Hedging Now Available for U.S. Real Estate

New options hedging derivatives are available for hedging downside risk in the U.S. housing market which is said to be in a bubble at the moment.

http://www.msnbc.msn.com/id/7993587/

Random Notes

Proceeds from the vesting (exercise) of employee stock options become a liability upon the company and this has a direct impact on operating expenses, and subsequently on the bottom line.

To fulfill their liability to the worker the company will do either one of two things:

1. Issue a new share (therefore diluting earnings and existing shareholders equity).

2. Go into the open market and repurchase shares which are then given the employee who can either hold onto them or sell them immediately (fairly similar to the manner in which in-the-money exchange traded (public) options are exercised upon expiration.

A slightly deceptive result of the second scenario is that is gives the appearance to the public investors that the company is engaged in large amounts of share repurchase programs whereas the shares are only being repurchased to fulfill the contingent liability towards the workers’ options sales. (Usually glancing over the footnotes in the financials will provide more clarity over such matters.)

Share buybacks by a company have the effect of making a company’s EPS appear larger without the company having earned more. Therefore, earnings figures should be used rather than EPS. For example, if a company buys back 1% of outstanding stock on the open market in each of it’s first three quarter – all else being equal – fourth quarter EPS will increase by 3%. However, the earnings will, in reality, have not changed. Hence the necessity to rely more on the net income figure than EPS.

After the passing of the new FASB regulation in 2005, however, such matters will become much more transparent, and it will become less easy for company accountants to hide such matters in the footnotes.

The S&P says the impact of the new FASB rule will be felt most in the “in the Information Technology sector, where unexpensed option cost would have reduced as-reported by 19.19% and operating by 17.79%.”

Random Notes

-Employee stock options and warrants are a form of arbitrage.

-The exercising of company stock options by insiders results in dilution to the overall outstanding shares because it simply adds that many more shares to the public float while the proceed from the exercise go to insiders.

-Question: When a worker exercises his options are they sold in the public markets or do the proceeds of the sale come from the company's operations (income statement)?

-With the new FASB regulation mandating that employee stock options be expensed, does it mean that the proceeds resulting from the vesting (exercise) of the options be showing in the "Operating Expenses" section of the "Statement of Operation", and if so does this mean that previously they kept off the books altogether?

The Sinking U.S. Dollar

The markets are very smart and adjust to new info quickly. They know things the average person doesn’t, and they exploit this info and profit from it. Here's some of what's being priced into the U.S. dollar currently.

HERE'S WHAT THE FOREX MARKET KNOWS THAT YOU DON'T!

The US Dollar is tanking and will more than likely continue to weaken (especially hard after year 2010) because of the economic problems plaguing the US economy which are being masked by Fed economists (the Greenspan Fed at least), the media, and the general carefree attitude of the American public. This will have a MAJOR negative impact on the US and Canada (of whom the US is the largest trading partner). And a bad U.S. economy means, you guessed it, a drowning U.S. greenback. And there will be severe international consequences as a result of the dollar sinking as other strong currencies in the foreign exchange market are pegged to the U.S. dollar. Though there are always survivors I'm not sure the U.S. will be one of them... Not for a few decades to come. "The Great Depression: Part 2"???

POINT 1:
U.S. federal budget deficit (national debt) is around $8 trillion and continues to grow WITH INTEREST each year. This is just the money the U.S. government has put to uses like,

i] "Health and Human Services" - roughly $565 billion set aside for budget in 2005 (the largest spending sector)

ii] "Department of Defense" - roughly $460 billion budgeted for 2005 (second largest)

iii] "Tresury Department" - roughly $380 billion, which includes interest paid on debt like T-bills and long-term bonds (third largest)

POINT 2:
U.S. consumer credit debt (credit card debt, mortgage debt, student loans, car loans, etc...) is at an ALL TIME HIGH with the average house hold carrying an average of 8 credit cards and 50% of credit cardholder sending in just the minimum payment or slightly more than the minimum payment, but not paying balances in full each month. Some estimates put total American consumer credit debt at around $7 TRILLION! About $4 trillion of this is owed in the form of mortgages, $2 trillion in the form of credit card debt, and about $1 trillion in the form of "other" bank loans (lines of credit, etc...)

