Holiday Sneer

Very few rock-n-roll Christmas songs are capable of achieving standard status. The primary reason is probably that your 75-year-old mother-in-law looks mighty funny singing the Waitresses’ “Christmas Wrapping”. However, in my book a couple do achieve that lofty goal. Chuck Berry’s “Run, Run Rudolph” is inducted, naturally because it’s a Chuck Berry song. However, the greatest rock-n-roll Christmas song ever is unquestioningly, “Father Christmas” by the Kinks. Telling the tale of a department store Santa who is assaulted and robbed by teenage hooligans, the princes of Snark Rock under the command of the legendary Ray Davies, catch and express a handful of genuine emotions most people experience during the holidays.

Investors, especially, are enjoying a bouillabaisse of fear, greed, apathy, and optimism as we slide into the rest of the year. The market tanked a little the first part of November with the S&P 500 (SPX) giving up around 3%. Then, it chugged sideways through Thanksgiving, breaking out and climbing over 5%. Even more so, the SPX is up nearly 20% from the July lows and over 10% YTD. Correct me if I’m wrong but that’s a good year. Some of the baseline economic data, inventories, a shrinking trade deficit, looks a lot better than it did two years ago.

That’s the good Santa. Here’s the bad Santa. It appears that the first couple of pieces of the Jenga game that is also known as “the government bond market” have been pulled out. In mid-October, 10 year yields were as low as 2.50. Now they’re at around 3.30. That’s a 32% move. It may be good for stocks as the glut of money rotates out of fixed income and into equities. But how will small investors react when they see the value of the gazillions of dollars they’ve been shoveling into bond funds go down? Probably the same way most 9-month-olds react the first time they meet a mall Santa. It’s a safe bet that they won’t flee into the safe arms of equities. Yes. MORE cash. That’s not going to help keep this thing going. Bah humbug.

There’s also a lot of optimism. I’m all for optimism, but not concerning the market. Usually, buying when everyone else is in a bad mood works out fairly well. Not always the most popular thing to do but making money isn’t always a popularity contest. The talking heads are chirpingly upbeat as are their guests. They did everything short of taking off their clothes to dance naked when it became apparent that the Bush era tax cuts would be extended. Is this good news? Of course it is and near term it will have a positive effect on the economy. But the proverbial can is still being kicked down the road. The deficit isn’t getting smaller. Are consumers coming back? Maybe. Maybe not.

Upscale retailers like Tiffany and Co. (TIF) are reporting stronger holiday sales. However, broader market mainstay Best Buy (BBY) fell out of bed the other day due to a not so hot Q3. It’s hard to make money selling flat screens when Sam’s is throwing them out the door for $300. T.V. prices are falling so quickly Jos. A Bank (JOSB) will probably be giving them away free when you buy a sweater. It all depends on the neighbourhood. 9.8% unemployment doesn’t help either. We don’t want to be the Grinch and ruin the mood. We’re just expressing an opinion.

The signals are mixed and the picture is far from clear. If you must put some money to work, there are still some things to buy and cash does absolutely no good. The big pharmaceuticals (we discussed last week) grossly underperformed the broader market this year. Most of them are cheap and yield more than the SPX or treasuries. If the business cycle is truly improving, some higher quality financials may be worth a peek. Reviled and maligned, but capable names like JP Morgan (JPM), Morgan Stanley (MS), even the battered B of A (BAC). BAC and MS have also turned in lackluster performances this year compared to the benchmark. Investors are looking for return.

Politicians and wealthy constituents want to keep the tax cuts at least for a few years, preferably forever. The unemployed want benefit extensions. It seems that these days especially, the chorus of the greatest rock-n-roll Christmas song ever sums it all up: “Father Christmas…give us some money!”

On Dasher…on Dancer…on three lil’ piggies!

“Eine telfon…bitte”

Deutsche Telekom ADS (DTEGY)

Recent Price: 12.92

P/E: 18.46

Current Yield: 7.98%

The Skinny

I can’t understand why Wall Street can’t get sexy over big telecoms? Perpetual cash flow. Expanding margins. Damn near monopolies. People won’t shut up about smartphones. Sick yield. It’s almost like buying a bond.

