Week 8/8/10 - 8/15/10 (SOLR)

Company: GT Solar International (SOLR) is one of the leading suppliers of manufacturing equipment to the solar industry. GT Solar designs, manufactures and markets CVD reactors for polysilicon manufacturing and DSS furnaces for silicon ingot/wafer production. The company supplies these two major product lines to polysilicon manufacturers and PV cell manufacturers.

Thesis: Demand from the rapidly growing solar PV industry will drive market for process critical DSS furnaces and CVD reactors.

Strengths:

• Order improvement in the CVD reactor business is exceptionally strong indicating a very strong trend for polysilicon capacity expansion, market share gain and adoption of next generation technology.
• Recently acquired Crystal Systems and will now be in the business of selling sapphire substrates for LED makers and will transfer over to becoming an equipment supplier in the space within the next 12-18 months.
• Company has $1.89 per share in cash, which is almost one quarter the share price. Gross margins are good at 40%. Net income margins are over 16% after paying 36% taxes.

Risks:

• Cancellations.
• Internal development of technology by customers.

Week 7/12-7/18

Pick of the week buy Pfizer (PFE) or sell August 14 strike (PFE) puts:

Why I like Pfizer: http://contrarianedge.com/2010/01/18/the-case-for-pfizer/

Also to borrow from David Einhorn of Greenlight Capital:

"Though the company announced a strong first quarter earnings result of $0.64 per share, a weaker Euro caused analysts to reduce 2010 consensus estimates from $2.25 to $2.15 per share. Longer term concerns about potential austerity measures in Europe and setbacks on some pipeline products also weighed heavily on the share price. As investors gain confidence in PFE’s future sustainable earnings at these levels, which we believe are attainable, investors may pay a higher multiple of earnings than the current sub-7x."

Investment Thesis: As investors gain confidence in PFE's earning potential the multiple will expand, in the meantime the company is paying a 4.9% yield.

Recent Developments/ Buffets Shareholder Letter

Seems like not much has changed since my last post. As I am writing this I am listening to Kris Kristofferson one of my favorite song writers sing, "Nobody Wins". For those of you who do not know Kristofferson here is a link to an interview with him on the Colbert report:

http://www.colbertnation.com/the-colbert-report-videos/219952/february-26-2009/kris-kristofferson-pt--1

One person worth listening to is the Oracle. Like most he has taken a beating but unlike you andhe has about 27 Billion of cushion. Buffet has reached the point where he couldn't panic sell even if he wanted to so instead he spending his time ruminating over economic collapse he has been dreaming up little gems like “In God we trust; all others pay cash.” Unfortunately, the question is quickly becoming can we even trust in cash. My beliefs and bets like in the yes camp. Which is why like Buffet I have been locking up secure income streams to get me through the next couple years. In that light I recently increased my position in NLY which yields 14.4%.

BERKSHIRE HATHAWAY INC.
To the Shareholders of Berkshire Hathaway Inc.:

Our decrease in net worth during 2008 was $11.5 billion, which reduced the per-share book value of both our Class A and Class B stock by 9.6%. Over the last 44 years (that is, since present management took over) book value has grown from $19 to $70,530, a rate of 20.3% compounded annually.*

The table on the preceding page, recording both the 44-year performance of Berkshire’s book value and the S&P 500 index, shows that 2008 was the worst year for each. The period was devastating as well for corporate and municipal bonds, real estate and commodities. By year end, investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game.

As the year progressed, a series of life-threatening problems within many of the world’s great financial institutions was unveiled. This led to a dysfunctional credit market that in important respects soon turned non-functional. The watchword throughout the country became the creed I saw on restaurant walls when I was young: “In God we trust; all others pay cash.”
By the fourth quarter, the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have never before witnessed. The U.S. – and much of the world – became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear.

This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation. Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political
challenge. They won’t leave willingly.

Whatever the downsides may be, strong and immediate action by government was essential last year if the financial system was to avoid a total breakdown. Had one occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America were all in the same boat.

