Don't Be a Yield Hog

One of the things many investors, particularly older, income oriented ones do is look first at the yield of investments. It is natural to see 8% as better than 4% and count those chickens long before hatching. The piece of the puzzle not on the page is risk. All those synthetic Merrill Lynch preferred shares looked pretty good once. Even the Lehman Brothers money market funds paid a little more than the average. Today we have an extreme example of why 8% is not 4% and why sometimes less is more.

General Motors. I have a friend who accumulated GM bonds for retirement and despite my groans and cautionary nudges held them. Today those 9.4% bonds due in 2021 are paying (excuse me, calculating) 196% yield to maturity. I could eat caviar everyday of retirement on that! I can only wince at her decision.

You have to buy a lot of bonds at 8 cents on the dollar to get much beluga. Of course that 196% is completely illusory and that 8 cents will shortly be 0 cents. The same thing happened in the latter part of last year (though not so dramatically) when a scan of stocks paying dividends over 5% produced a slew of well know companies. Alcoa, Citigroup, PNC, all have cut dividends to reflect cash constraints and market realities. A lot of chickens have crossed the road in the past months and more than a few didn't make it across.

High yield is as much a yellow flag as a semi-annual check so choose carefully.

John Barnyak
President
www.stonehouseasset.com

Pundit Love

I admit, I've hated this historic rebound in the stock market. Historical events are never exactly predictable and they have a siren's call to join in at just about the wrong time. For better or worse Stonehouse portfolio discipline makes emotion driven action more difficult. A remarkable similarity is found in the in commentary in 2001 by that successful self promoter and motor mouth Jim Cramer and some of the statements of the past week.

A Bull Is Born

By James J. Cramer
Published Nov 19, 2001

Professionals hate this stock market. They think it's overvalued on earnings and going up solely because of the lack of other alternatives. They think it's a roller coaster poised atop a downhill drop, an accident waiting to happen. And they hate that there are no alternatives: Cash brings you next to no return and bonds seem downright dangerous given their skimpy return and monster run.

Individuals hate this stock market, too. They've had it with losses, they're fed up with bad advice from crummy mutual-fund managers, and they're tired of the blue-chip tech stocks they paid hundreds of dollars for that are now worth a fraction of that. Either they've sold everything and turned their back on the market or just decided it isn't worth throwing in good money after bad and started hoping to one day get back within a few dollars of where they got in.

Which is precisely why I think the market is poised to go higher -- perhaps dramatically so. Look how easily it's shrugging off bad news. Last week, after an American Airlines flight crashed in Queens, it barely blinked; traders paused to sell off the usual suspects -- travel and leisure -- and then kept buying. This market might well be a baby bull, conceived in the despair of September 11 and born on September 21, 2001, after the worst sell-off since the Great Depression.

The main reason is simple: Interest rates are lower than they've been in 40 years. And those lower interest rates that allow buyers to finance new cars for nothing,

But for the date, it would not be out of place in today's punditocracy.



May 11, 2009
Published in Marketwatch.com

Gray Emerson Cardiff of Sound Advice has been mulling a major market move for some time. He wrote in his most recent issue, published in April: "As noted in the March issue, we are approaching the cusp of a new SuperCycle,

So what happened to Mr. Cramer's bull? It flirted with the forty week moving average then expired, sending the S&P to a new low, 30% lower, a year later which eventually was tested and retested before proving to be the base from which a bull market could begin. (click on image to enlarge)




Plan your trade, and trade your plan.

John Barnyak
President
www.stonehouseasset.com

Green Shoots or Soylent Green

One of the all time film cult classics was the futuristic Soylent Green in which a world beset by overpopulation and food shortages depended on the government for nutritional supplement. Without giving away the ending, let is only be said that the government solved both issues in one policy. Who knows how many problems are being solved today with similar sweeping efficiency!

In early march there was a palpable acceleration of feel good data and market action. Two months later we've experienced the sharpest stock market rebound in history on the back of short covering of investments in the worst companies in the economy and Tim Geithner's loose change. The power of sentiment is great and it is important. But some perspective is helpful.




The point of the chart is to illustrate where we were and where we are. Bear market rallies are the most powerful rallies and like when we stop hitting our finger with a hammer, it feels so good.

The leading sector in the rally has been financials. That beleaguered collection of insolvent and powerful companies rode up higher on the fact that the hammering stopped. Given the trillions of loans, guarantees and bailout funds for short sellers it was a good bet the juice was no longer worth the squeeze. For example the short sale of Citigroup at 46 when it fell below its 200 day moving average looked pretty good at $1. The incremental added profit betting on the move to zero wouldn't add much to the game. At about $3/share, the technical analysis indicated a shift in risk to the upside.

