The average American used to be able to work on his own car or truck. There was enough room under the hood to use a wrench and remove things like starters or adjust the carburetor. Since much of the car was mechanical, you didn’t need electronic diagnostic equipment to figure out what was malfunctioning. All it took was an occasional owner’s manual, personal knowledge, standard tools and some experience. Those days are long gone and today’s vehicles are so sophisticated that the dealership or a trusted mechanic is your only choice at $80 per hour. It’s no wonder that dealerships make about 40% of their profits from parts and service.

I don’t drive very much since I don’t commute to work so maybe I am not an expert commentator. Cars have never been an important asset for me, but the automotive industry is extremely critical to what I feel about our economy. The hundreds of thousands of high paying jobs at Chrysler, GM, Ford and foreign brands building cars in American factories are immensely important, but the number of smaller companies and suppliers to this industry provide a strong framework for manufacturing in general. Previously, I have written about my concerns for the loss of manufacturing jobs in America and what I would like to see done to save Chrysler. However, when I look at the past 30 years and assess the state of the automotive industry, I am greatly disappointed to see how far it has eroded. I cannot help but wonder whether the added complexity of the vehicle has contributed to the demise. I have this strange notion that consumers benefit from personal involvement with the products they buy. When cars became too complex to work on, I believe pride in ownership has declined and along with it, so did the companies and their stocks. Obviously there are other key factors like labor costs and poor design, but I think there is something to this idea.

After buying my new personal computer last week, I thought a lot about the similarities between computers and cars. I was fine with the old computer and didn’t need all the stuff that Vista is supposedly going to do for me. I know it may sound like I don’t like progress but I just cannot make the tradeoff between something I was perfectly happy with before and a much more complex product that I find to be a giant pain in the ass. I have no problems with my Excel and Word versions from 2000 other than Microsoft wants me to pay more for new ones that are more compatible with Vista. Like the car with a bigger sticker price that gives me new technology I really don’t benefit from, this new personal computer is not much better. And as far as maintenance, that’s a similarity as well. I find it really insightful that Best Buy makes a ton of money from its “Geek Squad” when only a few years ago, most people did not have a problem buying a computer and getting it functioning at home. For me, the “Geek Squad” is like having to pay a mechanic to change your oil or adjust your car’s timing. Here’s a satirical post that sums it up.

In their pursuit of coming out with a new product to generate sales, Microsoft has given us Vista. I should spend more time with all the features I never needed in XP to find out the goodies I am missing, but all-in-all, I am disappointed. I think the personal computer for home consumers or small businesses have crossed the same line that cars did. I suspect that Vista may be appealing to some market niches that are computer geniuses or have corporate IT departments, but for the vast majority of users, I think they have just shot themselves in the ass.

There’s a huge buyout premium developing throughout the Biotech sector thanks to the AstraZeneca purchase of MEDI. As you know, I am not a fan of speculating on which company is the next target, but that strategy is working quite well right now so who cares what I say. Kudos to Carl Icahn once again but the price paid for MEDI was over the top. The company is now trading at a trailing 12 month PE of 300 and a forward PE of 70. It’s up 74% since I gave the UP signal on 3-19-07 and I say “congratulations” to anyone lucky enough to be playing along. However, that deal is done so making the next bet is another story. At a time when credible biotechs with multiple products on the market like AMGN and DNA are well off their highs and trading with valuations a fraction of MEDI, I get concerned with the speculative game on the rest of the sector. If you are a biotech with minimal sales and narrow pipelines, don’t fret. The market is bidding you up on the hopes that your unproven drugs will not have to make it past Phase 3 - just look like a target. When I looked through the charts this weekend, I was struck by the number of biotechs catching strong bids and I can only imagine what they look like after yesterday’s AZN/MEDI announcement.  I hate to criticize the momentum ride, but I strongly caution you to evaluate fundamentals before entering any new long positions.   I understand that big pharma needs products to move forward, but despite the broad-based lift in the sector, not every company will be acquired.  So if you get into this area, please pay close attention because if the momentum slows down, reality may set in and your shares may suffer.

Until the Nigerian election is resolved, the short term bearish view on oil I wrote about two weeks ago is no longer valid. Until further notice, I am bullish on oil prices.

For far too long, the world has largely ignored problems in Africa (Rwanda, Darfur, Nigeria, Congo, et al) and any efforts to intervene have been very ineffective. I won’t go into a political rant here, but when it comes to the oil markets - Nigeria has only been paid lip service in my opinion. If OPEC makes a quota adjustment, it gets a lot of attention. If Iran threatens supply interruptions or brags about its nuclear development, it gets a lot of attention. Yet, problems in Nigeria have been tolerated as if they were meaningless.  I don’t appreciate rapidly blaming things on race, but things like this certainly add credibility to those complaints.  Hostages were repeatedly taken and untold lives have been lost in the past but their impacts have been treated as a “so-what” by major media. With the weekend elections and the killings that have followed, I think that has changed.

