3rd Year Presidential Cycle S&P 500 Returns

Bush 2003: 28.7%
Clinton 1999: 21 %
Clinton 1995: 37.5%
Bush 1991: 30.6%
Reagan 1987: 5.2%
Reagan 1983: 22.5%
Carter 1979: 18.4%
Nixon/Ford 1975: 37.2%
Nixon 1971: 14.3%
Johnson 1967: 24 %
Kennedy/Johnson 1963: 22.8%
Eisenhower 1959: 12 %
Eisenhower 1955: 31.6%
Truman 1951: 24%
FDR/Truman 1947: 5.7%
FDR 1943: 25.9%
FDR 1939: (-0.4%)
FDR 1935: 47.7%
Hoover 1931: (-43.3%)
Coolidge 1927: 37.5%

Average return 20.1%
Median return 23.4%
Positive 3rd yrs 18
Negative 3rd years 2

I suspect we'll see 20%+ returns in 2007 with most of the gains coming in the first and fourth quarters when liquidity is strongest. Recession fears are vastly overblown by most investors and pundits. We shouldn't have to worry about recession until about 2010. This is a mid-cycle slowdown which is an excellent environment for stocks. Enjoy the ride!

Merry Christmas

Here's hoping you're not invested in a company such as this:

Buybacks Galore!

According to Trimtabs, a whopping 78 new stock buybacks for $51.7 billion have been announced so far in December, surpassing the previous December record of $42.6 billion in 2004. In case you are wondering, reducing the aggregate level of outstanding stock is bullish for the market.

3rd Year Presidential Cycle S&P 500 Returns

Coming soon.

Western Union (WU)

First Data (FDC) just recently spun-off Western Union which I think is an excellent development for the company and its shareholders. With operating earnings and return on invested capital around 30% and 60% respectively, it's hard to imagine things getting better, but I think they can.

As part of FDC, WU was held back from cross-selling and up-selling valued added financial services to its customers because of some of the inherent conflicts it posed with FDC's traditional bank and merchant customer base. Now it's free to pursue opportunities like payday loans, small business micro loans and a global card network.

Also, the spin-off makes WU easier to understand and analyze. Simpler, more straightforward businesses trade at premium valuations compared with complex, more diversified businesses.

At $22.50, the stock is trading at 20.8 times 2007 EPS estimates which is below comparables like GPN, MGI, GCA and PAYX. When talk of the spin first surfaced, some analysts thought the shares could trade at a P/E of 24x given the high quality of the shares and strong FCF generation. However, WU saw some weaknesses in their business last quarter due to immigration reform talk and a slowdown in residential construction. This created general uncertainty and lower paychecks for Hispanics in the U.S. which led to lower transaction volume. So, you can make a case the stock has incurred a multiple correction although it has appreciated from its spin price of around $18. I'm still somewhat concerned about Hispanic layoffs in the housing construction market (U.S. money transfers to Mexico = highest margin service), but that doesn't seem to bother Warren Buffett. He is a huge fan of this company and has been buying the stock. I guess I can’t blame him. WU is a steadily growing, very profitable company with solid competitive advantages and high barriers to entry that will make it difficult and extremely costly for competitors to match what they have created on a global basis.

For additional info, see this article.

Crude Oil Set To Tank?

Evidence of demand destruction is showing up in tanker rates. Two key Persian Gulf routes have seen rates drop between 40% and 50%. This obviously reflects reduced buying of OPEC oil.

Also, there is more evidence that the price of crude is being held up by speculators or mindless investors who are pouring money into the futures market. The data released by the Treasury for OTC commodity derivatives showed exposures held by US banks more than doubled in the third quarter. If there is a financial disaster looming, it could be a large hedge fund that takes it on the chin in the bubbly energy market.

There are also rumblings that the Saudi budget is assuming $40 crude for 2007, about 34% lower than current prices. Longer term I think sub $40 is very likely as OPEC will want to make projects like the tar sands uneconomical and regain some lost market share and power.

Energy

I'm not in the peak oil camp. As a matter of fact, I'm strongly anti peak oil. These record energy prices are giving huge economic incentives for greedy corporations to find new reserves, and they are indeed finding them. Inventory levels around the world are high and growing while demand is starting to fall. One analyst I follow said this morning that demand appears to be growing at a level 40% below his estimate. Ouch! No wonder OPEC is cutting production. An inflated oil price + high reserves + weakening demand = correction to me.

