Wedneday - 11/23/11

Market - Bears' attack has been non-stop in the past 6 trading days when Spx lost about 7%. For history, we know the market does not travel in a straight line, but a reversal seems very elusive indeed!

A Bullish Case for Piper Jaffray (PJC)

The financial stocks in the U.S. and Europe have been decimated for fearing a Lehman like domino effect due to a potential Greek default, and because of the concern about a world-wide double dip recession. Some of the stocks are trading near their 2009 lows, just before Tim Geithner explicitly guaranteed the top "too-big-to-fail" financial institutions. One such stock is Piper Jaffray (PJC), which closed at $18.3 on Sept. 22. The stock bounced off its low since and has been trading close to $19.

Relative to its competitors, Piper Jaffray is much smaller and therefore much easier to manage. It also has a much simpler business. Its investment banking, institutional brokerage and asset management services, represented 50%, 32% and 13% of the total revenue in 2010 respectively. It does not engage proprietary trading, which can be very risky as shown in the recent case involving a rogue trader who booked a $2.3 billion loss at UBS. Furthermore, it does not have a prime brokerage business serving hedge funds. The prime brokerage business is a margin and commission business. However, it can be risky because the prime broker may have to take ownership of a troubled client hedge fund whose loss exceeds its capital due to excessive risk-taking.

If one were to use the ratio of total tangible assets to its tangible book to measure leverage, Piper uses roughly a third of the leverage in comparison with its competitors. As shown in the enclosed table, the Piper's ratio is about 4 and over 12 for JPMorgan (JPM), Goldman Sachs (GS), Jefferies (JEF), Morgan Stanley (MS), Bank of America (BAC) and Citibank (C) respectively. It survived the financial crisis of 2008 without taking TARP. As a matter of fact, they only had an operational loss of $75 million in 2008. They could have been profitable, had they significantly cut the compensation cost of $249 million. Another plus for the company, in this environment, is that they have very limited exposure in Europe both in terms of revenue (less than than 4% of the total) and the long-lived assets (less than 0.1%).

Key Risks

• First of all, this is not the industry for the long term share holders because of the excessive risk-taking and compensation. Furthermore, the commission or spread based institutional brokerage business has been experiencing industry-wide decline. Owners of the stock should consider exiting as soon as the financial crises subside and industry recovers. 
• Any financial institution that relies on short-term funding are at the mercy of the market perception of its credit worthiness. PJC currently relies on Repos (65%), commercial paper (23%) and short-term bank loans (12%) for its $513 million financing needs. I think this is not a significant risk given the friendly Fed under Bernanke.
• The company may have indirect exposures to risky financial institutions or sovereign debt through derivative contracts. 
• PJC is too small to qualify for too-big-to-fail insurance that the Fed and Treasury implicitly provides. In other words, PJC may be allowed to bust while its larger competitors will be bailed out in a crisis. 

Conclusion

At the current price of $19 a share, PJC is trading at a 35% discount to its tangible book value of $29.25 and PE ratio of 15.4 (using their EPS of $1.23 in 2010). Although, PJC is not the cheapest in terms of the discount to its tangible book or PE, but it is by far simplest and the least risky relative to the major shops on Wall Street. As we learned from the last financial crisis, what killed a financial institution was its leverage and amount of risky assets (New Century, Countrywide, Bear Stearns, Lehman Brothers, WaMu, etc.) in the last crisis. In summary, I believe PJC is the most attractive brokerage stock to own and can potentially offer a great deal of upside once the financial turmoil subsides and confidence returns.

Recap of Long Apple Calls Against RIM Calls

RIM missed earnings, guidance and gross margins in the latest quarter. The only positive that I could find was the higher expected phone shipment ("27% to 37%") in the coming quarter, and it was mostly due to their over-stuffing the channel in the previous quarters. The new BlackBerry 7 smartphones, which they touted so much in the conference call, are part of "the transition to QNX-based smartphones". That is real comforting for their long-term customers. All their future hopes are hanging on QNX-based smartphones, which are expected in 2012.

The main negative surprise for me was their paltry 200,000 PlayBook shipments, which were down 60% from previous quarter. Clearly, they were no match for iPads. The other downer was that they spent $780 million in acquiring part of the Nortel patent portfolio through a consortium, in which Apple is a part of. Since RIM needs to knock-down Apple and destroy the Android camp in order to compete, I just don't see the point of spending nearly a billion dollar to buy a bag of patents, which are useful for leaders to defend themselves against copycats. Does RIM have any copycats today? This is the trouble with troubled companies, which tend to throw good money after bad. HP (HPQ) just illustrated how they swallowed and choked on Palm.