Bloomberg interviewed Sebastian Spio-Garbrah of the Eurasia Group today and while I find his commentary to be excellent, I was struck by one of his blunt observations which I am paraphrasing: Authoritarianism would be good for Nigeria since it brings control to an economy that is 80% dependent upon oil. In a world full of oil producing countries controlled by dictators and authoritarian regimes, both sides of that argument can be made.  If you want a peaceful democratic government, you might want to push the need for better elections.  If your focus is on trying to keep oil supplies constant, you might be fine with an authoritarian.  I don’t want to compare the Nigerian government to the ones run by Prez. Chavez or Prez. Imanutjob, but it seems that the world accepts oil state dictators in exchange for the hope of less problems with oil supply and lower prices.  Dealing with them has been tough and unsuccessful.  However, getting rid of Saddam didn’t work out well either.  So take your pick but either way, much of the US and world fuel supply is determined by the decisions in these countries.  I’ve heard rumblings of $4 and even $5 gas this summer so if that is where the upper bar is being set, it won’t be long before consumers start their whining.

Many smarties have called a bottom in the subprime mortgage mess and the market was eager to believe them. Of course, the people being relied upon for this comforting message are the same who originally said subprime was not a concern. And along with their ignorance came another comment that really needs to be reevaluated. Remember when they said the problem will be isolated to subprime borrowers and it will not trickle into the prime category? Today is the first big shot across that bow - kinda like the one they ignored from HSBC to kick off the subprime fiasco. American Home (AHM) came out with a significant warning on earnings Friday (convenient that the market was closed) and it’s getting whacked today. UHOH!!! American Home is heavily involved in ALT-A loans and specifically mentioned their delinquency rates as a primary reason for the warning.

Between subprime and prime is the “ALT-A” category. These loans are those that do not satisfy the regular criteria for conforming or jumbo loan programs but are first lien mortgages to prime-quality borrowers. Many people know ALT-A by a slang term of “liars loans” because they do not require verification of the borrower’s income. But the key thing to understand is that there is very little difference in the credit quality between ALT-A and prime mortgages. So, now that we have AHM talking about weakness in ALT-A, you better believe this is a warning sign.

Despite what the same crowd who did nothing to warn you about subprime will say about ALT-A, it should not be ignored or downplayed. The consumer is in trouble and ALT-A is the last stop before we see more evidence in prime mortgage delinquencies. Just so you know, according to a February report by Banc of America Securities, ALT-A is 27% of the mortgage market, about twice as big as subprime. I recommend that you read this piece on the ALT-A subject and think about how you can manage your investments accordingly.

$55 to $84 million - that’s an estimate of Iran’s increased revenues from abducting the UK sailors over the past seven days. I compared each day’s close to last Wednesday’s close (before the abduction) and multiplied the increase in oil prices by the barrels per day (bpd) of Iran’s oil production. The range comes from the difference between its OPEC quota of about 4 million bpd and the actual shipments of about 2.6 million bpd. It isn’t fair or correct to assume that all the price differential over the past week was due to Iran, but I used it for the sake of this post anyway. Additionally, I had to assume that they were selling their production at spot prices rather than previously contracted amounts and that is oversimplifying things as well.

I am sure that the Iranians will have some costs associated with this maneuver but I just wanted to point out how much of an incentive Iran has to play war games with oil as its primary weapon. The past seven days was the proverbial “shot across the bow” in my opinion. I doubt it has much to do with mid-sea boundary disputes or trespassing or even making extra oil profits for Iran. Instead, Prez Imanutjob is sending a message to the Wicked Western World that this is a sample of what we will get by pressuring them. About 40% of the world’s oil is shipped through the Strait of Hormuz and whether we like it or not, we are at Iran’s mercy there. It’s easy for anti-Americans or anti-war activists to claim that the US government loves to go to war for oil. True or not, that’s the perception. Iran is just pushing those buttons and if they go to war with oil, the same crowds will likely find a way to blame the US for it. That’s just the way it goes. Until we do a better job increasing domestic supply, reducing our demand or developing an alternative fuel, this situation will not improve.

If you add up the market caps of New Century, Fremont General, NovaStar , Accredited Home Lenders you only get $1.4 billion. According to some strategists (aka - “bulls”) - the small amount of market cap that could be lost in these stocks somehow means that it’s no big deal. And if you don’t buy into that argument, there is always the other comment that subprime lending is just a small percentage of the overall mortgage market. Personally, I’m believing a range of 14% (Banc of America Securities) to 20% (Mortgage Bankers Association) but this process of identifying the size of the subprime market is very distracting. By trying to get everyone to adopt a small number, the bulls want you to believe that subprime is not a serious threat to the stock market or the economy. Of course, this is dangerously ignorant and there are multiple ripple effects from subprime that are woven throughout the markets.

It’s not satisfactory to limit the discussion to the smaller subprime pureplays like NEW, FMT, NFI or LEND - and it’s bigger than CFC or the problems at HSBC. Through GMAC’s subprime operations, General Motors will have an impact on its already strained financial outlook and General Electric’s WMC Mortgage unit, a top-ten U.S. subprime lender, said last week that it would cutback lending and fire 20 percent of its staff. But it really doesn’t stop there, subprime divisions became popular at quite a few companies when the housing bubble was throwing off huge returns. Morgan Stanley’s acquisition of Saxon last August might not turn out so great and Merrill Lynch’s $1.3 billion purchase of First Franklin Financial looks like it will be a charge to 2007 earnings compared to the original accretive claim. In addition to direct operating units, Wall Street firms have benefitted greatly from the securitization of these loans and from lending to them directly. So, I am looking forward to the earnings reports coming from Wall Street in the next week and will be paying a lot of attention to guidance from the impacts of subprime.