There are a lot of misconceptions about the energy market. For example, OPEC does not set the price of oil (duh!). They can certainly influence it, but ultimately the price is set by traders in the futures market. With the peak oil theory floating around and solid returns over the last few years, hundreds of billions of dollars have poured into energy markets which has caused a bubble in the price of crude. At these price levels, OPEC is actually losing market share to non-OPEC producers because of growing non-OPEC supply.

Current Portfolio

As I mentioned in my previous post, I'll bery bullish at the moment. In fact, I'm 100% equities with the following allocation in my 401(k):

51% Vanguard Total Stock Market Index
27% Highly Rated International Fund w/Emerging Market Exposure
11% Highly Rated Large-Cap Growth Fund
10% Highly Rated Mid-Cap Growth Fund

Outside of the 401(k), I have a pretty large position in CompuCredit (CCRT), a Dan Brown/Bankstocks.com pick, and smaller positions in some health care names (LNCR, CVH and LLY) that I think are undervalued.

CompuCredit (CCRT) is a sub-prime lending company which scares a lot of people, especially in a slowing economy, thus the cheap valuation. However, they basically have a license to steal and earn incredibly high returns. Their credit card for low FICO customers (very low limit with high fees) is a brilliant product and cash machine.

Lincare (LNCR) provides in-home respiratory services in the U.S. The stock is at an inflection point IMO because Medicare reimbursement cuts were not as bad as expected and the stock has broken a downtrend line. Also, the company is an excellent LBO candidate with its high normalized cash flow yield and strong balance sheet. I expect the stock to be weak today and maybe Monday as it's removed from the Nasdaq 100, but could easily trade into the mid 40's over the next 6 months and potentially much higher.



Coventry Health Care (CVH) is the smallest publically traded managed care company. They are an excellent operator in an attracitive industry but also a takeover candidate. My target price is in the mid 60's.

Eli Lilly (LLY) is a big pharma company with no near-term patent issues and an excellent drug pipeline. The shares represent good value in the mid to lower 50's and could tade $10 higher next year with some decent pipeline news.

A Great Environment

I'm amazed at how much pessimism there is in this market. I don't really understand it, but I'm glad it's there. Sentiment is an AWESOME contrarian indicator and with the put/call ratio at about 0.80, we are far from a top in this market IMO. The investment landscape is as positive as it's been in 10-15 years so DO NOT let the bears keep you from making money! Profits, valuations, sentiment and the biggest driver of all, liquidity, are all very bullish!

Optimally Utilizing Active and Passive Management

It’s no secret that active managers have a very difficult time beating their benchmarks, especially after fees and taxes.

In particular, large cap managers have an extremely hard time adding alpha (excess returns) because the stocks they buy and sell are heavily followed by the Street. In other words, the market for large caps is pretty efficient and there is not a lot of miss pricing for the managers to take advantage of. So, unless you are Warren Buffett, to beat the benchmark you either have to take more risk than the benchmark or get lucky. Taking additional risk is not particularly desirable and forecasting luck is impossible. The bottom line is that it’s smart to index your large cap exposure. This strategy alone will likely add 100 bps to your annual large cap returns.

Small cap managers, however, are typically able to add some alpha versus their benchmarks. Smaller stocks are less efficient and often neglected by Wall Street analysts. Why? Small companies are generally not very good investment banking clients. They don’t generate the big fees that large firms do. Using a good active manager in the small cap sector will often add 200-300 bps of returns versus a small cap index fund.

International managers typically add alpha as well, but not to the extent of small cap managers because the fees are higher. Still, an excellent international manager can add 100 bps or more of excess returns after fees.

On the fixed income side, you’ll generally want to avoid active management in treasury, corporate and high yield bonds. What little value these managers can add through security selection, sector bets and duration management are more than offset by the fees they charge. Granted, no true index funds exist in the bond world, but Barclay’s has introduced enhanced index exchange-traded funds with their low cost iShares. Two of them are the Lehman Aggregate Bond Fund and the Treasury Inflation Protected Securites Fund under the tickers AGG and TIPS. The expense ratios on these funds are only 20 bps compared to 50 bps or more for active funds.

Intro

This will be my investing and economics blog. I'm a professional money manager with about $150mm under management.