Amid this bad news, however, never forget that our country has faced far worse travails in the past. In the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 211⁄2% prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of
challenges.

Without fail, however, we’ve overcome them. In the face of those obstacles – and many others – the real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones Industrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during which humans secured only tiny gains, if any, in how they lived.

Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead.

Take a look again at the 44-year table on page 2. In 75% of those years, the S&P stocks recorded a gain. I would guess that a roughly similar percentage of years will be positive in the next 44. But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our usual opinionated view, we don’t think anyone else can either.) We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.

In good years and bad, Charlie and I simply focus on four goals:

(1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of
excess liquidity, near-term obligations that are modest, and dozens of sources of earnings
and cash;

(2) widening the “moats” around our operating businesses that give them durable competitive
advantages;

(3) acquiring and developing new and varied streams of earnings;

(4) expanding and nurturing the cadre of outstanding operating managers who, over the years,
have delivered Berkshire exceptional results.

Berkshire in 2008

Most of the Berkshire businesses whose results are significantly affected by the economy earned below their potential last year, and that will be true in 2009 as well. Our retailers were hit particularly hard, as were our operations tied to residential construction. In aggregate, however, our manufacturing, service and retail businesses earned substantial sums and most of them – particularly the larger ones – continue to strengthen their competitive positions. Moreover, we are fortunate that Berkshire’s two most important businesses – our insurance and utility groups – produce earnings that are not correlated to those of the general economy.

The rest of the letter is an update on Berkshire's operating businesses

Garnett Keith's February Update

Garnett Keith is my boss at SeaBridge Investment Advisors, below is an update he wrote to some friends in Europe...

February 2009 Update

A year ago we were worrying about sub-prime mortgages. Then larger problems in SIVs and financial institution leverage rose to the top of the worry list. Libor soared and the banking community ossified. Then Lehman, FNMA, AIG, Countrywide, WAMU and Wachovia focused our attention on failures of specific institutions. Falling markets, massive withdrawals from mutual funds, and hedge fund forced selling made September through November extraordinarily painful. December had a hopeful rally, and then January dashed hopes. So where are we today? Are we not ready for a rebound in the equity markets?

Through the confusion and all this pain, the “how we got there” is becoming clear. The world’s structural financial problems shifted from two decades of emerging market borrowing crises to a decade plus of huge emerging market savings. The savings were recycled to the U.S., and interest rates were substantially suppressed. This liquidity flow and low interest rates sent the U.S. consumer on a borrowing binge; a libertarian government supplied too much credit and too little supervision; investment banks enjoyed massive increases in leverage; plentiful liquidity meant rising securities prices and casual attitudes about risk; and commercial banks became intoxicated with their new merchant banking and “originate and sell on” capabilities.

In this litany, there are a lot of problems to be fixed. I doubt we are entering a sustainable bull market until more of the fundamental problems have been fixed. What is the progress report?

• The Bush team stabilized the major banks and pushed the auto industry debacle forward to March 2009
• The Obama $787 billion Economic Stimulus package will cut middle class taxes, reduce hardship by extending unemployment benefits; will fix the Alternative Minimum tax problem; and will unleash other spending programs.
• The housing support package (Foreclosure Prevention Act), approved by the Senate this week attempts to slow the decline of house prices; gives cities money to purchase foreclosed homes, restores the depleted reserves of FNMA and Freddie Mac; and slow the eviction of defaulting homeowners by allowing the adjustment of mortgage terms.
• Secretary Geithner’s plan for restoring the financial sector is still under development. Reports are that it will encourage and finance private sector efforts to lift bad assets out of the banks, probably providing some ceiling on losses on purchased assets.

The problem with this combination of efforts is that they do not seem to be adequate to solve the problems in 2009. It appears that many of the problems will have to be worked out by debt reduction via defaults over time.

