The Refiners Broke

Citigroup downgraded the refiners today on concerns about falling margins. It's a good call IMO. These stock have had parabolic moves and are now rolling over. I think that they are excellent shorts.



It's important to remember that these are not growth stocks, they are deep cyclicals that trade on margins.

SLM Deal Threatened?

The Senate Health, Education and Labor Committee passed legislation on Wednesday 17-3 cutting the government lenders by $18 billion over 5 years. Cuts in excess of about $16 billion threaten the buyout of SLM by J.C. Flowers/BofA and JPM. If the deal falls through, SLM will tank and FMD surge.

Link to full article

SMH

The semi's are breaking out with sentiment very low. It looks like a very good long play. Note from DeGraaf:

"We have maintained that technology is currently in the late stages of a secular bottom. There is some historical context in this, as post parabolic moves, and lost leadership generally take the better part of a decade to consolidate and reemerge into a viable money making sector. To this point, the SMH broke out yesterday, and several semi and related names had impressive positive volatility alerts. Such conditions, when they are broad across a sector, suggest legitimate money entering the space. Risks look minimal and other than the summer seasonals, we can not think of much to stand in the way of a bullish technical call."

Energy Tidbits

Oil inventories rose 6.9 million barrels compared with expectations for a 100k increase. Non-OPEC production is surging, displacing OPEC barrels. The world is awash in oil. There are even tankers (approximately 10) sitting idle in the gulf because storage tanks are maxed out. Tanker rates are below their 5-year average, reflecting slower demand. Worldwide oil demand is running about 80% below expectations this quarter and yet the price recently broke out above $68 and is only down about $1 today. Madness, pure madness. Prices could drop to $40 and we would still be swimming in oil.

US refining run rates are about 500,000 b/d below the 5 year avg, but gasoline output is running 400,000 above its 5 year avg reflecting higher yields thanks to the impact of increased fuel ethanol blending. There is absolutely no shortage of gasoline either.

More good news for First Marblehead (FMD)

After the close yesterday, FMD reported an increase in the quarterly dividend from 15 to 25 cents per share and disclosed that from April 1, 2007 through June 6, 2007, they repurchased 1,319,100 shares of common stock under authorized repurchase programs. In April 2007, the Board authorized the Company to repurchase up to 10,000,000 shares from time to time.

A couple other positive data points are that concentration levels from JPM and BofA came down in the latest securitization, and the yield curve is steepening.

According to the prospectus, JPM loan volume was 29%, down from 37%, and BofA was under 10%. Lower concentration means reduced revenue and earnings risk (through greater customer diversification) which should help expand the earnings multiple (investors pay up for less risk). As an aside, FMD's smaller, higher margin partners (along with the in-house brand) are growing much, much faster than JPM and BofA.

Secondly, the yield curve continues to steepen (leading economic prospects are accelerating) which, all other things being equal, helps slow prepayment activity. Management proactively increased the prepayment assumption last quarter due to the persistent inverted yield curve but that issue is starting to resolve as it should.

FMD surge in weak market

Unicredito Italiano has disclosed a 5.1% stake in FMD according to 13D filings. This bank has been pretty active with M&A in the past. As I've mentioned many times now, FMD is significantly undervalued at these levels.

Pru shuts stock research and trading arm

Article here.

This is a sad day because some of my friends and people that I have worked with have lost their jobs. Good luck to all of them with their future endeavors.

On the positive side, Ed Keon and his quant team will remain in place. Ed and ISI's Francois Trahan (formerly of Bear Stearn's) are my two favorite strategists.

Stocks still attractive in aggregate

From Pru:

"- As we showed in a 2005 note, “Buy Low, Sell High,” the current valuation of stocks and bonds has been a sensible and reliable indicator of future returns over the past 6 decades.

- In this piece, we update those findings and find that the higher returns obtained from buying low have not required investors to take higher risks, as measured by the standard deviations of returns.

- Said another way, investors have been able to use valuation to identify assets with an attractive risk/return trade off.

- At today’s valuations for stocks (a trailing earnings yield of about 6%, a forward yield of about 6.5%) and 10-year Treasury bonds (yield under 5%), stocks have offered a far superior risk/return combination.

- At these valuations, the downside risk of stocks has been about the same as bonds, with much higher maximum historical upside.

- Of course, past performance is no guarantee of future results, and the note contains several important caveats.

- But we suspect that investors who buy on autopilot, adding bonds and selling stocks as they age regardless of valuation might actually be adding to their risk of falling short of financial goals."

I agree with all of this although there are some sectors that I don't like such as energy, utilities and housing/mortgage related equities. I also don't like Chinese stocks in general.

Have refining margins peaked?!

From Mike Rothman:

"*The DOE released its revised monthly figure for March gasoline demand. Like the revised figures for January and February, the revisions came in significantly lower than the initial estimates.

*The weaker than previously estimated gasoline demand numbers make sense to us given the separate data we analyze for vehicle miles traveled which were distinctly soft for the same period. It seems that the oil market still believes US gasoline demand is robust.

*Gasoline imports surged almost 25% week-over-week. The elevated levels are likely to persist over the near term given the still wide "import arb" with Europe.

*US refinery production continues to ramp higher. We think output levels will climb at least 300,000 b/d from current levels by early July. Between refinery operations ramping up and imports being elevated, we expect continued downward pressure on the "gas crack" and refining margins.

*We've had a number of questions about the petroleum balance accounting employed by the DOE for ethanol. The short story is ethanol stocks aren't counted as part of gasoline inventories as yet, but gasoline output does include ethanol that's being blended."