RIM used to be a very successful and well-managed company. In many ways, it still is. I first encountered the stock at my old shop where my tech analyst was using a cool BlackBerry instead of a pager in the late 90s. They were the first major company to embrace message centric devices with full keyboards to counter then popular Palm OS-enabled devices using handwriting for input. RIM was able to dominate the personal digital assistants (PDAs) market, and later on the smartphone market. As a result, Palm was pushed to the brink of bankruptcy before HP swallowed it and now is trying to puke it out. I was a RIM customer and investor for years until Apple's introduction of iPhones in 2007 when I realized how great the iPhone was! The trouble at RIM has little to do with RIM itself, but everything to do with the iPhone. What Apple did to RIM is similar to what RIM did to Palm. This is just part of the tectonic shift, which happens from time to time in tech, and RIM just happened to be on the sinking side.

Position Recap

Since I recommended shorting 5 RIM Jan. 13 $40 strike calls vs. buying every 1 Apple Jan. 12 $400 strike call on Tuesday, Sept. 13, RIM shared tanked about 20% on the earnings' bust and Apple went up about 4% at the same time. Apple's (AAPL) calls are almost in the money now. RIM shares are 66% away from the $40 strike, quite safe from a takeover bid. As a result, RIM's call premiums got cut in half (from $4 to $2) and Apple's gained 18% from ($26 to $30.5). It was a good start and we should consider camping out for the new iPhone 5s.

at seekingAlpha.com:

http://seekingalpha.com/article/294308-the-trouble-with-rim-has-little-to-do-with-rim-itself

Long Apple Calls against RIMM Calls

Overview

The recent spike in volatility provides an excellent opportunity in shorting long-dated Research In Motion (RIMM) Jan. 2013 $40 strike calls ($4/contract at 44 implied volatility) against long Apple (AAPL) Jan. 2012 $400 strike calls ($26/contract at 32 implied volatility). I would recommend the trade at a ratio of 5 (RIMM calls) to 1 (AAPL calls). The central thesis of the position is to use options to express a bullish view on Apple and a bearish stance on RIMM. The expiration date for Apple is chosen to take advantage of the anticipated excitement of the introduction of iPhone 5 and the potential strong product momentum during the holiday season. Since RIMM has been a volatile stock along with the general volatile market, its option premiums have been highly inflated across all strikes and expiration dates. However, a short-term volatile stock does not necessarily mean a big long-term upside, which depends on the company's future prospect. If the trends for both companies were to continue (there is little evidence to the contrary), the upside for the position can be substantial with very little net premium upfront, which is preferable in the current uncertain and volatile environment.

Key Risks

1. A Turn-around at RIMM

At this point of the race to dominate the mobile devices, it is very hard for RIMM to catch up to Apple and Android. Their main competitor Apple is like the Mongol cavalry under Genghis Khan in the early 13th century. In order to compete effectively, RIMM needs a superior phone and a better tablet at the minimum. In addition, it needs to catch up in the race for apps as well. In other words, it really needs a miracle, and they don't have Steve Jobs as the great Khan.

2. A Disappointing iPhone 5

This is probably the biggest risk of all. However, I think this is highly unlikely given Apple's past track record and its perfectionist culture because Apple would rather delay a product than introducing a half baked device. A delay of the introduction of iPhone 5 until 2012 might be a bigger risk. 

3. A Potential Takeover of RIMM

My thesis of shorting RIMM has been based on its deteriorating competitive position against its competitors. It is always possible that some company may be interested in RIMM as a strategic asset or its patent portfolio as it was the case for Motorola. However, this is highly unlikely after Microsoft decided to push for its own Window phones with Nokia and the rest of the pack joined the Android camp. In addition, RIMM still commands a market cap of about $16 billion, a realistic takeover price tag has to be north of $20 to $25 billion, a hurdle very few companies can clear. To mitigate the potential takeover risk nonetheless, I picked the $40 strike, which is at a 33% premium to where the stock is currently trading. If the deal is in cash, the option premium would evaporate substantially. If the deal is in stock of a bigger acquirer, the call option should trade at a much lower premium, reflecting the lowered implied volatility of the acquirer.

4. Premium Decay

Because of the mismatch of the expiration dates of two calls, the decay on Apple call options is greater than those of RIMM. However, the decay is not significant until December.

Did Bernanke Give the Market a Needed Bailout ?