• At the head of the list of unsolved problems is the global imbalance. World trade is collapsing and domestic demand in the surplus countries will take years to offset the consumption swing in the U.S. Essentially, no consumer has been found to replace the tapped-out U.S. shopper and keep world production at its 2006-2007 level.
• The capital destruction numbers are grim. Jeremy Grantham calculates that 2008-09 losses of 50% on equities, 35% on housing, 35% on commercial real estate, destroy about $20 trillion of wealth from a starting number of $50 trillion. This compares to a $13 trillion economy and $25 trillion of corporate and individual private debt. As a result banks are rapidly trying to get more collateral and guarantees behind their loans. At elevated lending standards banks would like to reduce the $25 trillion of debt to $15 trillion. The pressure to reduce the other $10 trillion of debt is a major depressant on the economy.
• As U.S. spending falls, excess capacity and inventory cause layoffs, rising unemployment and a downward cycle of consumer confidence in the world-wide supply chain.
• With demand for both consumer and capital goods falling fast, export powers like China, Japan, and Germany are finding their economies falling far faster than anticipated.
• The second and third round multiplier effects of the global contraction will be moving through the global markets throughout 2009.

High level analyses being circulated from academe and think tanks, arrive at worrying conclusions that the proposals of governments, so far, provide much less stimulation than the negative forces being unleashed by a world wide contraction. For example, announced reductions in corporate capital spending plans exceed all currently discussed government stimulation plans. This means more and more pressure on global employment. In the consuming countries, unemployment puts heavy pressure on bank assets – defaulting credit card and prime mortgages in the U.S. and heavy losses on their Eastern European assets in European banks.

The most interesting statistics I have seen lately is from a paper from Wynne Godley at the Levy Institute (Prospects for the U.S. Economy and the World, December 2008.) It concludes that to restore balance, U.S. private sector debt needs to be reduced from 174% of GDP to roughly 130% of GDP between 2008 and 2013. This requires a savings shift from borrowing roughly 10-15% of GDP at the peak to saving roughly 5% of GDP for 5 years, 2009-2013. This equals roughly a $2 trillion a year savings increase on a $14 trillion economy ($10 trillion of consumption) for several years. A 20% U.S. consumption swing on a sustain basis requires a new world order or a global recession of large magnitude.

The Obama Economic Stimulus Act, even if one assumes it is 100% effective, is roughly $787 billion spread over two or more years. So the scale is mismatched in favor of continuing deflationary forces.

Debate now seems to be moving toward nationalizing major banks. This would allow an immediate “lift out” of bad assets (The Swedish solution) This probably has the best odds of fixing the banking system within 12 months. However, U.S. opinion still recoils from nationalization of anything, so there is a good chance we will apply the Japanese solution – banks struggle on for years – rather than the Swedish solution.

All these forces lead to major institutions ranging from Warren Buffett to Yale University to shift away from equities toward debt – especially investment grade debt until the problems are worked out. That thinking, of course, leads to lows in equity markets and very good equity values for those willing to look across the problems to an eventual recovery.

Equity commentators vary in their assessment of the odds for a sharp bear market rally. The composite scorecard looks something like:

Pluses:

1. There is huge liquidity on the sidelines which could push equities substantially higher if confidence were restored.

2. The Fed is making progress in fixing the capital markets and investment grade bonds have moved up significantly since November

3. The Baltic Dry Index has turned sharply higher signaling the beginning of recovery in China

4. There has been a huge increase of liquidity in China and the Shanghai market is moving higher.

5. Manufacturing orders around the world are declining at a less rapid rate.

6. Money supply in the U.S. has been growing rapidly, offsetting the fall in money velocity

Minuses

1. Bank profits will be negative in 2009 and industrial profit forecasts are still being downgraded

2. Industrial production, tech orders, and orders for durable goods are still falling

3. While optimistic earnings forecasts put P/E’s in the range of past bear market lows, there is very low confidence on what the E’s will be in a global recession of this magnitude. Pessimistic earnings forecasts show the S&P at over 25 times 2009 earnings

4. With $2 trillion of Government borrowing on the horizon, 10 year Treasury rates have moved significantly off their lows. The fear of stagflation is growing.

