Sunday, March 22, 2009

Common Valuation in Bear Markets: It is Bad and Will Never Get Better/Tribe on Impairment of Contracts/Alexander & Baldwin/Stock Rallies and Quantitative Easing

According to Lawrence Tribe, a Constitutional law scholar at Harvard Law School, the impairment of contract clause in the Constitution does not apply to the federal government. Law Blog - WSJ By its wording, it only applies to the states. So, arguably, the federal government would not be prohibited from abrogating a private employment contract at least on that basis. I was surprised to learn that the impairment of contracts clause only applied to the states and was not a restraint on the federal government's power. Possibly someone needs to inform Governor Pawlenty of Minnesota. Governor Pawlenty's Blather

I do wonder whether the republicans would howl if Congress passed a law abrogating private employment contracts that were lawful when executed by the parties in arm-length negotiations, other than the AIG contracts. For now, they are howling for the abrogation of the AIG employment contracts that allegedly required the payment of the bonuses, but where does a politician draw the line on the question of principles and power. Which contract is abrogated next once the power is exercised?

Generally speaking, any true conservative, as opposed to the millions of pretend ones, would not want the government ever to exercise such power, which exercise is apparently not restrained by the Contract Clause, no matter how distasteful those contracts were to me or anyone else. Those who read this blog know that I view the Masters of Disaster as worse than worthless, with a negative value as a class, somewhere around a negative 4 trillion dollars give or take a few billion.

(1) Quantitative Easing and Stock Market Rallies: Randall Forsyth had an interesting column in this week's Barron's.

Prior to reading it, I was aware the the stock market experienced some of the largest percentage rallies during the Great Depression. I was also aware that the Federal Reserve tightened after the stock market crash which only aggravated the problem. I knew that the market bottomed in 1932. Forsyth reminded me that there was a powerful stock market rally starting in 1932, with prices quadrupling, that coincided when the Federal Reserve started to aggressively buy government securities, called quantitative easing by nerds and printing money by the rest of us (now printing money is done electronically with bleeps).

The decline from 1929 to 1932, however, was steeper at a 86% decline than our current bear market, but the current decline was over 50% since the highs in October 2007 before the rally earlier this month.  Maybe the market got it right with its first reaction to the Fed's announcement last week. 

There is a common valuation technique in a bear market, which I will describe with a phrase: "It is bad and it is never going to get any better". The here and now, what is happening this minute and day, becomes the best forecast for as long as a human can see, which is not very far.  Maybe it is due to the slow motion effect of real time living, where days seem long and a year becomes an eternity when one dwells on the passage of minutes or days rather than the ebb and flow of history in the minimum unit of years. Generally, somehow and someway, the economy sinks and then prospers, then sinks and expands again. Ultimately, it is foolish to extrapolate the present into the indefinite future. This is sort of obvious looking back at a few centuries, but you would never know it based on how investors value companies based on a year or two of declining earnings caused by the latest in a long series of economic calamities.  Maybe it is due to an incomprehensible inability to "remember" much of anything that happened more than a few minutes ago.

It is sort of affliction of the human race, always predicable, to forecast the present condition into the indefinite future. Understanding investor psychology is always important, which is one reason why I read Professor Schiller's book Irrational Exuberance as soon as it was published in 2000. Home Page of Robert J. Shiller Irrational ExuberanceAkerlof, G.A. and Shiller, R.: Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism.

So now, after a bad year in 2008, and another one likely in 2009, it is going to be bad until the end of days, so turn back the clock fifteen to twenty years or more when valuing a company. Is a single company in the world going to survive, seems to the prevailing sentiment? Knowing that this is likely to happen in a major bear market that may last say 18 months, the prudent investor who is not stuck perpetually in the present probably needs to anticipate the madness of crowds, duck, squirrel away some money, and wait for the sun to return, or at least a better entry point for a long term hold. Otherwise, the more sensible ones will just be trampled by the thundering herd.  For some companies, managed by the arrogant and ignorant, though highly compensated and rewarded for failure, the sun will never return and they will be relegated to the dustbin of history by the downturn. Leverage does work both ways in case anyone needs to be reminded.

 Most major companies will survive and prosper during the next upturn.  Many of these companies are now traded at levels prevalent in the early 1990s or even 1980s, as if nothing has transpired in the last twenty years, or at least nothing good. I have mentioned several that I have recently purchased with strong hands and a long gaze into the future. One company which I do not yet own, working its way back to a 1980s price, is Alexander & Baldwin. 