Overview

It appeared that Bernanke showed his magic once again after he hinted more "stimulus", which is really the "bailout" market participants have been looking for, at the next FOMC meeting in late September. The S&P 500 index rallied more than 4% in two days since the speech on Friday, or 7% since August 22 when the Jackson Hole event was highly anticipated. The VIX index (approximated by ETF VXX), which measures the short term implied volatility on the S&P 500 index (SPY) or is really a gauge of market protection insurance premium, declined roughly 10 points from low 40s to low 30s. More than a third of the rally occurred on 8/29/11, the day after the Bernanke speech. The rally was very impressive with all sectors such as tech, commodities, and more importantly banks participating. Bank of America (BAC) and Deutsche Bank (DB), which have been under severe pressure lately, shot up over 8% and 6% respectively. The advancing stocks overwhelmed the decliners by a ratio of greater than 10 to 1. Using a military analogy, the bears experienced a "Waterloo" type of defeat against the bulls! Historically, days like this usually mark the beginning of a new bull run. However, a good day does not a trend make. In the next a few days before the long weekend, the bulls need to hold off the bears in order to sustain their gained territory.

What is Next

Uncle Ben's challenge now is that he has to deliver the "goods" at the next meeting on Sept. 20th and 21st. A simple QE3, or printing more dollars, may not satisfy the bulls because QE2 did not do much other than causing commodity inflation around the world. Also, there are some indications that Obama is planning more stimulus in September.

In Summary, how these measures are perceived will determine if the bull run has legs or not.

Short Term and Long Term Challenges Remain

In the short term, the austerity measures are getting widely adopted in most of the developed world. Even China is cutting back to counter inflation. Without the expansionary policies and the subdued consumers, it is hard to achieve economic growth, without which the stock market will suffer (it already did). The sharp downturn in the stock market worldwide can cause the next recession. 

There is another structural issue in the long run. The success of capitalism globally has some side effects. One is the widening wealth gap between the rich and the poor. The rich lobbied policies in their favor and made the real reform difficult. As a result, the financial system/economy is still extremely risky. At the same time, the poorer poor make poor consumers, dampening the economic growth. In other words, the very success of capitalism undermines its own success.

Market Needs a Bailout

Overview

The initial debt concern in weak members of EU and the debt ceiling debate in the U.S. have now turned into a confidence and banking crisis in EU and the U.S.. The old market leaders in commodities and tech were slaughtered. There is no new leadership emerging. Most of the rallies were driven by the S&P futures and short covering.

Redemption Pressure by Institutional Players

It appears that the current market malaise is similar to the last downturn in 08, although we don't have a Lehman Brothers yet and the banking system is better capitalized in the U.S.. However, the process of selling begets selling among institutional players, especially hedge funds and mutual funds to satisfy redemption demands, is the same. The market is not trading on fundamentals in the short term, but rather on who owns what. Can the market recover on its own? Yes, market can rally, driven by bottom fishers, but only if the corrections are minor and no key financial institutions are at risk of defaulting. The bulls have been badly injured in the past couple of months. The fact that David Tepper who made a killing by buying bank stocks at the last crisis sold most of his Bank of America holding shows that the hardcore bulls are surrendering. Bill Miller, another religious bottom-fishing fundamentalist, has no money. Warren Buffett, the biggest and most patient of all, usually waits until other bulls are killed. Now, he is making a move by investing in Bank of America. In summary, it shows the bulls' lineup is dangerously thin. I believe we are closer to the situations of 1987, 1998, and fall of 2008 when the bulls are too weak to fight the bears. 

A Bailout is Needed

Capitalism is great, but it needs bailouts by socialists. Buffett cannot save the banking system by himself. If last crisis is any guide, the turning point, in my view, was the explicit guarantee of the major financial institutions by the Treasury in March 2009. All hopes right now hang on to Bernanke's Jackson Hole speech. After that, Obama will be next in line to save his presidency. A similar guarantee is needed in EU, but it will be a lot harder to achieve because Germans do not want to bailout non-Germans until the current crisis affects Germany more severely. I don't think we are there yet.

Stanley Druckenmiller

Street Stories: Managed Futures

 

Stanley Druckenmiller

Market Wizards Index: +37%
Compound annual over 12 years

Fund or affiliation

• Quantum Fund, Duquesne Fund

Methodology

• Holding a core group of stocks long and a core group of shorts, then use leverage to trade S&P futures, bonds and currencies.

Research Techniques Employed

• Focused his analysis on seeking to identify the factors that were strongly correlated to the stock price movement as opposed to looking at all the fundamentals.
• He also used technical analysis.