Also, U.S. consumers tend to get too many loans against the value of the equity in their homes - in effect, SHRINKING their equity in their homes and increasing the amount of debt they owe the banks (with interest, of course).

If someone wants an iPod and a 50" Plasma screen TV they'll more than likely not have the cash to buy it outright so they'll either buy it on their credit card, or if the credit cards are maxed out they'll roll-over the card debt into their home equity, in effect "wiping the card clean" for new use, or get a line of credit against their home equity.

IT'S JUST TOO EASY GETTING CREDIT IN THE UNITED STATES. And this is NOT exactly a good thing!

POINT 3:
The U.S. trade deficit (the EXCESS of FOREIGN goods it IMPORTS over the amount of domestic goods it exports to foreign countries) is also at an ALL TIME HIGH. Currently hovering around $700 billion (2005).

The U.S. used to be a SELLER goods to other countries in the past. Now it has primarily become a BUYER of goods from other countries because the standard of living in North America has risen so much that more and more goods are needed to support it. However, the COST OF LIVING has ALSO gone up (inflation) and not for all the right reasons. More on that later. Like, for example, where having just one car was a big deal some time ago, the needs (and wants) of consumers has grown so great that having TWO CARS is considered average now. And these cars are primarily low-priced FOREIGN cars made in Japan.

Three major problems are evident here:

i] U.S. consumers let their greed and ego get the best of them and this leads them to do (foolish) things which are NOT supported by their personal economic conditions

ii] As a result they get into further and further debt, but think nothing of it since everything is "financed" (with interest) and the "monthly payments are so low"

iii] As a result US dollars go to FOREIGN economies, like China and Japan

POINT 4:
U.S. workers are losing jobs to foreign competition, like the new economy of China for example, where goods can be produced cheaper since labor is cheaper.

For example, a U.S. raw materials like cotton to China and gets back finished goods (of high quality we might add) like t-shirts, and it’s done in the most economic way to the U.S. consumer and the manufacturing plant.

However, as a result, the Chinese make money, while the U.S. consumer spends money, and the American guy who could’ve been given the job no sits unemployed because it went offshore to China.

POINT 5:
This brings us to the next point, off-shoring / outsourcing of jobs from the U.S. to foreign countries like China and India where workers will (in most cases) HAPPILY perform the job for a fraction of the cost it would cost if American workers were hired to do it. Therefore, the U.S. IS LOSING HIGH-PAYING JOBS (which have traditionally been the factory-type, “industrial age” jobs, and is supplementing them with low-paying “frontline” jobs (like working in McDonalds).

Wal-Mart is also a big negative here. Though it benefits American’s consumers in the short run by selling low priced goods, with jobs being outsourced by suppliers in order to maintain Wal-Mart’s status quo of keeping low prices (otherwise Wal-Mart won’t put their product on it’s selves) American’s are losing potential jobs. In the long run this job loss will shrink Wal-Mart's own revenues (in America at least) because no matter how cheap the merchandise, if you don't have an income stream you won't pay for it.

POINT 6:
The U.S. government passed a law called the “Employee Retirement Income Security Act (ERISA)” in the 1970’s. As a result of this law the idea of “social security” has been removed from the U.S. economy. Under the old law a person would work for a company (usually for life since the pay standards of old jobs where much higher, thus, workers didn’t have to frequently change careers to make ends meet) retire and expect to be taken care of by the company through pension which the company was required to set aside for it’s aging workers till death or till the company itself went bankrupt. Under the ERISA law a company is only required to meet a certain percentage of the savings a worker sets aside THEMSELVES each month in a company 401K, etc… And if the worker doesn’t set aside anything then the company is free from obligation to a large degree too. Robert T. Kiyosaki calls this a shift from “defined benefit” (DB) to “defined contribution” (DC).