5. With the rebound in Treasury rates, the spike in mortgage refinancing – providing liquidity to the system – has collapsed again

6. The debate over nationalizing the banks and the auto companies will be very divisive

7. Unemployment will likely rise from 7.6% to 9% during the course of 2009. While a lagging indicator, this will weigh on confidence.

8. Until there is a credible plan to fix the banks, money will stay on the sidelines.

Within the Yield Growth portfolios we continue to increase our focus on “reliable income streams.” These include significant positions in MLP’s, in Government Guaranteed mortgage REITS, and in corporate bond funds – especially closed end funds trading at a discount. We have begun buying some individual investment grade corporate bonds in the PIM Yield Growth SICAV where bond fund holdings are limited. With more and more fixed income, portfolio yields are at highs.

The Ascent of Money

I began reading The Ascent of Money by Niall Ferguson. Below is a review by John M. Mason that I think is informative....

Niall Ferguson has been getting a lot of press recently. Apparently he made a big impression on people in Davos at the recently held conference, and he has followed up on this publicity with a column in the Financial Times, where he is a contributing editor, and a blog on The Huffington Post. The basic idea Ferguson is presenting to the world is that the underlying problem in the financial crisis is too much outstanding debt. He says that rather than add more debt, through government stimulus programs, to the toxic waste that currently exists, policymakers should develop a plan that would actually reduce leverage, i.e. reduce the amount of debt outstanding.

He is highly critical of the “born-again” Keynesians who have taken the writings of Keynes out of context and applied them to a situation that is not appropriate. Hence, to Ferguson, those countries enacting “Keynesian” stimulus plans will be exacerbating the current financial problem and not solving it.

Ferguson's recent book “The Ascent of Money” is not only a very worthwhile read, but it also provides some of the history and background to his policy conclusions. For either reason - or both - I would highly recommend this book to the reader of this blog.

Getting away from the “current events” application of this book, there are several other important lessons in history that Ferguson would like us to consider, making the book not only provocative, but supportive of financial institutions and those that work in the finance field. Seldom today, do you see such a defense raised.

First, Ferguson takes on the work of those utopian writers who consider the ideal world to be one in which there is no money, no finance. He concludes that modern, successful economies have a well developed money system and effective financial institutions that contribute to economic innovation and growth. Those societies that do not have a functional money system and no financial structure are the ones that do not grow and develop; this includes areas or regions (e.g. urban areas and agricultural regions) as well as nations. He contends that before the Industrial Revolution could take place in the West, there first had to be a financial revolution.

Ferguson then presents a discussion of why finance and financiers have such a “bad” reputation and are so easily picked upon when something goes wrong. For one, he argues, “debtors have tended to outnumber creditors and the former have seldom felt very well disposed towards the latter.” Also, “financial crises and scandals occur frequently enough to make finance appear to be a cause of poverty rather than prosperity, volatility rather than stability.” And, finally,

“for centuries, financial services in countries all over the world were disproportionately provided by members of ethnic or religious minorities, who had been excluded from land ownership or public office but enjoyed success in finance because of their own tight-knit networks of kinship and trust.”

The book makes three other points. One has to do with the fact that finance is often looked upon as a parasite to the “real” activity that goes on in the world, contributing little to the actual production of goods and services. The second is that financial systems seem to “reflect and magnify” what human beings are really like. That is, money

“amplifies our tendency to overreact, to swing from exuberance when things are going well to deep depression when they go wrong…But finance also exaggerates the differences between us, enriching the lucky and the smart, impoverishing the unlucky and not-so-smart.”

A third point deals with the seeming contribution of finance to tremendous amounts of wealth and to skewed income distribution, which has raised suspicions that finance is a parasite to “real” economic activity and contributes to the violent swings that take place within the economy - the assumption being that “real” economic activity would be more stable and less volatile without finance around.