Trading Techniques Employed

• He never used valuation to time the markets. He use liquidity analysis and TA. Valuations only tells him how are a market can move if there is a catalyst.
• To attain truly superior l-t returns is to grind it out until you’re up 30-40%, and then if you have convictions, go for a 100% year. If you can put together a few near-100% years and avoid losing years, you can achieve really outstanding l-t returns.
• Soros taught: "when you have tremendous conviction on a trade, you have to go for the jugular. It takes courage to be a pig." As far as Soros is concerned, when you’re right on something, you can’t own enough.
• If a trade doesn’t work, Soros is confident enough about his ability to win on other trades that he can easily walk away from the position.

Philosophy and beliefs

• When you earn the right to be aggressive, you should be aggressive. A philosophy reinforced by Soros.
• The way to build long-term returns is through preservation of capital and home runs.

History and other facts

• At the age of 28 Druckenmiller launched Duquesne after a person offered him $10,000/mo. just to talk to him.
• In 1982, after losing all his money, he landed a client who had sold out his software business. This individual account allowed him to start using shorts and leverage.
• The queen in chess, which can move in all directions, is a far more powerful piece than the pawn, which can only move forward. [analogy: hedge funds vs. pension funds]

Examples

• Was dead wrong entering 19 Oct. 87 with a leveraged long position. Market opened over 200 points lower, liquidated his entire position and went net short; and made a small profit.
• Long Deutsche mark right after the fall of Berlin Wall in anticipation of expansionary fiscal policy and tight monetary policy.

Performance Record

• 37% over 12 years: "The longest-running measure of Druckenmiller’s performance in the markets is his own Duquesne fund. Since its inception in 1980, the fund has averaged 37% annually."

 http://www.streetstories.com/Stanley_Druckenmiller.htm

Antonio Gramsci

"History has left us an infinity of traces"
"The task is to compile an inventory of the traces that history has left us"
"To understand my history in terms of other people's history"
"to explain my experience through the experience of others"
"The goal is to include the other without suppressing the difference"

"Capitalism, it seemed, was even more entrenched than ever. Capitalism, Gramsci suggested, maintained control not just through violence and political and economic coercion, but also ideologically, through a hegemonic culture in which the values of thebourgeoisie became the 'common sense' values of all. Thus a consensus culture developed in which people in the working-class identified their own good with the good of the bourgeoisie, and helped to maintain the status quo rather than revolting.

The working class needed to develop a culture of its own, which would overthrow the notion that bourgeois values represented 'natural' or 'normal' values for society, and would attract the oppressed and intellectual classes to the cause of the proletariat. Lenin held that culture was 'ancillary' to political objectives but for Gramsci it was fundamental to the attainment of power that cultural hegemony be achieved first. In Gramsci's view, any class that wishes to dominate in modern conditions has to move beyond its own narrow ‘economic-corporate’ interests, to exert intellectual and moral leadership, and to make alliances and compromises with a variety of forces. Gramsci calls this union of social forces a ‘historic bloc’, taking a term from Georges Sorel. This bloc forms the basis of consent to a certain social order, which produces and re-produces the hegemony of the dominant class through a nexus of institutions, social relations and ideas. In this manner, Gramsci developed a theory that emphasized the importance of the superstructure in both maintaining and fracturing relations of the base.

Gramsci stated that, in the West, bourgeois cultural values were tied to religion, and therefore much of his analysis of hegemonic culture is aimed at religious norms and values. He was impressed by the influence Roman Catholicism had and the care the Church had taken to prevent an excessive gap developing between the religion of the learned and that of the less educated. Gramsci believed that it was Marxism's task to marry the purely intellectual critique of religion found in Renaissance humanism to the elements of the Reformation that had appealed to the masses. For Gramsci, Marxism could supersede religion only if it met people's spiritual needs, and to do so people would have to think of it as an expression of their own experience.

For Gramsci, hegemonic dominance ultimately relied on a "consented" coercion, and in a "crisis of authority" the "masks of consent" slip away, revealing the fist of force."

My Understanding of Market Sentiment

Ever since I entered the field of finance, in 1992 from physics, I have always been puzzled by the following question: what drives the stock market for the short term (months) and long term (years)? Is it valuation, economic news, earnings’ reports, or something else? Is the market really rational and efficient, as predicted by the Efficient Market Theory (ETM)? More specifically, why did SINA Corp. tank 45% and rally 50% within three months without much news or change in the fundamentals of the company?


