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This week Exxon Mobil (XOM), the world largest oil exploration company, announced that it would acquire independent natural gas producer, XTO Energy in an all stock deal worth $41 billion. XTO is a leader in drilling for Shale Gas, which was once thought nearly impossible to extrapolate. A Trade King blog posting highlights who could potential benefit from this transaction or possible be future M&A targets. As far as this deal goes, it is far from over, environmentalist issues surrounding drilling techniques, carbon legislation, and possibly antitrust issues, since this transaction would give Exxon a competitive advantage in the energy space.

Many are surprised to see such a big deal happen during the lows of this trepid recession. Many fail to realize that many energy companies are loaded with cash, which give them the ability to swoop in and rescue other cash viagra companies. Actually, many energy experts are predicting that this trend will continue well into 2011.

The prospect of increased natural gas demand makes this transaction ideal. Today, natural gas closed today at $5.79 per British Thermal Unit(BTU), down approximately 63% from its all time high of  15.378/BTU in December 2005 . The global push for alternative fuels sources, combined with the Obama administration’s pledge to reduce the United States dependence on foreign oil would make this deal attractive to any of the major energy companies. Currently, natural gas prices are at all time lows, and it is inevitable that these alternative energy initiatives will gain further momentum, which will usher demand higher in the not to soon, future for this carbon fuel. Leaving Exxon well positioned to make a handsome profit if the stars align for this proposed acquisition approval.

For years Black Friday signified the start of the Christmas season in the United States.  The day after the Thanksgivings holiday, tons of retail outlets would discount their wares, to entice customers into their establishments during the wee hours of the morning.  Supposedly, this is the day when most retailers move out of the red and into the black, or become profitable, thus being named “Black Friday”. Historically, November and December represent an estimated 50%-60% of annual sales for many retailers. Investors use this day as an indication of which Retailers are profitable or unprofitable, as exhibited in a tradeking blog post titled “Retail Stocks, ho ho ho!” Normally, the best selling stores have the highest earnings and a stock price that is steadily climbing upwards. This holiday shopping weekend truly severs as a psychological indicator for the overall health of the economy for the United States.

Many were predicting that this year’s Black Friday sales would be much better than the previous year, since the market has rallied 60% from the March lows, along with several of the government programs for increasing consumer spending, such as “Cash for Clunkers” and “First Time Home Buyers Tax Credit” have been rolled out with much success.  These successes have been beacons of hope for many who now realize that we need the consumer base to resume spending in order to truly bring this economy out of recession. On the other side of that hope are individuals who see the 10% unemployment rate, that does not include those who are no longer counted, who are not actively shopping.

True to form US consumer came out in droves and spent their hard earned cash. According to reports from the National Retail Federation (NRF) spending increased to $41.2 billion up from $41 billion, in 2008.  The NRF report also highlighted that 195million people ventured out shopping during this shoppers holiday vs. 175million in 2008. Although more shoppers ventured out this season, the average amount spend per shopper was lower than 2008 with 343.31 vs. 372.57. Mainly spending their money at major department stores and spending over 50% of there funds on clothing and apparel.  

Expectedly, low end and discount retail franchises ruled. Kohl’s Corp(KSS), Old Navy(GPS), TJ Max/Marshalls(TJX) and Ross experienced an increase in same store sales YOY of 3.30%, 6%, 8%, and 8% respectively, in the month of November.

Going forward the picture is starting to get brighter. Unemployment rates reduced to 10% and factory orders increased from the previous month. It could be possible to end the year on a good note as long as the unemployment figures continue to improve.

Christmas came early this year for the “Oracle of Omaha”, Warren Buffett. The Berkshire Hathaway CEO, recently, completed his big acquisition ever, with the purchase Burlington Northern(BNI), a railroad , for a strapping $26 billion, in cash.

This a typical transaction for Mr. Buffett, who is  a student of famed value investor Benjamin Graham. In addition to a pure value investment, there is also a green investment angle as well. Railway and trucking are the major avenues of shipping within the United States. Ironically, rail is much more environmentally friendly. One of BNI major sources of revenue is derived from coal shipments, which adds another clean environment component to this mega purchase.

The BNI deal was truly a Buffett special. Axioms for value investing are high cash flow, relatively low debt levels and healthy future revenue projections.

However dividends have grown by a 20.88% over the lasts five years. Plus BNI only utillizes 28% of it overall capital structure, and the average  2 yr growth is 10.45% with operating margins of 21.71%.

