Misplaced Dominance

Twenty years ago this month, I packed up and moved to Tokyo, Japan when Morgan Stanley (MS) sent me over to help establish a beachhead in Japan and Hong Kong The Japanese economy and markets were the rulers of the roost across the global economy. The opening up of these markets to foreign brokerages was the biggest changes to the financial markets probably since the deregulation of fixed commission in the US markets several decades ago.

MS sent me out for “1 year” and after being there for 3 months wanted me to commit for 2 years. So, I had to adjust my own personal agenda and my wife and I got married in August 1987. We had a delayed honeymoon in November which we took in Bangkok and Phuket, Thailand (before both became popular). In Phuket, at the Club Med we had dinner with 3 other couples – one couple each representing Canada, Australia and the United Kingdom. The discussion turned to the dominance that Japanese companies and individuals were developing over the global economy. The other couples were convinced that Japan would gain control over the world’s economy. I disagreed. I said that if we sat around the same table 10 years before that, the same would have been argued about the OPEC nations with their petrodollars. Perhaps before World War I, the same might have been argued about the British Empire. And so it goes.

Now the same discussion is centering on China. Time and time again, a country’s economy finally begins to emerge and grow at a tremendous pace. These economies will attract and amass huge amounts of capital leading one to the incorrect assumption that they will dominate. On many occasions, the explosive growth is unsustainable and sometimes results in a contraction as we have seen in Japan for the better part of the last 15 years. Japan’s problems and mistakes were too numerous to mention in short order in this blog right here and now. Sometimes, those economies need to grow and fill a void left by the rest of the world. Many might have argued that the US grew too fast after WWI. That has been anything but the truth. However, we did have an awful depression in the 1930s. Considering an economy like China with well over 1 billion citizens, I have to conclude that there is more growth in its future and we are in the early stages of such growth. There will be some volatility along the way. On the other hand, as we saw with Thailand in the 1990s and now with Vietnam, such growth is speculative and unsustainable.

Global Warming ?

Whenever I hear discourse about global warming in the media I don’t ignore the message but I have to chuckle a bit. If I recall, the Earth has been warming since the ice age ended millions of years ago. When we had one of the warmest months on record recently everyone was pointing to global warming as the culprit. Now that February is colder by several degrees than usual, where are the global warming alarmists? To top it all off, it snowed in Katmandu for the first time in 63 years. Let’s not also forget that global cooling can also occur. If you ask me, we need to point fingers at iced tea which may be the culprit for all weather variations and problems.

My Thoughts On The Housing and Sub-Prime Mortgage Debate

Here are some of my thoughts on the very intense and emotional debate continuing on the subject of the housing market and sub-prime loans:

Housing is going to crash. Our society will soon be living in cardboard boxes. No wait, housing has bottomed and is getting better. Never mind, sub-prime foreclosures will be creating plenty of inventory for the Toll Brothers (TOL) homeowner-wanna-bes. I better check the housing blogs and chat rooms to be sure of what the real story is.

Hasn't this housing debate become more heated than a judicial appointment on Capitol Hill? It sounds like my children arguing over who gets to pick the movie we watch from On Demand. I prefer to take the higher ground. Here is what I think:

· Housing overheated about two years ago (as does any asset class that tends to attract too much speculation). The margin morons got into the real estate game and that signaled a top.

· Homebuilders recognized that:

· They needed to shrink inventory in speculative hands and slowed down construction to absorb the oversupply.

· They held too much land or land options in areas in which land was plentiful and needed to adjust and write-down accordingly.

· Housing is regional, not national. You can't compare housing in Florida or Las Vegas or Phoenix with that in suburban Chicago or New Jersey or Metro DC.

· The secondary market for housing is still strong where the jobs are. Take a look at the towns located along the Metro North or NJ Transit Midtown Direct commuter lines to New York City. New homes are being built out further on those lines and I don't expect that to diminish until all that land is built on. If the Midtown Direct could expand to Phoenix, that would be another story.

· A surge in sub-prime housing was created as:

· Hurricane relief brought a huge surge in demand for lower income sub-prime housing such as trailer homes and lower income private homes.

· Improved financial, infrastructural and crime conditions in urban centers combined with government tax and other incentives have created a environment conducive to inner city lower income single family home construction and purchasing.

· Increased employment pushed more people from rental to home buying on the margin.

· Homebuilders are in the "kitchen sink" part of the cycle in which they will write-down, sell off and reserve as much as they can. Throwing everything into the kitchen sink comes at the bottom, not the top, of a cycle.