In the mainstream media, reporters and pundits tend to attribute every little price movement to some underlying fundamental change, which ranges from economic growth expectations, to earnings, to geo-political events. For many years their arguments sounded very convincing to me. If they were right, good news should be followed with positive price actions, and bad news should be followed by price declines. In my experience, however, I find those explanations unsatisfactory because they do not work all the time. What seems to be really going is that the market moves first and then the media scrambles to looks for a smoking gun. Such a narrative is typically provided by some professionals or experts. In the natural sciences, which are based on evidence, any theory that works only partially is either rejected, or has to provide well-defined boundaries. However, in soft fields like finance, that is not a requirement. Therefore, it is not surprising to see that two Nobel Laureates in economics can give opposite assessments of the economy or give two completely different recipes for a problem.


As for Efficient Market Theory (ETM), I have not met many real, rational and independent market participants, who save the right amount for retirement; are not overweight, and who are immune to financial manias and panics. On the contrary, most market participants are highly social, half of them being over-weight and emotionally driven creatures who can only be rational at times. The question is whether a theory designed for rational robots is applicable to real human beings. The answer should be obvious.


How about valuation? After all, legendary value investors such as Warren Buffett and Peter Lynch seem to be the only credible ones. The problem with valuation is that it simply cannot explain the existence of so many stocks that are trading at levels that defy the gravity of reasonable valuation.


What drove SINA up and down wildly then? After exhausting all rational factors that I can think of, the only variable that I am left with is market sentiment, which seemed be in sync with the price behavior. There are ways to measure market sentiment, even though it is not as tangible as GDP or a price-to-earnings (PE) ratio for a stock or the market. Over the years we have developed many technical indicators to gauge how Mr. Market feels, and most importantly when He is about to change his mood. The reason that the study is so useful or beneficial is that a rising tide lifts nearly all stocks when Mr. Market is happy. Under this market friendly condition, it really pays to expand one’s portfolio, which acts like a pot full of pop corn. The crucial task is to get enough pop corn in the pot, and not wasting energy on the corn seeds that did not pop for whatever reason. On the other hand, almost nothing goes up when He is mad. Then it does not really pay to own stocks, which act more like a field of crops after a big freeze in the Fall. From my experience, and the study of historic market data, Mr. Market does not change his mood easily. He only changes his mood after an extremely bearish or bullish price action of the whole market during a two to three day period, provided there are no extreme external events such as major natural disasters, failure of systemically important institutions, etc. Our goal is to pin-point these days, so that we can adjust our portfolio exposures accordingly.

Individual stock positions can also be managed based on market sentiment. Too often, good earnings reports were poorly received in a bear market when the odds are against owning stocks. Similarly, mediocre earnings can be forgiven in a friendly market. In other words, what is directly driving the stock is the perception of fundamental factors. Therefore, one should be bold in a bullish market and cautious in a bearish market during the earnings season.

What are the drivers for a stock in a long run term (years) ? Again, I believe it is the long term expectation, which is another form of sentiment. Let's take Amazon (AMZN) and Research In Motion (RIMM) for example. Both companies increased their revenue and earnings about five fold. Yet, RIMM went up and came down to the same level and AMZN went up about 5 fold. The main difference in performance is that RIMM's future expectation is gloomy because it is losing against iPhones and the smart phones based on Android. On the other hand, AMZN is crushing its competitors such as Barnes and Noble, Best Buy, Circuit City (bankrupt) and so on. Its future looks as bright if not brighter than 5 years ago with its accelerating growth in electronics segment and AWS. The implication is that one not only has to right the fundamentals, but also the perceived prospect in the future! It sounded harder than it is. Let's use Microsoft (MSFT) as an example, one can make reasonable projections of its future financial metrics. It is perceived as a mature and not an exciting company which has a dominant position and it is reasonably cheap. Five years from now, that perception is unlikely to improve.


It is much harder to figure out what drives the market as a whole because it involves many more variables and the processes are non-linear. Because timing the market is difficult, most market participants don't even try. Many adopt simple "slogans" to guide their decision making. "Buy when there is blood on the Street (Wall Street)" or "When the market is greedy, I am fearful and when the market is fearful, I am greedy" are a few examples of the phenomena.


What I described above is my preliminary finding about market behavior. My goal is to develop an intuitive description of the market, supported by observations. I believe we have just barely scratched the surface in that area. Currently, we are studying whether certain sectors have more sway in shaping market sentiment than others.

What does a stock's price depend on?