Berkshire Halthway, still has plenty of  cash and a world of investment ideas. Becton Dickerson(BDX) is a company that fits the Oracle’s investment philosopphy. Becton Dickerson is a medical device and supplies, who mainly cater to institutional clients. Operating Margins are above 23%, dividend growth over the last 5 yrears is 17% and theyonly utize 10% of the overall capital structure on debt. BDX could prove to be a worthy for additonal investment by Buffett.

To date many have been confused around the hows and whys of the financial bail out that started in Oct of 2008. People just don’t understand why taxpayers should subsidize Wall Street’s fat cats, for losing money. While at the same time the core of the country’s economic stability, small businesses, have not received any bailout. As a result of the public’s outcry many people are divided, as to whether the efforts of these initiatives have truly been a benefit to the citizens of this country. Reviewing the economic facts gives a bit of a mixed picture as well, with expectations of the unemployment rate breaching the 10% mark before companies resume hiring again, the US auto industry (Ford Motors) is still in the reconstruction phase, housing has potentially bottomed out, and ISM manufacturing figures have been above 50 for the last three months, which is a sign for a recovering manufacturing sector. Much of the recovery efforts are due to the Bush and Obama administrations, that worked to enact legislation to remedy this issue.

President Bush began the bail out proceedings in Oct of 2008, by signing a $700 billion bail out plan into law, after the collapse of Lehman Brothers. Due to this collapse the 3 month London Interbank Offer Rate Overnight Index Swap (Libor-OIS) spread, a rate charged by banks that lend money to other banks,  rose to an staggering level of 3.64% in the beginning of October 2008. Prior to the Lehman break down Libor OIS spread was confound to a range of .12% – .83% for approximately the five year prior period. Due to this large rise in the Libor-OIS bank seize lending to other banks, thus creating it harder for banks to offer financing to small business owners who may use lines of credit to facilate payroll on a month to month basis to buffer any disrupptions in operational cash flows from their businesses. In reaction to this credit freeze equities markets crashed in October 2008, falling by approximately 24%. So when you look back in retrospect, the bail out was essential for the US government to provide capital in order to divert a complete meltdown of the financial system.

In February of this year, less then one month into his presidency President Obama moved swiftly to pass an additional $787 billion in stimulus aid. This plan was a bit different from the October bail out.

Below are the stimulus package spending allocationss:

Many skeptics have critized this plan because of this sharp raise in government spending. The skeptics felt that the credit and financial markets will work themselves out naturally, and did not need government interceding in place of the market. When you examine the results of the multiple stimulus packages, we have seen 50% plus increase in the S&P 500 since the March lows, provided extended unemployment benefits for job seekers, and thawed the credit markets where the current Libor OIS spread returned back to normal levels at .13%, so banks are able to begin lending. As a whole the stimulus plans have been very effective from keep the country from repeating “The Great Depression”, where government did to little to late.

Solar Energy has been one of the most notable of all the Green/Clean technologies. Solar energy is not a new phenomenon; it can be traced back before the birth of Christ, but did not start getting serious notice until the multiple The Energy Crisis’ of the 1970′s crippled America. The oil embargo of 1973 was the first incident, with OPEC’s “October War” when they decided to stop shipping oil to countries that supported Israel. Followed by the “Energy Crisis of 1979″, which saw Iran’s oil infrastructure impeded due to a coup d’état that installed Ayatollah Khomeini as the new ruler.

In response to this massive disruption, the US government began instituting legislative policies to reduce the country’s dependence on foreign energy sources. …reminds me of a T. Boone Pickens commercial. Thus the “Crude Oil Windfall Act of 1980″ was enacted, for oil companies that earned extra profit due to the increase in oil prices. The act established an excise tax, which would tax the difference between the current market price and a 1979 base price, as well as energy tax credits. Businesses and homeowners who utilized alternative energy sources, such as solar, wind, and geothermal,  received this energy credit. Unfortunately, these tax credits were phased out in 1986, as oil prices subsided.

History Repeats Itself!!!

Fast forward to the new millennium, and you find a repeat of the 70′s Energy crisis with $146+ a barrel oil prices in the July of 2008 and most recently $80 a barrel oil, after oil price fell to $46/barrel in Feb 2009. Ironically, congress started to reintroduce energy credits, just a few years prior to this last oil run up. These credits, which did not originally cover alternative energy sources, have been amended to include solar, wind and biofuels.

