY at anytime. Currently he has no position in CRUD or USO and may be long or short these ETFs at anytime.

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Growth beneath the surface

For those that follow my Twitter feed @acornnyc you know I have been long agriculture for some time and I am invested on a global basis. The basics: growing global population mixed with growing wealth in emerging markets causes increasing demand for protein and better nutrition. An emerging class of people is demanding more chicken, beef, pork etc all which feed on grains in industrial farms. Additionally there is increased demand for higher quality fruits and vegetables. Agriculture simply put, grows on fertilizers. As I am a global agriculture investor, I invest directly in commodities and also on occasion invest in strategic support companies in growing regions.

Based in Santiago, Chile I am in a full size long position with Chemical and Mining Company of Chile (NYSE: SQM). Taken from its web site, the firm is broken into four business segments with the largest comprised of fertilizers and specialty chemicals marketed globally. SQM produces soil nutrients including potassium nitrate, sodium nitrate, sodium potassium nitrate, and specialty blends for crops, such as vegetables, fruits, flowers, potatoes, and cotton. The firm has also joined the global craze developing products for organic farming.

Another substantial business unit produces iodine and its derivatives which are used in a range of medical, pharmaceutical, agricultural, and industrial applications. It represented 22% of Total Gross Margin back in 2010. The largest economically exploitable reserves of Caliche Ore are in northern Chile, and SQM holds the largest part of them. Iodine is produced from this ore, and SQM has the world’s largest production capacity.

In addition, the company is probably best known as the world’s largest lithium producer and lithium carbonate. They are used in various applications including the rapidly growing market for new technologies for batteries., frits for the ceramic and enamel industries, heat-resistant glass, primary aluminum, lithium bromine for use in air conditioner equipment, and continuous casting powder for steel extrusion, pharmaceuticals, and lithium derivatives; and lithium hydroxide, which is used as a raw material in the lubricating grease industry. Lithium represented 10% of Total Gross Margin in 2010.

Further, it produces various industrial chemicals, 11% of Total Gross Margin 2010. When it comes to Nitrates, Potassium Chloride, Boric Acid and Magnesium Chloride, SQM has proved to be a reliable and committed supplier. Due to its ample product range, SQM can satisfy the raw material needs of different industries.

The company made a presentation back in May that is the source of much of my market share data. Although it is not completely current, it still serves as a guide to where the company is headed. Approximately 87% of sales are exports. The firm exports to over 100 countries. There are other fertilizer firms growing revenue faster, but SQM is growing at a good pace for a firm of its size. The firm boasts Return on Equity on a trailing 12 month basis of 26.31%, and good cash flow. One negative is its 252 day beta of 0.73 which can be light in both the materials sector and emerging markets. I view it as another data point to manage in the portfolio and an advantage in flat to down markets.

Year-to-date the stock is beating the iShares MSCI Chile Index Fund (NYSEArca: ECH) and the US Materials Select Sector SPDR (NYSEArca: XLB) which I use in tandem to hedge my exposure. The firm has vast natural resources, production capacity and exports to all major and most secondary markets. With a slowdown in the developing world financially, I find limited correlation to the “need for feed” and other agricultural requirements for a growing population of humans and live stock.

Disclosure: Mr. Corn is chief investment officer of E5A Funds LLC. Through various equity strategies under his supervision, he is currently long SQM. He may be long or short the ETFs mentioned as trading and hedging vehicles.

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Searching For Growth in China – BIDU

As an economy, China remains one of the global growth leaders. However, one would hardly think that its economy is growing at 4 to 5 times the rate of the US based on the performance of its equity markets. China’s stock markets have not been reflecting this underlying growth trend trailing US equities. Any hint of a slowdown, currency adjustment, real estate rumor or if China’s big customers in the US, Europe or Asia hint of slowing imports, China’s stocks take a big hit.

The old investment adage applies; if you have the nicest house in a crappy neighborhood, your home’s valuation will still reflect the environment, not just the fundamentals of your house. Meaning the best stock in an embattled market may still be challenging.

Such is the plight of most equities in China. Interest rates, inflation fears, bank capital requirements,  the health of economies of client nations, supply chain disruptions and the cost and availability of raw materials all play into swift and steep movements both down and up in stock markets.

For example on 09/30/2011 US listed Chinese companies were clobbered after a securities regulator told Reuters that the Justice Department was investigating accounting irregularities at Chinese companies listed on US exchanges.

Among the casualties was Baidu, Inc. (Nasdaq: BIDU) one of our longest held stocks.

This was an isolated incident but the past 12 months has been challenging for Chinese equities which far trail their sector counterparts in the US. Year-to-date, Chinese equity markets are behind the S&P 500 or the Global Dow by a material difference.

Our investment in BIDU is profitable. One reason is that it has changed in position size and even seen a brief exit in late September of this year. One of the beauties of liquid equities is the ability to move in and out and change risk profile by position size. The stock moves and quickly. Its beta as compared to the S&P 500 is over 1.5 but, remember, geopolitical events, currency moves and sentiment towards China, its economy and its pending economic soft or hard “landing” all come into play.

A clear overview of the firm is provided curtsey of a NY Times article 07/17/2011.

With an 84 percent market share, according to iResearch, Baidu can see exactly what most of China’s 450 million Internet users look for online, be it the latest political scandal, pop tune or movie schedule. And it is a formidable opponent for other companies, as Google can testify after scaling back its operations in China last year.