I would venture to state:

P = f (HS)                                 (1)

Where P is the stock price,
and HS (Happy/Sad) represent the prevailing sentiment towards the stock like the faces on the right.

HS (sentiment) in turn depends on, at least, the following three variables:

• Market Sentiment - When Mr. Market feels good, everything under the Sun flourishes. However, when he is in a foul mood, it is as if the world is experiencing a nuclear winter when everything perishes. For instance, all Dot Com stocks took off in the 90s and almost all stocks crashed in late 2008! Possible causes for the mood swings:
• Collective mood swings of the market crowd. There are natural cycles in the collective mood changes of the crowd who can get extremely euphoric and depressive by itself, causing bubbles and crashes.
• External forces
• Industry Events: Emergence of new industries: Semiconductors, PCs, Wireless, Internet, Sub-prime lending, Social Media
• Man-Made events: Authorities' Decisions: Interest rate policy changes, Money Printing/QE, Bailing out or Abandoning certain companies (Bear or Lehman, Greece or no Greece). 
• Conflicts: Wars, Trade Barriers
• Natural Disasters: Volcano, Earthquake, Tsunami, Nuclear Accident, Hurricanes, etc.
• Sector Sentiment - Sentiment changes wildly from sector to sector and from time to time. When the Dot Coms were hot in the late 90s, everything goes up. On the other hand, the traditional industries such as insurance companies hardly took notice.
• Trends: Emergence of new industries: Semiconductors, PCs, Wireless, Internet, Sub-prime lending, Social Media, Secular demand growth.
• Sector Challenges: 
• Hawkish policy: FDA, Regulation of the banks, Nuclear industry
• Slowing growth: PC, Drug, Brick and Mortar retail industries
• Company Specific Sentiment - Every company goes thru its love affair with Mr. Market who have many concubines, he does not stay with the same one all the time.
• Earnings
• New Products/Inventions
• Product obsolescence
• Fraud
• Competition
• Interactions with external forces
• Authorities' handouts or panelties
• Lawsuits

The next question is how much does P change when sentiment HS changes:

dP = f'(HS) dHS                                                                      (2)

f'(HS) is the first derivative, it is kindly of like beta, which depends on the market cap, industry, stock price, domicile, short interest, etc.

Equation (1) and (2) should not be treated as precise mathematical formulas as in physics, but it is rather an attempt to draw a stock's dependence tree, which hopefully can help to better understand the movements of stocks. In general, dominant variables change over time. Yet too often, market participants are trying to look for one smoking gun (one variable) for explanation. The end result is that it only leads confusion and poor decision making.

My First Impressions of Apple's Keynote at WWDC

Apple (AAPL) presented the latest Mac OS (Lion), iOS 5 and iCloud in the World Wide Developer Conference (WWDC). These products are significant and may mark the beginning of another tectonic shift in the tech industry: from PCs to the connected mobile devices and the cloud.

The most important product is "iCloud". "iCloud stores your content, and wirelessly pushes it to all your devices", and "iCloud is integrated with your apps, so everything happens automatically" said Steve Jobs.  "A competitor that doesn't own apps or does not have great developers to integrate the apps, they can never do this, they can never make 'it just works'." added Steve. Like email, the content (messages) is tightly integrated with the email app, so users don't need to worry about where and how the messages are stored. iCloud is the new digital hub for connected mobile devices. As more sophisticated apps or possibly business apps are developed over time, iCloud will become a more important piece of Apple's ecosystem. iCloud at least doubles the whole Apple's platform's stickiness because developers not only have to deal with the iOS APIs but also the iCloud APIs when they transition their apps to another platform like Android. Not to mention data or content, which are harder to move. Even though Google does not even have anything like the iCloud yet, I do expect Google, a great copycat these days, to follow Apple's footsteps soon, but other competitors like Ressearch In Motion (RIMM), Microsoft (MSFT), Nokia (NOK) and Amazon (AMZN) would have a far harder time to catch up because they are so far behind in the operating system/app/cloud offerings. The new iCloud/iTunes' music match is another well-thought-out, clever and efficient offer, which sharply contrasts with Amazon and Google's comparable "brute force" counter-parts. Some people may be disappointed that iCloud does not stream to the mobile devices. Why should it? Why should Apple worsen users' experience on AT&T? Who said it is a good idea?