POINT 7:
It gets UGLIER. The MAJORITY of such company funded plans (401K’s etc…) are tied up to STOCK MARKET INDEXES! In other words, if a worker has $400,000 saved up in their company’s 401K and the market goes up 50%, GREAT! And most of the time the capital gains are “tax DEFFERED” (NOT tax free).

HOWEVER, if the market goes DOWN 50% (as has happened after the bursting of the Dotcom bubble in 2000) then that $400,000 worth of savings and contributions by the worker and the company becomes $200,000!

And this HAS HAPPENED to several MILLIONS of people in the early 2000’s.

POINT 8:
The first of the aging Baby Boomer population (which has a roughly 19 year span – from the eldest baby boomers to the youngest) will hit age 65 – “retirement age” – beginning in year 2010. This is a population of about 78 million in the U.S. alone (not including Canada and other WW2 countries). And though they are estimated to have a $2.5 trillion per year spending power (which is expected to grow to $3.0 trillion by year 2007) it will be very difficult for them to retire since most of their wealth is tied to paper assets like stocks and hard assets like real estate. So though they have roughly $32,000 - $38,400 of spending power per person per year who will buy all those assets from them when they start pulling funds out of the market and real estate?

POINT 9:
This brings us to the next point, REAL ESTATE. After the Dotcom bubble burst most of the proceeds went into housing. This created the biggest bubble the residential housing market has ever seen in U.S. history after the first housing crash in 1995! Ten years later, up until the summer of 2005 at least, everyone was flipping condos and getting rich. Now, though the bubble hasn’t burst, it’s flattened out and will deflate slowly AT FIRST. But come year 2010 when the U.S. economy will go into a tailspin with Baby Boomers cashing out an all, the burst WILL happen – especially in the more overbought / overvalued areas like California.

POINT 10:
The U.S. WON’T win the “War On Terror” as the Bush Administration promises because terrorism is cheap. Robert Kiyosaki says, “you don’t need an MBA degree to be a terrorist” – and it’s true. All you need is the feeling of being angry at the world and with the crisis the U.S. economy is in and the troubled times ahead “domestic terrorism” (bad term, but I guess I’m the first to coin it) will increase more than threats from overseas. People riot and rally when they’re unhappy (hey that rhymes). And they’ll have PLENTY of reason to be unhappy with the U.S. government and the U.S. economy in the decade ahead.

POINT 11:
U.S. dependence on oil from the OPEC (Oil and Petroleum Exporting Countries) is greater than every before. Now with China’s oil consumption going through the roof since it’s economy is booming things are getting scary. If even 10% of it’s 1.3 billion population starts looking for cars to drive it’ll put a damper on the ALREADY LIMITED supply while the demand keeps going up and up!

Gas prices will continue to rise after year 2010 (though before that they’re expected to come back down to $40/barrel). Harry S. Dent believes so, and I agree.

POINT 12:
The Fed and media keep telling half-truths to Americans that GDP is great, unemployment is low (5%), inflation is low, consumer debt is manageable, and the national debt “can be managed if we do something quickly”.

Actually, the truth is that it’s more like “we can’t do jack now!” The situation IS, in fact, “damage beyond repair”.

GDP is a flawed economic indicator. The reason is because most of the time people (who care – as most people could give a damn since they have to get back to watching the twentieth re-run of “Friends” instead) only look at the RESULTING GDP figure rather than breaking it back down into separate parts and examining each part individually.