Making Money with the Sun….

One of the many companies at the forefront of the alternative energy space is First Solar (FSLR). Incorporated in 1999, First Solar is a leading producer of solar panels and at the amazement of alternative investment naysayers, it has been quite profitable. Recently beating the streets earnings estimates of $1.746(EPS) vs. actual earnings of $1.79 (EPS) for 3Q 2009. Year-to-date FSLR has returned a 9.87% return. Since its IPO, in 2006 this company has produced amazing revenues growth, earning  $134,9700,00 in 2006, $503,980,000 in 2007 and $1,246,300,000 in 2008. Earning growth over those three years exceeded 823%. First Solar is also the largest holding in the Claymore/MAC Global Solar Energy ETF (TAN), with a weight of 11.98%, in the fund.

When you examine this company’s geographical revenue segments, you discover that the 73.77% of it’s revenue is derived from Germany versus 21.17% in the United States. Ironically, the number one geographical segment represented in the Claymore solar ETF (TAN), is Germany as well. Clearly, the Germans favor solar energy more then the American do.

Federal Solar Allocation
State		Allocation
California		$675,618,483
New Jersey		$45,263,475
Florida		$34,000,000
Arizona		$22,890,000
Massachusetts		$14,855,881
Nevada		$10,235,053
Delaware		$2,700,770
Vermont		$1,371,756
Wisconsin		$1,000,000
Oregon		$433,000
Washington		$250,000
data provided by Internal Revenue Service

 Thursday delivers another installment in the 3Q earning season saga. This episode will showcase earnings from many market heavyweights, such as AT&T (T), Phillip Morris (PM), Merck (MRK), Occidental Petroleum (OXY), McDonalds (MCD), American Express (AXP), Amazon (AMZN), and United Parcel Services (UPS). This small group will command the attention of the entire street, since they are some of the most heavily traded stock in the world. As the bulls and bears battle, it has let many investors baffled as to what side to choose and many have  decided to ride the pond.. 

The street is looking at top line growth and bottom line increases through cost cutting measures.

Thursday’s market performance will have two contributing factors: Earnings & Economic data. From an earnings stand point most of the focus will be concentrated on these three bellwether companies: AT&T, McDonalds and UPS. From an economic data point of view, the spotlight will be on Initial Jobless Claims and Continuous Claims. If earnings and economic data are able to provide better the expected results, you will probably see stock indices push through higher levels. Any other scenario will be a catalyst for stock to test lower levels.

The major sectors impacting Thursday’s market performance are industrials, consumer discretionary and telecommunications:

Industrial Impact- UPS

UPS reports at 7:45am on Thursday. The street is looking for the $.517 earnings per share (EPS), but UPS has already given guidance of $.50. So the prospect of UPS exceeding the estimates are slim to none. Unfortunately, UPS has been saddled with various issues that are counter productive to increased earnings, such as decreasing shipping volume due to the economic slow down, union problems and overcapacity. If UPS beats its earnings estimates it will be a result of aggressive cost cutting and not top line growth.

Consumer Discretionary Impact- Amazon & McDonalds

Amazon is also reporting tomorrow. Recently, Amazon has been benefiting from increased video game sales and more increased marketing and media buzz surrounding the price reduction of its popular Kindle digital book viewer. US consumers are looking to save more aggressively and Amazon’s lower price points, has it properly positioned to take advantage of this during this economic downturn. Earnings estimates for Amazon are $.331, but many analyst believe Amazon will surpass this figure due to stronger revenues.

McDonalds, king of the hamburger, is set to release it earning before the bell rings for trading on Thursday. Earnings estimates are set at $1.108 eps. Many analysts have a buy rating on this stock despite, increased competition from the likes of Burger King with the introduction of it $1 double Cheese burger. Much of this optimism is due to store locations. There are now more Golden Arches in Europe (2014) then there are in the United States (1697). In addition to the greater European presence, McDonalds also charges higher franchise fees in Europe 17.4% vs. 13.6% in the US. Foreign Exchange rate are in McDonalds favor since the US dollar has been in a downward spiral vs. the Britain’s Sterling Pound and the Euro Zone’s Euro.