There is one other key element to Ferguson’s world view. Ferguson does not believe in economic determinism; that is, he does not think that all decisions are made using rational economic reasoning. He believes that politicians and political events, especially wars, shape the institutions and policies, the rules and regulations, of modern economic life. In pure economic theory these inputs are treated as “exogenous” shocks, events that occur outside of our economic models but that significantly affect the future path of the economy.

What are these exogenous shocks? Well, how about a taxcut for the wealthy? How about a war on terrorism? How about a policy of keeping “real” short-term interest rates negative for over a year and a half? How about “domestic political conflicts” that arise relating to religion or other factors that can divide a nation -- say, cultural wars that relate to abortion, stem-cell research, and same-sex marriage? Ferguson contends that there is nothing in economics that can specifically account for these types of events and yet they play a major role in determining the evolution of an economy.

The body of the book is about the subtitle: A Financial History of the World. This may be a bit of a stretch, but he does cover a lot of history. There is a chapter on the history and evolution of the bond, a chapter on the rise of the joint-stock, limited-liability company and stock markets, a chapter on insurance and insurance companies and a chapter on the development of the idea of home ownership and whether or not home ownership should be a universal dream.

And then there is a chapter that moves us up to April 2008, when the book was being finished. The focus of this chapter is on “Chimerica”, the co-evolution of China and America in this current age of globalization. This chapter is worth reading even though a lot has happened since the author wrote the book. Of course, this leads into a discussion of all the debt that America has recently put on the books, and how this debt has been financed by nations that are just emerging into the modern financial system, dominated by China.

The rest of the story remains to be written -- and Ferguson, I’m sure, will contribute to its writing. Read this book. Read Ferguson’s earlier book “Cash Nexus: Money and Power in the Modern World, 1700-2000.” I believe that his ideas are going to be much discussed, and rightfully so. Having consumed these two books, as well as his several others, will give you a leg up on those discussions.

Annaly Update

I purchased Annaly, in Aug 08, it has been a solid performer. In December 08, I sold April 16 calls against half the position. The stock currently trades at 14.43. Annaly is poised to continue performing well considering the steepening of the yield curve. In a nutshell, Annaly borrows at Fed Funds and buys Agency-backed mortgages. Annaly is moderately leveraged at 7X. The biggest risk to our NLY ratings is that the Fed would resume its tightening campaign at some point in the next 12 months however I find that most unlikely given recent rhetoric. The stock is in a good trading range. If I can get some premium I may write calls against the rest of the position. I will look to exit around 17 if possible.

Comments from BCA Research

The recession is deepening, in terms of key consumer indicators such as employment and spending. Some surveys are showing that sentiment has bounced a bit, albeit insignificantly relative to the plunge in the second half of 2008. Importantly, leading economic indicators are still pointing down, as are leading gauges for inflation.

Against this backdrop, policymakers are going all out to support the financial system and provide some fiscal stimulus. So far the results are unimpressive in terms of easing lending standards or lowering private sector borrowings rates. Our expectation is that the authorities will continue to provide stimulus until the economy stabilizes, but this could still take some time and any recovery will be slow to develop.

The fed funds rate will hover at zero until the economy has decisively gained momentum and the credit creation process has been restarted, i.e. at least through to the end of 2009. The recent rebound in Treasury yields has been driven by fiscal angst and inflation fears, both of which should diminish in the coming months because higher yields reduces the odds of economic recovery. The Fed may soon purchase Treasurys if yields keep rising. In terms of fixed income sectors, we still prefer those credit areas where the government is providing direct support, as well as higher-quality corporate bonds.

For stocks, the slide in earnings and lack of positive guidance remain powerful headwinds. Good value and policy stimulus suggest that the late-2008 low should hold, but a sustained rally awaits some glimmers of economic hope. Most likely, a volatile bottoming phase will occur, similar (but longer lasting?) to the environment after the crash of 1987. Only a gradual nibbling in favored equity sectors is recommended.