What about the economic evidence to support an end to the recession. It remains in the realm of second derivatives. Less bad is the new good. The headline employment data looked good-ish. Here's the good news:

* 539,000 jobs were lost in total vs. 663,00 jobs last month.
* 110,00 construction jobs were lost vs. 126,000 last month.
* 149,000 manufacturing jobs were lost vs. 161,000 last month.
* 269,000 service providing jobs were lost vs. 358,000 last month.
* 47,000 retail trade jobs were lost vs. 48,000 last month.
* 122,000 professional and business services jobs were lost vs. 133,000 last month.
* 15,000 education and health services jobs were added vs. 8,000 added last month.
* 44,000 leisure and hospitality jobs were lost vs. 40,000 last month.
* 72,000 government jobs were added vs. 5,000 lost.

Don't misunderstand, things must get less bad before they are good, but several items give me pause.

The automotive plant closures haven't hit these data yet.

There are approximately 2 million college graduates about to hit the job market.

The Bureau of Labor Statistics has been particularly aggressive in downward revisions a month after initial release. Each month the revision has been greater job loss by between 30,000 and 100,000. So the green shoots are delicate indeed.

The statistical adjustments, which are statistically justifiable, still create obscurity. The Birth/Death adjustment calculates a projected gain or loss of jobs from failing businesses and new businesses. The BLS is assuming the net creation of 226,000 new jobs from new businesses in April.


The government creation of jobs was principally the hiring of census workers for the upcoming census, temporary workers.






I am keeping the vintage champagne corked and chilled still.

John Barnyak
President
www.stonehouseasset.com

More Marcellus Analysis

For those following the local gas bonanza or bust, depending on your perspective below is an report from Toby Shute of Motley Fool put out this week.

By Toby Shute
updated 4:56 a.m. ET, Fri., May 1, 2009

Range Resources (NYSE: RRC) and Cabot Oil & Gas (NYSE: COG) may call Texas home, but don't let the zip codes fool you. These independent oil and gas shops have deep roots in Appalachia and are feeling right at home in the race to unlock the mighty Marcellus shale.

Range Resources' first operations in the area date back to the 1970s, when predecessor Lomak Petroleum got its start. Cabot, as a spinoff of the eponymous chemical company, goes back over 100 years, to the days when the firm drilled gas wells in order to produce carbon black. Now, what's old is new again, with horizontal drilling and multi-stage fracturing technology breathing new life into the birthplace of the American oil and gas industry.

In case you're still wondering why you should care about the Marcellus, check out these rate of return estimates by Range:


Flat NYMEX Price (per Million BTU) Rate of Return

$7 75%

$6 60%

$5 46%

$4 34%

$3.25 20%


Figures from Range Resources' April 8, 2009 Hart Energy presentation and 2008 Annual Report. Assumed reserves of three to four billion cubic feet equivalent per well, and $3 to $4 million cost per well.

Those are simply killer economics, so long as you've got the right acreage. Considering their quality positions in the play, plus the solid hedges that both firms have in place, Range and Cabot are the envy of many a gas producer today.

Both firms just reported first-quarter earnings this week, so let's see what kind of headway these E&Ps are making, despite the headwinds of low commodity prices. So long as we're looking under the hood, let's also check out the firms' cost structures to make sure they're built for this environment.

Home on the Range
Range, a very technically savvy shop, got an early jump on the Marcellus play, drilling its first well into the formation in 2004. The management addition of Mark Whitley in 2006 really set Range's various horizontal drilling programs in motion. Whitley helped Mitchell Energy (acquired by Devon Energy (NYSE: DVN) earlier this decade) unlock the Godfather of Shale: the Fort Worth Barnett. Range just announced what it believes to be the highest 30-day initial production rate for any Barnett well. Considering that the competition there includes Chesapeake Energy (NYSE: CHK), XTO Energy (NYSE: XTO), and EOG Resources (NYSE: EOG), Whitley is clearly some kind of shale whisperer.

Range exited 2008 with 30 million cubic feet equivalent of daily gas production (Mmcfe/d) from the Marcellus and is looking to roughly triple that rate in 2009. The firm has been punching holes into the Marcellus at a pretty rapid pace -- so much so that the regional infrastructure buildout is hardly keeping pace. Fortunately, Range has found MarkWest Energy Partners (NYSE: MWE) to help it add gas processing and pipeline infrastructure to support this busy program. Cryogenic plants, for example, will help Range to extract more high-valued natural gas liquids from its hydrocarbon stream.