· Our population is growing by 3 million to 4 million people per year. That amount is likely to increase, not decrease, as we age and immigration continues. Where are they all going to be housed?

Think about all the above when we consider KB Home (KBH), which is reporting. To be fair, I have a buy-write on Hovnanian (HOV). When I put it all together, I see a mixed bag -- some good, some bad -- and we may be close or at equilibrium. The top of the housing market is behind us. The bottom is here or near but those betting that the worst is yet to come will be proven wrong. What we are not at the bottom of, but are near the top of is the emotion attached to the housing and mortgage market.

Epilogue: KBH reported its 4^th quarter results. My thoughts of the earnings report and conference call is summarized below:

You cannot characterize KBH’s quarter as pretty. Cancellations are still running high even though management tried to put rose colored glasses on the fact that they seemed to decline sequentially. Gross margins were putrid. As always, we need to look forward not back. The two most informative parts of the conference call came from the peek in 1q07 and the Q&A with Ivy Zelman. So far, if the traffic and sales for 1q07 is only of about 10% then one can argue that the deterioration in the housing market is slowing down and that the worst may already have occurred. The interaction with Zelman on sub-prime was interesting. It confirms my belief that sub-prime housing is a category onto its own and is also part of the localized nature of real estate. I would expect homebuilders to begin to abandon certain states that are in secular economic decline, such as Michigan and Ohio, while waiting out the storms in Phoenix and Las Vegas.

Favoring the housing bulls is the fact that this quarter was definitely a "kitchen sink" quarter for KBH. They tossed so much out the window as part of the company's impairment and write-down that you know that the company is cleaning up the balance sheet and getting ready for the next upturn in the market. When you back out the impairments and write-downs, KBH earned about $2.26 down 34% year over year, which was less than the drop in cancellations. Furthermore, revenues rose 13% and ASPs increased as well, another point for the bulls.

My opinion is that the cyclical decline in housing is near or at an end. Furthermore, the big meaty shorts trades have already been booked. We will continue to have a high level of volatility in the sector and more trading opportunities will present themselves as the sub-prime, housing and interest rate dramas continue to unfold. The next step for this sector is going to be takeovers especially if the bears continue to push shares lower.

Finally, KBH has its own specific issue of the departure of a respected CEO and the ascension of a new individual to that role. That is always a risk for any stock. I am maintaining my positions in HOV for now.

At the time of this Blog entry and the Street.com articles, Scott Rothbort, his family and or clients of LakeView Asset Management, LLC was long shares of HOV and short calls of HOV -- although positions can change at any time.

Five Business Hookups You Might See

This column was originally published on The Street.com’s Street Insight on Jan. 11

All too often, the media and investors merely speculate about potential takeovers and start rumors. I, on the other hand, prefer to contemplate what would make a nice corporate match in a Yenta the Matchmaker-type way.

Here is my list of five mergers and acquisitions that make sense to me -- with the reasons why, and the reasons why they might not happen:

1. Sears Holdings (SHLD) to acquire warehouse retailer BJ's Wholesale Club (BJ).

Why it makes sense: Sears still has underperforming stories -- or Kmart-Sears stores that are cannibalizing one another -- and it's in the process of transforming them into new concepts or selling off their real estate. BJ is dwarfed by Costco (COST) . Sears can buy BJ and expand BJ, utilizing those superfluous Kmart-and-Sears stores to capture more of the fast-growing warehouse business from Costco and Wal-Mart's (WMT) Sam's Club. Currently, BJ's market cap is just under $2 billion. Sears has the cash and stock currency to easily pay a 20% premium to BJ shareholders and still make an accretive acquisition.

Why it might not happen: Sears' Eddie Lampert is focused on improving the merchandising in existing Sears stores and continues to experiment with new concepts such as in the Gwinnett Place Mall.

2. Morgan Stanley (MS) to acquire an investment adviser: Legg Mason or T Rowe Price (TROW).

Why it makes sense: The missing ingredient in MS' mosaic of businesses is asset management, and it's a glaring hole. MS must make inroads into this segment if it truly wants to compete with Merrill Lynch (MER) and Goldman Sachs (GS). John Mack brought in James Gorman from Merrill a few years ago, and he would be the right person to spearhead this effort.

Why it might not happen: Mack is still focused on rebuilding MS from the ruins left behind by Phillip Purcell. Furthermore, MER has already picked off the best of breed when it acquired a 49% stake in BlackRock in an asset-for-stock swap last year. Biting off LM or TROW will come at a heavy short-term price because it won't come cheap. It will be dilutive for many years.

