Agora Financial’s Rude Awakening

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Laguna Beach, California

• Banking on refiners and cutting back on banks,
• An appetite for the ags and the trouble with relying on transactions,
• The kind of probes that delight TSA officials and much more…

Eric Fry, recalling his recent encounter with U.S. Customs, reports…

“What do we have here?” a rotund Customs officer cheerily exclaimed, as he stared into the monitor of his X-ray scanner.

“Wuddah you got, Pete?” a fellow officer replied.

“Two handguns,” said the officer named Pete, nodding his head with a self-satisfied smirk.

“Metal?” the colleague asked.

“Yep,” said Pete. “Let’s open this bag up and take a look.”

“Um, they’re just toy guns,” your editor explained. “They belong to my 9-year old son.”

“Did Air France just let you cruise on through with these when you boarded the plane in Paris?” Pete asked.

“Yes,” your editor replied. “Why wouldn’t they? This is checked baggage. Not carry-on.”

“Well,” the other officer replied, rocking back on his heels, “it’s just that these firearms don’t look legal.”

“They’re not firearms,” your editor said. “They’re toys. We bought them in a French toy store.”

“But they’re metal,” the officer countered.

“That’s right,” your editor agreed. “They’re metal toys.”

“I understand what you’re trying to say, sir. But guns like these aren’t legal in the United States. I’m going to verify that with the commanding officer.”

“Okay,” your editor sighed. “But what do you believe is the problem with these toy guns?”

“Well,” the officer answered, “they don’t have any red tips at the end of the barrel to indicate that they are toys. Toy guns have to have a red tip on the end of the barrel. And they’re metal. So they look like real guns.”

“Okay,” your editor persisted. “So let’s pretend they aren’t toys. Let’s say they’re real guns. Would that be a problem? If we say they’re real guns, can I keep them?”

“No,” the officer answered. “Toy guns like this aren’t legal in the U.S.”

“I got that, but real guns like this are. So let’s say they’re real.”

“Well, sir, that’s not possible,” the officer insisted. “These are illegal guns. May I have all of your passports please? Go sit over there and the commanding officer will be with you in a little while.”

Obediently, your editor and his children occupied four of the seats reserved for the accused-but-not-yet-condemned Customs violators. The youngest of your editor’s four children was fighting back tears. These were his brand new toys after all. And they were REALLY cool. He was planning to use them in the James Bond movie he is filming.

The oldest of your editor’s three children was utterly disgusted. “Can you believe this? Two minutes after walking out of this airport we could buy real handguns that could actually do some harm to someone. So who do these guys think they’re protecting?”

“Well, I’m not sure they’re protecting anyone,” your editor agreed. “But it looks like they’re trying to protect their jobs. Did you see those tables by the X-ray scanner with tonight’s confiscated items? They were full of potted flowers, raw eggs, coconuts and other agricultural contraband. These ‘guns’ were probably the biggest haul of the night.”

“That’s pathetic,” your editor’s oldest son scoffed.

“Welcome to America,” his father replied. “We’ve got more handguns per capita than almost any country in the world, but if a 9-year old brings a toy gun through Customs, his Dad’s a criminal…And guess what happens next? My name goes into some vast government data-base as a gun smuggler…Hopefully, I won’t be detained.”

A few moments later, the commanding officer approaches with a couple of official documents in his hand and a very grave expression on his face.

“May I speak with you a moment, sir…away from your children?”

“Sure,” your editor replied, trying to fight back laughter.

“This is a very serious offence,” the officer began. “Now I realize that you were just trying to bring toy guns through Customs, and that you probably didn’t even know that you were breaking the law. So we’re just going to let you go with a warning. But let me give you this document that states we have confiscated these guns and will be destroying them.”

“Okay.”

“I just want to emphasize,” the officer continued, “that we take this kind of thing very seriously.”

“I noticed.”

“Of course you would know that these are toy guns,” the earnest officer explained, “But if I were a law enforcement officer and I saw you out on the street brandishing one of these guns, I would probably drop you.”

“I can see that,” your editor replied, secretly referring to the macho mentality of the Customs officer.

“We just can’t let things like this through Customs,” the officer insisted.

“Fine,” your editor replied, hoping that monosyllabic responses would discourage the officers from continuing their asinine commentary. “So does this piece of paper that you’re handing me mean that I’ll be whisked into a dark room every time I return to the States? I do a lot of traveling. So I hope you guys didn’t blackball me, just because my son bought two toys guns.”

“Ohhh noooo,” the highest-ranking moron replied. “You won’t have any trouble. We’ve just put a file in our records that tell us that you tried to bring illegal look-alike guns into the country. That’s all.”

“Uh huh. Got it. Can I go now?”

“Sure and thanks for your cooperation.”

Your editor’s response to this inquisition was less a result of cooperation than coercion. He said what he believed he had to say, not what he wished to say. He was not aware of any other viable options, except to pretend that toy guns posed a threat to national security and to feign respect for this particularly ridiculous aspect of the law.

Concerning the financial markets, by contrast, your editor may speak his mind. He does not worry about disproportional overreactions from government employees. He does not fear detention for suggesting that some passionately held beliefs are misguided. He does not feel compelled to embrace prevailing misconceptions.

He worries only about one thing: being wrong…or, at least, wrong enough to lose lots of money in the financial markets. (Losing little bits of money here and there is part of the price of admission). Your editor knows he will be wrong…often…which is why he cares more about guarding against losses than about maximizing gains.

A risk-averse investment strategy could be particularly useful in the current investment environment – an environment we call the “Era of Caution.” In today’s edition of the Rude Awakening, we present the third and final installment of your editor’s speech to the Agora Wealth Symposium last month: “The End of Peak Greed – Preparing for the Era of Caution.”