Telecommunications/Consumer Discretionary –AT&T

Due out at 8am AT&T is expected to blow away it earnings expectations of $.501. The market is overjoyed about the reduced price of the 3G iPhone, which is the offspring of a union between AT&T and Apple (AAPL). The iPhone is so successful it has exceeded AT&T’s network infrastructure capacity in certain areas of the US causing poor service for many subscribers. This product will be the driving force in the AT&T earnings story, especially since the wire line division has been continuously dwindling away as the entire globe goes mobile. In this scenario a good showing will prove that the consumer is still willing to purchase discretionary items, as long as they are priced sensibly.

The Bottom Line

Economic numbers have the potential to overshadow the greatest of earnings estimates, as witnessed on Tuesday October 20th, with the poor Housing Starts, and Building Permit figures, that bested Caterpillar’s surprise earning in excess of 856.5%, ending the day with the Dow Jones Industrial Average tumbling by 100 points. Ultimately, earnings results and economic indicators need to produce positive results in order to sustain an on going market recovery. Without positive results you will definitely see a market correction in the very near future.

Since the March 6 lows the entire market has been praying for the return of the Dow Jones Industrial Average (DJIA or Dow) to the 10,000 level, which it has not seen since October 3, 2008. The 10,000 level for the DJIA has always held a special place in the heart of the investment community. It first closed above this landmark level on March 29, 1999. This historic day was so celebrated that they actually had a party on the trading floor on the NYSE. Ironically this bust through took place during the infamous tech boom of the 1990’s, while today’s break out is occurring during a time of economic uncertainty & turmoil. The Dow closed today’s session to the tune of  10015, leaving the market jubilant and overjoyed, as I write this Asian markets are rally off of this news, at last glance the Nikkei is up 1.77% for the day. Bifurcation comes to mind when thinking about overall investor sentiment, some feel that the economy has come to far to fast, without showing any signs of independence from US government intervention, and feel the market is positioned for a correction/crash vs. the camp that feel that the market is an early signal of economic recovery and is a leading indicator and feel that we are currently in a bull market. Read Nicole Wachs, Director of Education at TradeKing Comments on this split in opinons. The true is both sides have valid concerns, but at the end of the day the only thing that matters, is if your investments are profitable or not!

The Optimistic Side

A large majority of investment industry analyst are forecasting a strong 3Q earnings season, already evidenced by JP Morgan’s and Intel’s beating analyst expectations hands down by 62% and 23%, respectively.– This is just the beginning!– Major Dow and S&P companies are reporting  before months end, Apple, General Electric, Wells Fargo, Morgan Stanley, American Express, MetLife, Caterpillar, Boeing and ExxonMobil and if the pattern of beating analyst continues you could see the markets move even higher.

Tom Lee, Chief US Equity Strategist for JP Morgan stated on Oct 2nd, that there were many things favoring a positive month for October:

v     3 Qtr earnings will  beat Top & Bottom lines estimates, setting stage for the market to move higher

v     Found that 44% of the crashes, since 1960 have occurred in October and severely bad Octobers in the 1930’s and the 1970’s have led to souring investor sentiment.

JP Morgan’s Research Found:

Ø      Crashes are unpredictable

Ø      Reviewed the last 18 crashes and found a combination of three common factors that preceded these crashes

·        Sharp 3 month rise in the VIX of 50%-100%

·        Widening of high grade bond spreads over a 3 month period

·        Strengthening Dollar

v     Less likely to see tax loss harvesting, since January to September period has been positive for asset manager and about 15% of  mutual funds have an October year end

Tom goes on to say that, according to their research in order to have a crash you have to have at least  one of the conditions involving the VIX, widening Bond spreads or a stronger dollar to have to significantly increase the probability of an a crash in October.

JP Morgan’s research coupled with the Dow breaking the 10000 level, presents a clear case for a sustainable rally.

The Pessimistic Side

Economists are keeping a keen eye on the unemployment rate which is at 9.8% with projections of double digit rates on the horizon. Initial Jobless claims (4 wk first time unemployment claims) loom around the 500,000 rate and continuous claims married to a 6 million plus figure incessantly. These rates are catastrophic for the US economy because approximately 70% of GDP (Gross Domestic Product) is generated by consumer spending. Not to mention the stalled housing market and a financial industry that still have not quantified the total liabilities outstanding for residential and commercial mortgages. None of this is new!  

In Mark Zandi’s, of MoodyEconomy.com commentary, “U.S. Macro Outlook: Training Wheels Still Needed”, Zandi states “An economic recovery is underway, but it remains tentative and fragile.” Zandi also states “The Great Recession is over, but the current economic recovery will be a difficult slog through much of the next year. Like many others Zandi is predicting delayed recovery in 2011 or 2012ish, which could translate into a selloff in the overall markets, if these type predictions prove to be worse then anticipated.