The individual parts which make up GDP are:

(1) Consumption
(2) Business Investment
(3) Government Spending (Federal Budget a.k.a. National Debt)
(4) Exports
(5) Imports

The GDP equation is:

(1) + (2) + (3) + (4) – (5) = Gross Domestic Product

The Fed also uses other deceiving measures like “consumer confidence” which is only a monthly survey of 5,000 U.S. homes regarding their (consumer) optimism about current and future economic conditions. Such measures GREATLY MASK reality because for one thing it doesn’t make sense to go by the opinion of a measly 5,000 out of a population of about 300 million. And secondly, I’m willing to bet most of those surveyed don’t themselves know the truth underlying the U.S. economy. If they can buy an iPod, High Definition LCD TV and finance a new car OF COURSE they’ll say “we’re confident in the U.S. economy!”

Who Will Suffer The Most?
Not the wealthy, since they already have this info and are acting on it. But rather (as usual) the middle, working class (blue-collar) population. And it makes up a mighty large % of the total North American population.

The rich get richer... Again.

POINT 13:
The U.S. dollar was taken off the "Gold Standard" back in 1971 by President Nixon. As a result the paper money (and even plastic cards, etc...) we are accustomed to currently are not backed by solid asset reserves (like gold). The money supply in circulation now has become a "fait money" system - Money that a government has declared to be legal tender, despite the fact that it has no intrinsic value and is not backed by reserves.

This means the U.S. (and even Canadian) dollar is only good as long as people continue to believe in the North American economy. When the story starts to die, so will the dollar, and inflation will accelerate.

The FED economists argue that in such a scenario market forces will emerge where the US dollar will actually "gain" leverage because it's reduced buying power will cause foreign businesses to want to open up shop here as they would have to pay less to the workers in relation to what they would have to pay workers in their own currency back home. This arguement does not, however, display the entire picture.

POINT 14.
The aging baby-boomers will be the largest "beneficiaries", or "consumers" if you will, of heath care services in the future. At the time of this writing it is estimated that these needs could amount to $78 TRILLION in their remaining lifetimes after retirement age, and most of these boomers will be dependent on things like medicare and other health and social programs which may exist or which would likely be created in the future. This imposes a heavier burden on the U.S. Gov't. While $78 trillion is nothing to sneeze at, it's important to break down this massive price tag into appropriate divisions to understand where the most pressure from this future liablity will be felt, and how it will trickle into the U.S. (and North American economy).

Insurance Companies:
These big boys' floats - espeically life insurers - will be in serious jeopardy which, of course, is not a foreign concept in the insurance business, but perhaps nothing of this magnitude (aging boomer phenomenon) has ever occured in the industry before. This could mean an onslaught of bankruptcies in the insurance world which would tricle down to the re-insurers as well. And this means that promises these companies have made would be left unfulfilled on a massive scale. Let's say of that $78 trillion roughly 50% falls on the sholders of insurers - so $39 trillion - and let's assume that 10% of these $39 trillion obligations are not met as a result of the insurers going bankrupt (this is most probablly a conservative estimate though)... That's $3.9 trillion in evaporated insurance benefits. And other compaines not forced into bankruptcy may just do what Buffett does (as a matter of being prudent) and just stop writing insurance policies. So perhaps there won't be as many "shoulders to cry on" just because everyone will be busy crying. I'm no expert on the insurance industry, but I can forsee the possiblity of some sort of negative chain reaction occuring which will ultimately affect the U.S. economy to a large extent.

Personal Health Spending Budget:
The retirement money the boomers will rely upon, while it does factor in health care costs to some degree, it is doubtful that their portfolios will be able to weather the storm ahead. Let's say, of the remaining $39 trillion, "personal health spending" amounts to roughly 40%... That's $15.6 trillion dollars, or $200K PER BOOMER in their remaining lifetimes after retirement! How can someone retire on a $1 million - $2 million portfolio after factoring such massive costs (with inflation adjusted dollars, mind you)??? And these are just health care costs. It is estimated that around 75 percent of baby boomers will require some form of home care, says Health Insurance Association of America. On the average, $50,000 - $60,000 is required annually to keep a patient in a nursing home. So $55,000 * 13 years (average life expectancy = 78 years AND RISING) = $715,000! And this does not include expenses as vacationing, recreation, and the FEELING of retirement. If boomers think they can retire on $18,000/year they've got another thing coming!