My other important takeaway from the iOS 5 and iCloud is the "demotion" of a PC from a digital hub to just another device. This is done by adding more editing functions to iOS 5 and allowing software updates over-the-air (OTA). iCloud replaces PCs as the new digital hub where iTunes resides along with all the content. The most intelligent part is that everything is done automatically in the background and OTA. The end result is that the whole process is easier for users to create and access content seamlessly from multiple devices. They don't have worry about finding, syncing, saving and backing up the content. "It just works" said Steve Jobs. The demotion of PCs may have a huge impact to the entire PC food chain in the long term. A small decrease in growth rate may not matter much to the high margin players such as Microsoft (MSFT) and Intel (INTC), but it is an issue of life or death for the likes of Advanced Micro Devices (AMD) and Micron (MU), which have razor thin margins.

One subtle new feature of iOS 5 is the Safari Reader, which allows a user to get rid of distractions or ads when reading an article on the web. It not only improves users' experience, but it also hurts Apple's competitor Google (GOOG), whose "display distractions" may be negatively affected. Obviously, Yahoo (YHOO), who makes a living on display ads and spam, will be much more affected.

Another new feature of iOS 5 is "iMessages", which allows instant messaging for all iOS devices. This is a very smart move for Apple because it increases the stickiness of iOS devices. Clearly, it is going to take a bite out of the carrier controlled SMS, which has been a cash cow for them.

There are two other trends about iOS devices worth noting. One is that iPhone 4's cameras may just be good enough to dissuade a typical consumer from buying another alone conventional camera - the losing streak of Japanese consumer electronics makers such as Sony (SNE) continues. Another trend is that Apple's Game Center has more games (over 100,000) and more users (50 million) than the comparable figures for Microsoft's XBox. At some point, I expect Apple to erode the user base of video games. The game developers, console makers and retailers, GameStop (GME) in particular, have good reasons to worry about their growth rate.

"Lion", the latest Mac OS, contains more iPad-like features such as multi-touch gestures and is only downloadable at Mac App Store. Mac App Store has become the largest software channel for personal software, surpassing Best Buy (BBY) and Walmart (WMT) in just 5 months. If this becomes a major trend for software distribution, it is going to have major consequences to software retail segments for Best Buy, Walmart, GameStop and others. Another trend is that Macs are getting more mobile: the latest laptop sales made up almost three quarters of the total. With the introduction of iPad-like features of App store, multi-touch functionality and long battery life, a Mac laptop is becoming an iPad on steroid.

In summary, Apple's innovation train shows now no signs of slowing. The people at Apple just "get it"! They just have a fundamentally deeper understanding of the "cloud" than their competitors who are bound by their PC experiences. iCloud and the demotion of PCs will have far greater consequences for years to come. The people, who are disappointed about the lack of a new gadget, are too near-sighted and are missing the forest. Apple's direct and indirect competitors from Microsoft, Google to Sony have good reasons to worry. How can they compete? Apple may not kill your business, but may kill your stock if your growth rate slows as the experience of RIMM and NOK showed.

Another Chance to Buy Mosaic

Mosaic (MOS) is the largest integrated phosphate fertilizer producer and third largest potash fertilizer producer in the world. Historically, the stock price closely tracked Potash's (POT) stock until January 18th when Cargill, majority owner of Mosaic, filed to sell 100 mm shares of MOS. Since then, Mosaic underperformed Potash Corp. by roughly 15% mostly due to the anticipated offering of these shares. After the offering finally took place on May 20th at $65/share, the stock quickly rebounded above $70. The recent sell-off brought the stock back down to $66.70 on June 7, giving investors another attractive entry point to own it. I believe the long term prospect of owning fertilizer stocks is very good, given the annual addition of 70 million people to the world population and the continued urbanization or industrialization in the developing countries.

AMD - A Perpetual Short

Overview

The misery for Advanced Micro Devices (AMD) started in 1986 when Intel (INTC) decided to cancel its agreement with AMD as a second source microprocessor producer for personal computers (PCs). Ever since then, AMD has been under Intel's thumb, usually finding itself on the losing side against Intel. The company has been dogged by product delays, short of financial resources and lack of innovative ideas. On one hand, Intel has enough engineering talent and capital to put constant competitive pressure by consistently introducing more and more advanced microprocessors generation after generation. As a result, Intel has been successful in fending off AMD from competing in the high end chips such as the ones being used as the brains of computer servers at data centers.
That only leaves AMD to compete for the low margin crumbs. As a result, Intel has been a very profitable enterprise with its gross margin being more than 20% ahead of AMD's. Even after Intel outgunned AMD in R&D and capex spending, it still has money left over to return to shareholders through dividend payments and share buybacks. In contrast, AMD has been treating their creditors and shareholders as its ATM whenever the company could not keep up with its bills or needed money to buy innovation.