But despite its redoubtable position, Baidu finds itself faced with a thorny challenge — keeping both the technocrats in Beijing and the financial analysts on Wall Street happy at the same time.

Also from the Times article are some interesting insights and data.

“Whether private or state-backed, domestic or foreign, competitors can’t tell us what the users can,” said Jennifer Li, the chief financial officer of Baidu. “We handle more daily queries in China than any other search engine does in any single national market. That much data on the intention of users yields real insight into their needs and how to satisfy them.”

Acquisitions are another important part of the company’s strategy. Last month, Baidu announced it would invest $306 million for a majority stake in Qunar.com, China’s leading travel search engine. The announcement came a month after Tencent, its rival and the largest Internet company in China, said it would buy a 16 percent stake in the online travel site Elong.com.

In social networking — where Chinese people spend 6 percent of their time online, according to ComScore — Baidu has failed to enjoy the success of Facebook clones like Renren and Kaixin001. That is a concern for the company if Chinese Web users become more like those in the United States, where about a quarter of Internet browsing time is spent on social networks.

Much of this sounds familiar. Google Inc. (Nasdaq: GOOG) pursues a similar business model here in the US and has greater ex-country market penetration to help it grow. One could easily argue that BIDU follows GOOG. We like and own GOOG but BIDU is growing at twice the pace with one quarter the head count and nearly a 20% superior operating margin. Fittingly the market has awarded BIDU with a much higher multiple, P/E just over 65 and its P/E/G five years expected remains just a hair over one or 0.18 more than GOOG, This level still indicates growth in stock price.

The stock is up ~50% year to date and over 250% over the past two years where GOOG is up just over 10% in two years. Although it is not a smooth ride, BIDU is on a great run. Its latest earnings report last week confirmed its growth, profitability and investment in its future.

Given that less than one quarter of the population of China is currently online, migration to cities, proliferation of smart phones and other major growth factors, more great things are expected from BIDU. Like all public companies, competition has its sights on the same markets and services but unlike working in the west, the unknowns of government can dramatically work for or against the firm.

Like all stocks, after any earnings pop or rapid price movement we examine position size to assess risk. Balancing today’s price and tomorrow’s growth potential position size is calculated. For now we see a bright future for BIDU but remain vigilant of all external forces.

Disclosure: Mr. Corn is chief investment officer of E5A Funds LLC. Through various equity strategies under his supervision, he is currently long both BIDU and GOOG.

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Where are Oil Prices Going?

We have been watching oil prices get crushed even more than the S&P 500 over a three month period. The story for investors is far less black and white. Over the past three months the market is down, but oil is down more. Now the two ETFs that “replicate” an investment in oil are down a little less (CRUD and USO) so they are not tracking as well as they could over this 3 month period (CRUD is tighter on tracking than USO) and in the long leaning investor’s favor.

Energy focused equities have performed far better beginning with Energy Sector SPDR (NYSEArca: XLE). The issuer’s web site fact sheet breaks down the underlying constituents as 79.31% Oil, Gas & Consumable Fuels and 20.69% Energy Equipment & Services, but let’s face it, Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX) comprise over 30% of the ETF. The pure plays are losing to the multinational integrated giants in a sharp downturn simply because they are in so many businesses and parts of the world. In fact CVX is down approximately a quarter of this group in this time period.

So how low can oil prices go? We saw huge swings in 2008/9 as the markets, traders and investors assumed a huge recession. Global demand was viewed as dropping rapidly and even rising demand in emerging markets was not enough to slow the drop. In 2008 we had tropical storms to prop up prices as we do today, but it proved to be transitory and the price continues to slide.

Are we already in a new global recession? I do not know. What I can explain is why I will soon move from a neutral position (I am as short as I am long different energy securities) to a net long position: politics.

Global politics are going to make all the difference. It is not just pirates off the African coast. Now it is about world order. Energy hungry countries are buying up supplies where ever they can, including the US. Countries and corporations have blocked, straight-armed and moved troops to secure economically viable energy.

Economic viability and stability are now the keys to estimating prices. Today the ability exists for many nations to threaten to upset the global economic apple cart. There are several, not-so-friendly-to-the-US countries that are net exporters of energy around the globe. Each has its own unique price of energy extraction. If global prices fall below the price of extraction, the counties’ operations begin to lose money. Coincidently, some of these countries are not democracies and the people in charge can act quickly when their money machine is slowed or turned against them.

Money and a strong flow of it insure sustained power and status quo. A persistent lower price for energy can mean internal unrest. And, many of these leaders like to “share” that problem with the more developed world and not in a good way. Unrest causes uncertainty which rocks markets. In this case it could rock-et energy prices to the highs seen earlier this year or even higher.

On the flip side of that same coin, excessively high energy prices can be the tipping point for global recession, and even greedy dictators are aware of this delicate balance, and prefer to test the highs before negatively impacting demand.

Governments know this, big oil companies know this, and many energy hedge funds know this. Oil may dip below $80, but do not count on it staying there long. Unfortunately, what is good for some dictators and temporary détente creates high levels of energy prices.

Disclosure: Corn is chief investment officer of E5A Funds LLC. Through various equity strategies under his supervision, he is currently long CVX and short XLE.

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