November 19, 2008

Global Market Comments for November 19, 2008
Featured trades: (MSFT), (ORCL), (SY), (INTU), (PLD)

1) October housing starts came in at a shocking minus -4.5%, a 791,000 annualized rate, 409,000 below the replacement rate. Huge disruptions in the classical economic data by the credit freeze are ongoing, and will continue for the next couple of months. October CPI fell to 3.7% YOY, the biggest drop since WWII.

2) To give you an idea of how much liquidity is out there, excess banking reserves held by the Federal Reserve are now at $400 billion, and are expected to rise to $600 billion by year end. The normal figure is zero to $2 billion. No typo here. In October, a massive $143 billion in net capital flows came into the US as investors bailed on their foreign investments, especially in their BRIC, euro, and sterling holdings.

3) When the market turns there is going to be a huge movement of cash into technology stocks, the only debt free, fast growing sector of the economy. Buy software names first, because they see the most rapid improvement in profitability in any recovery, and because they have nothing to physically make, no assembly lines to restart. Think Microsoft (MSFT), Oracle (ORCL), Sybase (SY), and Intuit (INTU).

4) The City of San Francisco is raising the minimum wage in 2009 from $9.36 to $9.79/ hour. It looks like I am getting a raise.

5) Watch the market slide whenever there is congressional testimony. When investors see the stupidity of the people voting on crucial economic and financial matters that affect our country, which they clearly will never understand, they just want to throw up their hands in despair and go away.

6) Q4 will almost certainly be the bottom of this recession, and October the worst month. Watch the economic data get less worse after that. If you can make it through the next six months, you have made it.

7) I'll make a gentlemen's bet with you. I think oil will trade at over $100 sometime next year, nearly double the current price. The loser pays for lunch at either the Olympic Club or the Marines' Memorial Association. Semper Fi.

8) Prologis (PLD), the world's largest developer of commercial warehouse space, and a leading manager of REIT's, has seen its shares collapse 94% from $65 to a low of $3.62. It is effectively trading as if the company has already gone bankrupt. The Denver based company employs 1,500, managing 2,898 properties, totaling 548 million square feet in 115 countries. It had been a highly leveraged call on the growth of international trade, which is now imploding with unprecedented speed. PLD listed $40.8 billion in assets on its balance sheet, and until recently, was one of the largest listed REIT's. CEO Jeffrey Schwartz, a 14 year veteran at the company who spearheaded its growth into China, where it now has 3.3 million square feet, resigned on November 12 and will be replaced by CFO Walter Rakowich. Thus, the keys to PLD have been handed over from the visionary risk taker to the bean counter. On November 4, the company announced a Q4 dividend of 52 cents, giving the shares now trading at $3.78/share an effective annualized yield of 55%! The company refused to issue a forecast for 2009, which didn't exactly inspire shareholders. PLD's 5 5/8% bonds due in 2016 are trading at just 43 cents on the dollar, giving it a low grade junk yield of 16.7% over Treasuries. PLD is now clearly in survival mode. It has suspended development of the $8.4 billion of projects in the pipeline. It is dependent on rolling over $353 million of company debt and $1.46 billion of fund debt in 2009 in credit markets, which are now effectively closed. It hopes to carry out distressed sales of $2 billion of assets by next year to deleverage its balance sheet. On November 13 it told shareholders it would save $290 million by slashing its future dividends, and another $100 million in cutting administrative costs. The stock has clearly been pulled down by the general distress in the sector in an environment where leverage has become a dirty word. The default rate on commercial properties is expected to soar from this year's 1% to as high as 5% next year. 18 publicly traded REIT's have cut or suspended dividends so far this year. PLD was badly hurt by a deal with Lehman Brothers struck in July, 2007, at the absolute peak of the market, where it bought a $1.85 billion national portfolio of warehouses from Dermody Properties and the California State Teachers Retirement System. Lehman was unable to repackage and resell the debt. There are dozens of stocks like this out there now where share prices have fallen to the level of an undated, highly leveraged call option. It is a bet that we have a 'V' type recession, not a 'U', and that credit markets recover rapidly next year. I give it a 50:50 chance of survival. But the risk/reward ratio is good. If you are wrong, you lose $3.75. If you are right, the stock could very quickly make it back up to $20, giving you a return of 533%. If you were running a portfolio, you would be buying these all day long, where the mathematics of venture capital applies. If four out of five go bankrupt, you breakeven. If only three out of five go under, you double your money. You need to buy five PLD's, not just one.