For the first quarter, Range cranked out 416 Mmcfe/d in total, with 82% of that production attributable to natural gas. Price realizations after hedges, which cover 83% of gas production for the balance of the year, came in at $6.62 per thousand cubic feet equivalent (mcfe).

As for cost structure, Range provided, in convenient form, all of the metrics that we need to calculate this. Note that some people prefer to exclude interest or corporate overhead (G&A), but let's be inclusive today. Combine the direct operating expense and production tax figures provided, and you've got $1.15/mcfe. Layer on G&A and interest, and you're looking at $2.36/mcfe. After depletion (DD&A) charges, Range's all-in costs roll in at $4.61, allowing it to net right around two bucks per mcfe of production, pre-tax. Not too shabby!

Cabot crackles
With a foothold in each of the two hottest resource plays in the country right now -- the other being the Haynesville -- Cabot's riding pretty high these days. Despite the hype potential, I do find this firm to be pretty conservatively run. The fact that last year's capital raise was the first since 2001 really grabbed my attention. Excessive equity raises have really turned me off of some of Cabot's competitors.

As far as Marcellus development goes, Cabot is at a slightly earlier stage than Range. The firm's got four horizontal completions under its belt now, with the most recent setting a new high. Having identified the Marcellus as its "most economic program," and with new rigs ordered for the region, Cabot is definitely committed to pushing this play forward.

In the first quarter, Cabot's high-priced hedges helped it achieve significantly higher price realizations than Range, at $7.51/mcf for gas production alone. Liquids appear to bump the overall take to $7.76/mcfe. This higher price allowed Cabot to realize a fatter pre-tax margin than Range, despite what I calculate to be a 10% higher cost structure for the quarter.

Of course, these figures bounce around from quarter to quarter, so keep monitoring these cost trends and hedge positions going forward. While I'm a bit more comfortable with Range as an operator, both of these shale players appear positioned to deliver strong economic returns in a lousy environment for natural gas.

John Barnyak
President
www.stonehouseasset.com

Dickensian World

"It was the best of times, it was the worst of times." Such timeless words can find fertile soil in the investment world of today. The system will endure. Like it or not, the changes will be incremental, protect the whales and occasionally toss a sprat into the pan. The SEC filing suit against the managers of the Reserve Fund for misleading investors is not a bad thing, if you like your sacrificial lambs small. Reserve was the money market fund that broke the buck and brought the short term commercial paper market to a stand still.

Actually it was Lehman that was the big fish behind that debacle, but tant pis as the french would say. That whale has left the building.

As an advisor of client portfolio's I have to say, this extraordinary run up has been very schizophrenic. My gloating at moving (or trying to move) clients to raise beta on portfolios has turned slightly bitter as my cautious entries were obviously far too modest. (Beta is the sensitivity to the market. An S&P index fund has a beta of one, more aggressive holding have higher betas as they move with greater force than the broad market. Long term positive? Increase beta. Have a negative outlook, decrease portfolio beta)

Investors would do well to memorize cliche's. They come in handy when you need a good dope slap.
1. Don't fight the Fed. When out to dinner with a guy with a trillion dollar line of credit, let him buy. Don't argue, just enjoy. If you think he's gauche and ordering the wrong things, swallow and smile.

2. The market can remain irrational longer than you can remain solvent. Lord Keynes comment still rings true. If your trillion dollar buddy is slipping 100's into g-strings, let him. Starting a fight will only get you bounced out of the club. Wait until he passes out and then drive him home. Until then you use $1's, and smile.

3. Don't fight the tape One thousand years ago King Canute sat upon the strand in England and ordered the sea to stop rising and the waves to still. He had no luck either. Go with the flow there may be more powerful forces at work than can be seen.

The money flow and source of trading indicates two things still. First, the weakest stocks and companies have done the best recently. This would suggest a strong short covering rally. Second, online trade activity has increased much more than institutional activity. This leads me to believe that this bottom still has some work to do, but the definite bias is to the long side.

John Barnyak
President
www.stonehouseasset.com

Light at the end of .....

Ok, I confess, I don't get it. The Treasury finally offers its assessment of the very weak stress test for BAC and the light shines brightly. The hard hitting stress test assumes a worse case of 8.5% unemployment when we are already at 8.6 among other soft pitches down the middle of the plate and then guess what? Bank of America is fundamentally insolvent to the tune of $34 Billion and the stock goes up like a rocket.