Alexander & Baldwin (AXB) expects to break even during the first quarter, well below analyst expectations of a 35 cent profit. Okay, Alexander & Baldwin is going to have a bad quarter, maybe even a bad 2009. The culprit is a significant fall in its shipping business to and from Hawaii.  Eastbound volume from China was down 20% and westbound traffic from the mainland to Hawaii had fallen 12% from the year ago levels. Alexander & Baldwin expects to break even in 1Q: Financial News - Yahoo! Finance Shipping constitutes about 80% or so of its revenue. Shipping is clearly sensitive to the health of the U.S. economy and our trade with China.  So, are we going to never pick up our trade with China again, apparently not? 

 Although I do not own AXB now, I have owned it in the past, and my interest is invariably perked on valuation grounds, primarily as it relates to its large land holdings in Hawaii and it efforts over the past decade or so to use its base in Hawaii real estate to expand to the mainland. This stock was in a channel between 20 to 30 from 1987 through 2003-a real dead ender.

In 2004, with the shipping business in an upturn, and global trade with China the rage and the hot new investment theme, the stock rose to a new range of between 40 and 60, finding a lot of resistance around 58, until it broke that channel in October 2008 by moving decisively below 40, and closed last Friday at 20.17, cut in half in five months.  Since I do own this company, I would not mind seeing Wall Street kick it some more while it is down, maybe drive the price down to close to $15 again, where I will be tempted to buy it again. The companies real estate is what always draws me to it.  The real estate may be worth about $55 to $60 per share based on Morningstar's analysis.  Book value is over $26 per share. The undeveloped land in Hawaii was acquired ages ago at almost no cost. Some of the land is set aside for agriculture in Hawaii, which is frequently an unprofitable operation for AXB, while some land may be developed by the company. Only a very small portion of the 89 thousand acres owned in Hawaii (Maui, Kauai, and Oahu) is currently zoned for development.

The last annual report has a lot of the details about the companies real estate holdings. AXB also owns commercial property in Hawaii and the mainland (about 6.5 million square feet), and sells residential properties in Hawaii and has a joint venture to develop 1040 acres at the Santa Barbara Ranch (pp.8- 9 of annual report).  The last quarterly report also has some details about real estate sales. 

AXB had about 47 million in proceeds from real estate sales that were available as of 12/31/08 to invest in tax deferred exchanges (real estate nerds call this a 1031 exchange). Those who focus on the here and now will sell this company and continue to so. S & P has it rated as a sell. The focus always seems to be on the ups and downs of its shipping operations. But when I view that operation, while acknowledging that shipping provides 80% of the current revenue, I view it as contributing around 1/6th of the break up value.   But I know the history and realize that I have to pick and choose my entry and exit points. I would not buy it at 50, but would be a seller at that price. I would not however be a seller at $20.   

General Growth Properties, an owner of 200 malls, with over 1 billion in debt past due, is inching closer to oblivion, with Citigroup filing papers to foreclose on a mall in New Orleans.

Another economist who has learned nothing from the events that led to the current meltdown is Gene Epstein who basically argues that what got us into this mess, wild west capitalism with no adult supervision, needs to be restored in all of it grandeur, but without the Federal Reserve meddling in the "feckless expansion of money and credit" In this world, which ignores virtually everything that actually happened during the past decade, none of my top twelve causes have any relevance other than Greenspan's actions. Buy 50 AINV at $2.35 in IRA/Revisions to top Twelve Causes of the Not So Great Depression   

Another economist wrote a letter to the editor complaining about the use of the term negative feedback loop when he asserts, probably correctly, that most economists refer to it as a positive feedback loop which no one would understand, given the normal meaning of positive, other than other economists. Letters to the Editor -  The author of that missive, a Mr. Gerald Lillienthal, is an analyst of what he calls "closed-loop dynamic mathematics".

Admittedly, I am a little dense at times, maybe I got too much sun working for $2 hour in the summer way back when, Value of Real Labor/Buy of UNG, and too many brain cells were baked and fried into oblivion. You know how we talk down south, real slow, so as not to draw too much of the hot humid air into our lungs all at once. But I am going to continue using the phrase "negative feedback loop" regardless of what the expert in closed loop dynamics or whatever says about it.  Besides, although I have a higher opinion of economists than I do of lawyers, I still put both of them below politicians and used car salesman. Besides there are mostly ideologues with a lot of numbers. Japan GDP/ Economists: Secular Theologians with a lot of Numbers

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