As we know, even the worst sports team can win a few games. AMD was no exception as it shined briefly for a few quarters with its successful AM386 microprocessors in the 90s and Athlon chips in the early 2000s when it was able to capitalize on Intel's missteps.

Financial Drain

AMD's financial performance mirrored its spotty product history. The company only had three profitable years out of the last 10, during which it lost over $6 billion in total, or $4 billion excluding charges and write-offs, which were once paid in cash or equity. In general, the charge-offs reflect the company's past mistakes that resulted in the destruction of equity value. Struggling companies tend to have more of a history of kitchen sinks than successful ones. Take Eastman Kodak (EK) for instance, extraordinary charges have become a quarterly occurrence ever since the world started to shift from analog cameras to digital ones.

In a free market, how can a company like AMD be allowed to survive for so long? The problem is that the market is not completely free. There are interested parties who love to see AMD limping along than resting in peace. The first group are the PC makers who want to use AMD as a bargaining "chip" against Intel. The second group are the investment bankers who would do anything for a fee. They are more than happy to keep their fee stream alive by providing equity offerings and subprime loans to AMD.
These are the same people who facilitated the subprime mortgage bubble, kept the money losing airlines and many poorly run insurance companies alive at the expense of some not-so-smart investors. The past decade was not particularly kind to AMD shareholders who saw their price declining more than 60% from the low $20s to less than $8 at the end of 2010 and their share count being diluted by 127% from 315 million to 717 million.

Future Prospect

It is unlikely that the suffering, which AMD endured in the past, will end any time soon. If anything, its future is even more bleak as the PC industry has become more mature and more competitive. In the past, Intel has been using innovation to mitigate the falling prices, but it is getting harder and harder to increase computer power by jamming more transistors into a processor. In other words, Moore's law is getting stretched. This means that innovation will be harder and more costly to achieve. It will have a negative implication for Intel and a grave one for AMD.

In addition to the slowing growth of the PC industry, the paradigm shift from desktop computing to the cloud is another troubling sign for the PC industry. The main reason that Microsoft (MSFT) and Intel (Wintel) were so dominant in the operating system (Windows) and the microprocessor market was because many critical apps could only be run on their PC platform. When some of the apps started to shift away from desktops to the web or cloud, it gave non-Wintel device makers a more leveled playing field to compete. Therefore, it is not surprising to see Wintel losing market shares to Apple's (AAPL) Macs.

The increasing popularity of smart phones and tablet computers poses another threat for the PC industry. In general, these mobile devices are more ubiquitous, easier to use and can accomplish a lot of the same tasks that are done on PCs. Microsoft and Intel, which are so dominant in the PC market, could not make a dent in the mobile phone and tablet market even after numerous tries. This was partly because Microsoft and Intel were so fat and happy, and could not focus on the new market with slim profit margins. However, it was a different story for their competitors who had their backs against the wall. Apple Inc., for instance, was almost bankrupt when Steve Jobs returned in 1996. Apple had no choice but to explore a new market. In the beginning, Microsoft treated the new mobile devices as miniature PCs and were not willing to start with a clean slate. As a result, the baggage they carried over from PCs turned out to be too great to overcome. This is because both Windows' operating system and the design of Intel's x86 based microprocessors are a hodge-podge of some old technology and the accumulated fixes over the years. They are not efficient and demand a lot of memory and power to run. This is usually not a big issue for PCs, but a huge one for the new generation of more light weight mobile devices.

Strategy

In summary, AMD has a sustainable competitive disadvantage and faces a tough industry headwind. The management has not been kind to shareholders. It is very hard to value the company in terms of earnings, which were mostly negative. Its tangible book value is only about 85 cents per share, which will not provide much support for the stock. In addition, its joint venture with GlobalFoundaries Inc., which makes chips for AMD, could be a financial drain in the future. The company is the exact opposite of a typical Warren Buffett stock.

Given these factors, AMD makes a great short candidate. The size of the short position should depend on one's portfolio characteristics and risk tolerance. Historically, AMD under-performed the market during the downturns. However, there are some short term risks involved. As a single digit stock in the semiconductor industry, AMD is much more volatile than the general market.

"Short squeeze" is another risk because the short interest is over 10% of its total float, which is fairly high. There is always a risk that the company will make an innovation that can change its future fortunes. This is a risk for shorting any stock. Given AMD's expertise and its current roster of management, this is highly unlikely.

Disclosure: I am short AMD, INTC.