So from age 65 to 78, is 13 years of health care costs. Even a modest $10,000 per year from a boomer's bank balance amounts to $130,000 in that 13 year period... And what happens if God Almighty had predecided for that person to live till 100??? That's decades of living, but living in PAIN and SUFFERING when the porfolio dries up!

Government Spending on Health Care:
The U.S. Gov't can't let it's aging citizens suffer misery without at least "promising" them some future assistance. And while not fulfilling such promises would be politically incorrect for the Gov't I suspect the Whitehouse will have no meaningful alternative. For example, how is the remaining $15.6 trillion supposed to fall on the shoulders of the Gov't when the Gov't can't even meet it's OWN expenses and runs a budget deficit every year? Obviously the Federal folks can't manage the country's budget, so how would they manage an even tighter budget in the future? On top of this Uncle Sam will be all to glad to tax these same folks at, perhaps, alarming rates in the future. Don't forget that these IRA's, pension plans, 401K's, etc... are NOT "tax free", but rather "tax deffered". And yes, there IS such a thing as a "Death Tax".

Factor In Everyone Else:
Don't forget, I'm being modest with these projections because the baby boomer popluation is obviously not the only demographic popluation residing in North America... What about their parents? And even their own kids to some degree? Granted that young adults don't need as much health care coverage as older folks, but sickness doesn't come with a warning. Therefore, everyone is a potential candidate for health care, but not everyone will get it. And if an epidemic struck in such depressed times in the future (hey, when things are bad they usually get worse before getting better) then forget about the North American economy for a very long time.

I'll add more points to this list as I come by them.

The New Bull Market

• Oil prices retreating to $40
• Stock undervalued compared to bonds
• FED raised short term interest rates to 4%, causing more momentum movement to flow OUT of housing and into
  stocks
• "War On Terror" is apparently being won
• GDP growth was good (economist figures, NOT actual figures)
• Consumer spending is robust with babyboomers having an estimated $2.5 trillion/year spending power which is expected to grow to $3 trillion by year 2007 ... That's $32,000 - $38,500 of spending per person per year in the babyboomer generation
• IPOs are back
• Second technology wave has begun with broadband and networking techonologies approaching 90% penetration on the "S-curve"
• China has joined the race

The bad news - FED deficit, trade deficit, and national debt, won't affect the dollar and the US economy till this bull market is over around 2010. At that point a switch into the Chinese Yaun will be the best course of action.

Harry S. Dent is one of the great business thinkers of our time, and I learned most of these points by listening to him and reading his books.

Random Notes

Analyst estimates, especially FWD EPS estimates, should be looked scrutinized for (likely or unlikely) accuracy.

If a company warns two-consecutive quarters in a row and is selling stock at the same time the overall economics of the business and management’s honesty should be questioned.

The discrepancies existing between the lowest and highest FWD sales and earnings figures should be examined. If a large spread exists then you’ll have to figure out which range is more likely based on your own DD. Taking into consideration how many times the Street has been “surprised” (either upside beat or downside miss) by the company in recent quarters, you might be able to draw parallels as to how much the company will beat/miss in the near future, and thus be able to arrive at a less narrow range of estimates that those put out as a Street consensus by analysts.

Near expiration options which lie close to an earnings call are often too pricey due to the fact that the options market factors into them an anticipated acceleration in volatility in the immediate future. And you might bet the wrong side, or you might bet on the right side but the movement might take longer than the amount of time remaining till expiration (thanks to the big boy hedge fund dudes and their crook MM pals and floor boys on the exchanges). Thus, longer term options (LEAPS) are more advisable, especially when you’re laying a large part of your portfolio on the line.