3. Hewlett-Packard (HPQ) to acquire Palm (PALM).

Why it makes sense: Hewlett-Packard failed in its early attempt to deliver a handheld PDA several years ago. Palm has an excellent device with the Treo line of smartphones but is now facing brutal competition from Research in Motion (RIMM) and Apple (AAPL) in the consumer segment. Hewlett and the other Microsoft (MSFT) Windows-based computing companies are also facing stiff competition from Apple as the iPod halo effect continues to attract users away from Windows to Mac. A combination of Hewlett-Packard and Palm would help to energize Palm and give Hewlett another key technology to combat the ever-growing Apple. Palm needs some strong marketing and logistical expertise, which Hewlett can offer. Lastly, Hewlett can swallow up Palm for pocket change.

Why it might not happen: Hewlett-Packard might be twice shy about getting into the PDA/smart-phone business. Furthermore, HPQ is still reeling from a recent management shakeup in the wake of an ethics scandal and threats of criminal indictments.

4. General Electric (GE) to acquire Alcoa (AA).

Why it makes sense: Sure, there are rumors of an AA takeover or leveraged buyout, but those rumor-mongers are looking at the wrong suitors. Don't let one good quarter from AA fool you. This is still one of the worst-run companies in the U.S. GE is one of the best companies at managing industrials in the history of business. That is what AA needs. There is nothing fundamentally wrong with the aluminum business -- it's just that new leadership is necessary.

GE is in the process of selling the plastics business, which is a tough industry. GE can easily use the proceeds of the plastics sale to buy AA, although it has plenty of resources without the plastic sale. The deal would be immediately accretive to earnings.

Why it might not happen: GE is simply too big and may be looking to slim down rather than add on. There are other businesses beyond plastics that the company also needs to make some decisions about, namely NBC Universal.

5. Boeing (BA) to merge with or acquire Ford (F).

Why it makes sense: This sounds like a real wacky match, but the more I think about it, the more it might make sense. So hear me out. Airplane, defense, automotive and truck manufacturing all require similar (but not necessarily the same) raw-material inputs and parts. Thus, a combined manufacturing effort would have economies of scale in terms of component and material purchasing. Make the deal subject to a one-time, take-it-or-leave-it labor agreement, focusing on pensions and benefits. Get rid of the defined benefit programs. Ford Motor Credit and Boeing Capital can create a very powerful financial-services company. Consolidate the overhead and eliminate other wasted costs. A healthy Ford without all of the recent write-offs can probably make $1.50 per share. If you clean up the balance sheet, it might be more. Heck, if done right, this could be accretive to Boeing.

Why it might not happen: It's just too complex. Expecting the United Auto Workers to cave in would be expecting a miracle. Furthermore, I doubt if the Ford family egos would permit losing control of a failing company to having a hefty stake in a healthy one. I believe that they think that they would be better off to rule in hell than serve in heaven.

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At the time of this Blog entry and the Street.com article, Scott Rothbort, his family and or clients of LakeView Asset Management, LLC were was long AAPL, GS, SHLD and BJ, with small legacy positions in COST and MS; long stock and calls -- MER; short PALM -- although positions can change at any time.

10 Things I Won't Miss About 2006

This column was originally published on Street Insight and was republished on TheStreet.com

Another year has passed. I hope that you are all a year healthier, wealthier and wiser. As I have done for each of the past four years and will do again by popular demand, I would like to share with you the 10 things that I will not miss about 2006 (and do not want to see or hear about ever again). So, in no particular order, here they are:

1. Long-running network classics.

I hate to say this, but General Electric's (GE) NBC Universal has to pull the plug on Saturday Night Live. The show is simply unwatchable. I don't know if it's the feeble writing, the weak cast or both, but the show has overstayed its welcome.

NBC is not alone in needing to jettison an enduring show born in the 1970s. If Howard Cosell were still alive, Monday Night Football would send him to his grave. The broadcast team in the booth is just plain awful. We don't need some Hollywood or rock-and-roll star joining in for a quarter's worth of banter. No wonder the ratings for this weekly sporting event hit an all-time low this season. (By the way, Disney (DIS) moved Monday Night Football from ABC to ESPN, in case you didn't notice.) I will be egalitarian in my desire to never again see an oldie-but-goodie network show. CBS' (CBS) 60 Minutes has also run its course. With deference to Morley Safer and the late Ed Bradley, CBS needs to put this show to rest. I understand that the network needs a time slot for CSI: Sheboygan.

2. Microsoft (MSFT) Vista.

The coming of Vista has been as over hyped as the coming of Comet Kohoutek in 1973. Of course, as soon as Vista does get released -- wake me up when it happens -- then we will have to listen to the never-ending coverage and hype for the Yahoo! (YHOO) release of its Panama advertising system. I have the solution for all of this hype: Apple (AAPL) and Google (GOOG).