I once used to sell metals and alloys to a manufacturing company in Wisconsin and recall a conversation one day with the purchasing agent. This fellow dabbled in commodity trading for himself and was focused like a laser on the silver market. The day in question he said to me, "John, it makes no sense. The silver market makes no sense. Something is going on. It's being manipulated." I being the wise and youthful know it all smirked. Not long afterwards the Hunt brothers were arrested, silver plummeted from $40/oz to single digits.

This time its different. You don't have to look hard but what the outcome will be, I can only guess, change my mind and guess again.

Goldman Sachs is incredible. No, not incredible, god-like. In trading, being right slightly more often than wrong is the stuff of legends. A trader is going to be wrong, a lot. But the concept of cutting losses and letting profits run is what separates good from gone. That being said, GS was right in predicting the market 87.5% of the time in the first quarter! They generated over $100 million in trading profit 34 trading days, was profitable 56 days and lost money on 8 days. The days they lost over $100mm? Zero.

The NYSE's Supplemental Liquidity Program is designed to promote aggressive quoting activity and liquidity to the market. In return the NYSE will pay providers a 15 cent rebate per 100 shares traded. Additionally, it is designed to lead to tighter spreads between the bid and ask price. One of the reasons given for GS profits is very wide spreads in a program for which they seem to be the sole beneficiary. GS is currently the dominant trader on the NYSE, trading about 6x the trades as principalof the nearest competitor, Credit Suisse.

Look at the US Fed and Treasury activity, trillions of dollars in guarantees, purchases and loans. This administration clearly has a rocket in its pocket and Goldman is the fuse. But I can't help but hear in the back of my head the saying, "when the Fed taps on the brakes, somebody goes through the windshield."

Tread very very carefully people.

John Barnyak
President
www.stonehouseasset.com

Savings Bonds Stop Paying

'I Bond' Payments Get Wiped Out - When Inflation Goes Negative, Investors in These Savings Products Suffer

Wall Street Journal, May 2, 2009

Rates on government securities, certificates of deposit and savings accounts all have plummeted in recent months. Now, yields on another safe haven -- Series I Savings Bonds, or I bonds -- are dropping to nothing.

Friday, the Treasury Department said these inflation-linked bonds that are purchased between May and October will earn 0% for their first six months, the first time rates have hit 0% since the bonds were issued in 1998. The announcement also affects current I-bond owners, whose interest rate drops to 0% the next time their rates reset.

Blame the financial crisis. Normally, yields on inflation-linked investments gradually rise as prices rise. But amid the sharp drop in consumer-price inflation last fall, returns on many inflation-linked products were hammered.

Rates on I bonds, whose maturities are all 30 years, have two parts: a fixed rate, now set by the Treasury at 0.10% for new issues and which lasts for the bond's life, and the inflation adjustment, which reflects the change in the Consumer Price Index over a six-month period. Since that inflation adjustment worked out to a negative 5.56% annualized rate for the September-to-March period, the fixed-rate portion of every I bond will be wiped out during its next six-month rate period. The Treasury announces the rates each May 1 and Nov. 1.

The silver lining is that rates can't fall below 0%, so I-bond holders won't lose their principal. What's more, "prices tend to go up in the first half of the year, so because of that, we'd definitely expect there to be a positive inflation component" the next time the rate resets, said Tom Adams, editor of www.savings-bond-advisor.com.

Over the long term, inflation-linked investments are still a good bet, experts say. "In the short term, inflation will be hard to detect because of the weak economy and lack of pricing power," says Greg McBride, senior financial analyst at Bankrate.com. "But over the longer term, the substantial debt issuance by the government and large ongoing deficits bode for higher inflation than what we've experienced in recent years."

Until rates pick up, the best option might be to "suck it up" while the bonds pay 0%, Mr. Adams says. I bonds typically lag behind returns on other investments, so its investors are coming off returns of 4.92%, while stock-market indexes fell around 40%, he says. Returns on Treasury Inflation-Protected Securities, by contrast, fell last year, but have started to inch higher as signs of inflation emerged in recent months.

For those thinking about cashing in I bonds after the one-year minimum holding period, be sure to find out what your bonds are earning now and when their rates will reset, says Mr. Adams. The Treasury has an online calculator at http://www.treasurydirect.gov/indiv/tools/tools_savingsbondcalc.htm.