 The Technical Side

Below I have attached some charts of the DJIA. In the chart I have drawn Fibonacci retracement lines. In the chart it is clear the Dow usually breaks through a level, tests that level and moves higher. Also volume has increased drastically over the last few trading sessions. Interestingly, the first leg of DJIA recovery occurred between March 9^th and July 10^th, returning approximately 24%. The second leg up took place from July 10 to Oct 14^th, producing an estimated 23%. Ironically, both legs took place between a 3 and 4 month time frame, and return between 23% and 24%. Is it possible for this rally to continue with the same measure of momentum? Who Knows!! A similar upward movement would put the DJIA above 12000….     

 Finally, the media has been constantly reporting that there is plenty of cash on the sidelines and it is waiting for the right time to step back into the market. Clearly the DJIA close above 10,000 is a positive signal that the coast is clear or at least clearer for now. YTD the DJIA has returned 14.12% and over the last 12 months starting from October 2008 until now the Dow has returned 16.76% (assuming dividend reinvestment). With the Dow being in positive territory from last October, you will have even more media personalities and sales man(financial advisors) shouting how great the market is, and convincing retail investors to make the switch from cash to stocks, and take the Great Leap, since the “GreatRecession” is now over,  during this last quarter of the year.

A Different Perspective on Bond ETFs

There was a wonder article titled “Bond ETFs are Popluar But Pricing Is a Problem”, written by Eleanor Laise, in the Wall Street Journal. The article highlighted many of the short comings of bond ETFs, particularly the huge difference between the share price and the underlying Net Asset Value, but despite this phenomenon, investors are still demanding these investment vehicles.

“Share prices of many bond ETFs are drifting far from the value of their underlying holdings, which can create big trading cost for investors. Some of the funds are straying from their benchmarks, meaning investors aren’t getting the returns they expected.

None of this has stopped investors from jumping into bond ETFs. The category has snagged over half the new cash flowing into ETFs this year through August, up 52% from the end of 2008.”

Many articles covering bond ETFs usually cover the same topics, premium/discount, Net Asset Value/Indicative value and index drift, but rarely do I see any mention that these are exchange traded securities (no pun intended), and thus are subject to the whims of the market. All market traded securities are at the mercy of the “Animal Spirits”, which is the title of a book written by George A. Akerlof and Robert J. Shiller (Case Shiller Index Co-founder). This book highlights how human emotions play a major factor in the markets and the economy. The undeniable human nature of fear and greed is a clear example of these emotions at work when these bond ETFs continue to appreciate without regards for the underlying fundamentals. Historically, stocks and bonds have been negatively correlated, largely because most bonds aren’t traded daily, so the supply is much more limited than stocks. Unfortunately, many individual investors as well as financial advisors do not understand that the illiquid nature of bonds cause their corresponding ETFs to stray away from tracking the performance and holdings of their underlying benchmarks, thus defying what they were originally set out to do.

Today’s investor demographic is largely dominated by baby boomers that  still have vivid and freighting memories of the 2008’s market crash. These baby boomers are still gun shy when it comes to investing their retirement nest eggs in equities, thus the huge amounts cash, parked on the sidelines being held in money market funds. As the article highlights the majority of the new assets were allocated to bond ETFs. Many however, are expecting Bond ETFs to have the same security characterizes of an actual bond. Nothing could be further from the truth. Barrier for entry into the individual bond market can be quite steep, since most individual bonds don’t trade daily. Also, the cost for purchasing a bond is substantially higher than the price of one ETF. On the surface, these funds appear better than traditional mutual funds with bond holdings, due to the transparency and liquidity ETFs offer. On the flipside bond mutual funds, don’t trade on an exchange, so they are not as exposed to the ebbs and flows of the equity market.

Institutional ownership in bond ETFs is a factor, but most of these funds are owned by retail investors, who tend to pay a bit more for their holdings versus an institution. Clearly a case of fear and greed has been demonstrated when you see majority ownership of these bond funds, being individual investors. This is also a testament to the ETF movement. The fact that retail and institutional investors and are willing to utilize ETF over actual bonds or mutual funds to implement the fixed income portion of their overall asset allocation, speaks volume. As more baby boomer begin to approach retirement, bond ETFs will continue to increase in demand and that will only increase the probability of Bond ETFs to continue to trade at larger premiums.