3. Celebrity babies.

I could care less about Brad and Angelina's baby, Tom and Katie's baby or Kevin and Britney's baby. Once they give a darn about my wife and five kids, then maybe I will pick up one of Time Warner's (TWX) People magazines.

4. Soft landing.

I did not know that the economy had hemorrhoids.

5. Dire consequences of an inverted yield curve.

Anyone who believes that an inverted yield curve at low levels of nominal interest rates is a sign of impending recession must still believe in the Phillips Curve. I believe that the Phillips Curve is a flawed concept. We need to understand how the yield curve is constructed. Earlier this year, I wrote the following:

"The yield curve does not worry me. The FOMC controls the short end of the curve; the marketplace controls the longer end. Now more than ever, the more expansive holding of U.S. dollars by foreign central banks is creating increasing demand on the longer-maturity U.S. government debt instruments. Thus, the yield curve is flattening out and to some extent inverting. The shape of the yield curve will no longer only be reflective of perceived economic conditions but will also include the impact of central banks on the U.S. dollar and their appetite for Treasury securities. While I hate to use the term 'new paradigm' and will not, I will say that we are going from a single variable yield curve to a multivariable model. We need to understand and respect that."

6. Monthly same-store-sales comparisons.

This is without a doubt the most overexposed metric of the year. (See No. 8 in last year's list for my rant on the subject of overused metrics.) My research indicates that while same-store sales are a factor in retail and restaurant earnings, they are not the sole determinant. Furthermore, margins are more important than same-store sales in determining profitability. Take Sears (SHLD), for example: Same-store sales were engineered to decline while the company focused on selling more profitable products. Shareholders are better off for that effort. We also need to wean the market off monthly sales data and move to quarterly sales reporting as several companies, including Men's Wearhouse (MW) and Yum! Brands (YUM), have done recently.

7. Body art.

I think that's an oxymoron. I'm disgusted whenever I see tattoos and body piercing. What really gets my goat is seeing it glorified by athletes and movie stars. This stuff is ugly and permanent. If you want to adorn your body, might I suggest a few shirts from Ralph Lauren (RL) or some jewelry from Blue Nile (NILE)? Those are far more attractive options than tattoos and body piercing.

8. Bad Starbucks (SBUX) jokes.

It seems that every two-bit stand-up wannabe comedian has some bad Starbucks joke. You know like: "Why is there a Starbucks on all four corners? So that people with Alzheimer's can find one." I don't want to hear another comedian say, "I will have a grande mocha latte capudrinko." That said, if you own Starbucks, this is great. Free advertising! So if I may suggest some new targets for comics' material in 2007, how about some McDonald's (MCD), Ruth's Chris Steak House (RUTH) or Taco Bell (a division of Yum!) jokes? Something like: I'll have a taco, hold the E. coli.

9. OTC bulletin-board solicitations.

My email and fax machines are increasingly being stuffed with stupid OTC BB ideas. The emails manage to get through spam filters, and you can't have your address taken off the distribution list. Cagey mongrels, these folks. Maybe some smart software vendor can find a solution to that problem.

Where is the SEC when we need them? How many people are losing hard-earned money by falling for the OTC BB rags-to-riches pitch? I bet many more than are being hurt by hedge funds. Instead of raising the minimum net-worth level for investment in hedge funds, how about if the SEC raises the minimum net-worth requirement for investing in OTC BB stocks? That would send those purveyors of dreck right back to the caves from which they came.

10. OPEC.

This group of nations cheats on one another more often than Tony Soprano cheats on his wife, Carmela. OPEC lies with the same alacrity as Tommy Flanagan back when SNL was quality entertainment. (See No. 1.) Yeah, that's the ticket.

My best wishes for a happy and healthy holiday and New Year season to all of you and your families. Thank you for your personal notes and professional advice during the past year. I hope our Street Insight team has made this year a profitable and enlightening one for our subscribers. Last but not least, thanks to our tireless contributors and editors who work so hard every day to produce this fine product.

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At the time of this Blog entry and the Street.com article, Scott Rothbort, his family and or clients of LakeView Asset Management, LLC were long shares of Apple Computer (AAPL), Google (GOOG), Sear’s Holdings (SHLD), Men’s Wearhouse (MW), Ralph Lauren (RL), McDonald's (MCD), Yum! Brands (YUM) and Ruth's Chris Steakhouse (RUTH) although positions can change at any time.