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The End of Peak Greed, Part III
By Eric J. Fry

Financial stocks will be a buy someday. It’s just that I prefer to miss the first 20% of the upside. And I’d rather buy into something where I can see at least a sign of a rebound. So why not invest in the companies that are making the world go around, and are performing well, instead of the companies that are making the world go into a tailspin?

I think it’s a matter of picking one’s poison. Agricultural commodities and oil-refining stocks are a couple of the types of poison I would ingest. But financial stocks are the type of poison that I would refuse. Let me give you a couple of hypothetical pair trades to illustrate the point…

A company like Visa (NYSE: V). A company that relies on dispensing credit to people who have too much already and relies on consumer transactions. So here’s a pair trade that I would suggest, just to give you a hint of what I’m talking about.

Alright, so I’m going to suggest one hypothetical pair trade here: Sell Visa (NYSE: V), buy agricultural commodities. This idea is actually the distillate of another Rude Awakening column from a couple of months ago. Visa was higher then, by the way. It was $87, now it is $71. So far, so good. But I still like the idea. The macro backdrop for the idea is that debt-financed consumption is not an essential bodily function. Eating is. So if the economy were to slow down a little bit, maybe people wouldn’t transact as much to buy stuff. Maybe they would buy food, for example.

On top of that, you’ve got some nice little micro aspects to this story. Visa is an expensive stock. It’s about forty times earnings. It almost doubled off of its IPO price from March. Its valuation bears no resemblance whatsoever to other industries to which it is somehow related – meaning, homebuilding and banking.

These industries that reflect the approximate health of the American consumer are in a tailspin. Somehow Visa is still okay. The fans of Visa stock say that it is merely a transaction processor. It has no exposure to credit. That’s true. That’s a virtue. That’s great. But, a transaction processor still needs transactions to process. Also I would say that if Visa is JUST a processor of transactions, then why is it at forty times earnings? One other item here; we’re beginning to see the beginnings of delinquencies in the credit card industry, as well. No big surprise there.

On the other hand, agricultural commodities are very UNLIKE Visa. They don’t facilitate commerce; they facilitate existence, of course. Everybody on the planet is hungry and they all want to eat. This doesn’t make these commodities a buy, but there’s also the fact that the worldwide supplies of
all cereal grains have dropped to 25-year lows. Wheat stockpiles are lean. Wheat stockpiles in the U.S. are at 60-year lows. And at this moment, you’ve had a very big correction in the ag commodity sector. Corn prices are off from their recent highs. So are wheat prices. So I like this trade from a macro standpoint.

I also like the refining industry. So I would ask this simple question, “Are you better off buying refining stocks today than financials?” I’m not sure, but I think the answer is probably, “Yes.” One amazing stat, however, is that since the credit crisis burst onto the scene one year ago, the S&P Refining Index is down 52%; the XBD Brokerage Index is down 30%. So despite all of the known, horrible news that’s flowing out of the finance sector, the Brokerage Index is only down 30%.

Refining companies are making money. They produce robust cash flow. The finance companies produce robust losses. So I’m a fan of the refining sector. You know, there’s no exact reason why the refining stocks would be performing this badly. But the analysts on Wall Street believe that earnings will fall in that sector going forward, just as they have been falling in the recent past. Because soaring crude prices are compressing their margins. So they think refining company earnings will drop; they think finance company earnings will rebound. They’ll be great!

But even on forward guesses about earnings, the refiners are at nine times; the financials are at 28 times. And those are just guesses about next year. What we know is that the current PE ratios on finance companies are infinity. There are no earnings. What’s more, the refining executives are buying their own stock. And so that’s usually a good thing. Doesn’t mean they’re a buy, but it always helps.

There’s always a bull market somewhere. That’s the happy way of interpreting activity in the financial markets. And the phrase is true as far as it goes. Unfortunately, sometimes some of the world’s most prominent bull markets are not the ones that bring wealth and high fives. Sometimes the bull markets are in things like foreclosures, job losses, and bankruptcy filings.

And in fact, we’ve got some sizzling new bull markets in drought and famine and bank failures. So, yeah, there’s always a bull market, but sometimes the kind that generate wealth easily aren’t that lentiful. So during markets like these, caution tends to outperform risk-taking.

During the early 1970s, Warren Buffet spent several years engaged in boringly cautious activities. Now he’s a billionaire. I don’t know; that seems kind of sexy to me. That doesn’t seem so boring.

So I’m thinking that maybe the cycles in financial markets are coming around to what Charlie Munger suggested recently that the Berkshire style of investing is coming back into favor.

That having passed through this valley of the shadow of death – the CDOs and the leverage and the corrupt accounting etc. – that we’re going to end up in a place where we are back to basics. Where you really have to understand what it is you’re buying. And hopefully, you’re buying that thing at some sort of discount to what it’s actually worth.

So with that exhortation, I hope to see you all back here next year wealthier than you are today. And if not wealthier, at least healthier.

[Joel's Note: That concludes our round up of the Agora Financial Investment Symposium for 2008. For parts one and two of the condensed, Rudified version of Eric’s speech, click here: The End of Peak Greed, Part I and Part II. Also, if you are interested in grabbing an audio set containing all of the speeches, including the explosive breakout sessions and specific stock pics, you can grab a CD or MP3 set here.

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[Rude Endnote: For our money, this year’s conference was the best yet. We sincerely hope to catch you there next time around for some savvy investmentinsights and perhaps a beer or two downtown.

Until next time…

Cheers,

Joel Bowman
Rude Awakening

aussiejoel@the-rude-awakening.com