Here we’ve got T and VZ. Across the pond VOD and on the Continent, DTEGY is the 9000 pound, Teutonic telecom gorilla. The company’s numbers are starting to improve after a not so hot couple of years. Cash on the balance sheet also increased 60% last year over the prior. Cash is always good. They’ve also got a good foothold in the U.S. through T-Mobile which boasts super speedy 4-G technology. The stock is off around 15% from the 52 week high. Not a bad deal for $56 billion communications company that covers two continents.

The Danger

Why will DTEGY shares underperform the broader market YTD? Look at the chart from the first part of November. Tracks almost perfectly with the crazy new dance called “The Euroslide”. Things are ugly over there and will probably remain so for the near to mid term. Pressure on the currency is going to have a negative effect on how all businesses function in the Eurozone. That’s the MACRO macro challenge.The plain old macro challenge for the industry sector is saturation. Wireless penetration is starting to top out. Growing market share is tough when everyone is just sort of shuffling the same customers around. And although revenue numbers have picked up, on the whole they’re still fairly saggy. Steady revenue is good for the dividend. Declining ain’t.

“They’ve got gas…”

AGL Resources, Inc. (AGL)

Recent Price: 35.43

P/E: 11.39

Current Yield: 4.96%

The Skinny

Formerly the old Atlanta Gas and Light, AGL traces its roots back to 1856. That would probably mean that General Sherman probably smashed a few of their mains on his destructive March to The Sea. AGL provides natural gas to about 2.3 million customers. They also maintain and operate a fibre optic network (remember a few years back when companies started stuffing old pipes with wires?). Good numbers. Shares are cheaper on a P/E basis than its peers and the stock has underwhelmingly lagged the broader indices. Their debt levels haven’t increased alarmingly and the dividend payout ratio is a comfortable 60%. AGL is currently in the process of acquiring Nicor, Inc. (GAS) which should expand share and with natural gas being hailed as the bridge alternative fuel, the company should be poised to benefit.

The Danger

Mergers can be great. They also create limited near term visibility. AGL expects the deal to be earnings neutral in 2012 but accretive the year after. That’s fine and all, but that’s two years in the future.If you want to try to read between the lines, “earnings neutral” probably means “earnings reverse”. It’s never as easy as it looks. Stand alone, AGL is trying to dig itself out of a one year earnings slump of 17.25%. Earnings drag due to the merger won’t help. Not only has the share price underperformed the market, they’ve also underperformed some of their peer group (ATO, LG, PNY). Outside of the merger, makes you wonder why AGL’s classmates are more successful.

“From Zero to Hero?”

PIMCO 25+ Year Zero Coupon U.S. Treasury Index Fund (ZROZ)

Recent Price: 68.07


Current Yield: 4.31%

The Skinny

These days it’s wise to tread lightly amongst anything having to with sovereign debt. We learned that first hand (some the hard way) this week as Treasuries were smacked about like a holiday piñata. Then again, the PIMCO guys are pretty good at running fixed income, although ZROZ is basically a semi passive ETF indexed to the B of A Merrill Lynch Long U.S. Treasury Principal STRIPS Index (try saying that three times fast with a mouth full of crackers).

Thanks to the presumed end of the bond bull, ZROZ is off nearly 27% from its August all time high. Better to buy here than there if you’re considering. The yield is just shy of the 30 year Treasury and quite northerly of the benchmark 10 year. It’s liquid so no waiting around for a bid on those strips in the IRA and lastly, no leverage which is good news in this current bond environment.

The Danger

Well, for starters, ZROZ tap dances at the long end of the yield curve: the one prone to go up much more violently than the others. 27% looks like a steep discount. It will probably get steeper. Rates have been ridiculously low for a long time. The economy may not be going great guns, but growth is going to put upward pressure on rates and downward pressure on bond prices as sure as the day is long. That’s just how it works. And thanks to the Washington wizards (the ones who don’t play basketball) and their magically expanding deficit, owning anything that has the words “long”, “treasury”, and “bond” in the name is more treacherous than ever. Be very very careful or avoid altogether if you don’t have the intestinal fortitude to climb into the ring with the government bond market.

Disclosure: long AGL in client accounts


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