Subprime loans are sprinkled through portfolios at institutions like pension funds and insurance companies so let’s not forget them. And how about the rating agencies? When Moody’s and S&P start ramping up their credit downgrading activities for the impact of subprime mortgages, the effects will be hard to avoid. Moodys’ Brian Clarkson, co-chief operating officer denied that his firm has been slow to cut ratings but whether by intent or not, it just hasn’t happened very much. If / when it does, there could be a selling surge for anyone that cannot hold securities that are rated below investment grade.

A few months ago, the bulls said subprime was not a worry and now they are working hard to say it’s a bunch of small issues that will not materially affect the economy or markets. Meanwhile, subprime lenders are going bankrupt (click here for updates), their lenders are taking hits, delinquency and foreclosure rates are rising, and in the pursuit to identify the size of this mess, I think we are missing a much simpler assessment. The consumer is cracking. Up to 2 million homeowners might lose their homes and their difficulties will impact many other aspects of consumer debt from credit cards, to car loans to general spending. Maybe the loans will be absorbed and the earnings impacts will be hidden by performance in other areas, but no matter how I look at this - the problems just don’t disappear. I am going to hold off on more subprime posts because it’s getting enough attention in the media. But despite what you might hear elsewhere - subprime is not a small problem and it has ripple effects thoughout our economy and markets.

I was too busy today doing research on an upcoming post to express my opinion on the ridiculous reaction to the retail data. In my best “Tomnitz-ese”, the state of the shopping world “sucks.” But commentators suggested that no one should worry, they’ll do better next time and go buy some retail stocks even though you are clearly not buying enough at their stores. Once again, financial media puts a bullish spin on the story, keeps repeating the absurd weather excuse for retail failure, and then it becomes accepted as investing fact. Pathetic! Investors need to do better than listen to this crap and worse yet, buy these stocks.   It is supposed to be cold in February and if retailers aren’t expecting that, shouldn’t we be holding them accountable for being morons?  And how about those Wal-Mart numbers? Aren’t you getting tired of dealing with their sales guidance, revisions, and misses? I guess most investors don’t care very much since the stock has not suffered the usual consequences for unreliable guidance and has traded within 5% on each side of the current price since October. If Wal-Mart is the proxy for American consumerism - we are in trouble regardless of the temperature. Rather than going into a full rant, I am going to just defer to Barry Ritholtz’s post on the subject of retail sales as it could not be better said. Please do yourself a favor and click here to read the shopping list of excuses.

I’ve been intrigued by the moves in oil prices during the past week of declines in global stock markets. Usually, the stock market is affected by moves in the oil pits. Price per barrel goes up and investors fear that stocks will have downward pressure and vice versa. For the past 5 trading days, oil has been mirroring the moves in stocks based upon the fear that slowing global growth will reduce the need for energy. Based upon the Chinese premier’s comments yesterday, it is not irrational to expect less demand for oil or at least less of an increase in demand. Now that stocks are poised for a higher open and Asia had a one-day reprieve, oil will likely turn up today as well. Higher oil prices used to be a concern for stock markets, now it is a coincident occurrence. One of the anecdotal signs that I’ll be looking for to believe the stock market is getting back to “normal” is the inverse relationship between oil and stocks as it relates to the market’s perception of what should go up when the other is going down. Given that the S&P did well for the past four years while oil doubled in price, we know that longer term correlations are not strong. However, in the short term, perception is key and when oil stops fixating on global growth concerns and stock movements, my perception will change as well.

A month ago, the oil trading headlines were telling everyone that OPEC had no credibility and you should not care that they announced a supply cut (oil continued to decline.) Today, we are hearing headlines from Al-Naimi that OPEC is probably not going to make additional cuts for the time being and oil prices are declining on that as well. So which one is it? Do OPEC comments matter to traders or not? Fortunately, we don’t evaluate the credibility of oil traders or these conflicting comments might not be too impressive. One day the weather is too hot, the next it’s too cold. Too many hurricanes, not enough hurricanes. Driving season is a long way off, driving season is just around the corner, blah blah blah. Hopefully Senator Pete Domenici (R-NM) is paying attention so he can once-and-for-all get an answer to his question about who (what) sets prices in the oil market. Unfortunately, the truth is that the answer you get today is wrong tomorrow. But in the end - traders trade, OPEC produces and exports, consumers consume and in the midst of all the confusion a price is generated every day. OPEC matters when the traders say it matters and the same goes for the weather or any other factor affecting the assessment of supply and demand.

With EOP’s deal finally being done by Blackstone, it’s time to state the obvious - I have been mostly wrong on the REITs. Right now HEDGEfolios has about 25 of the 130 REITs with UP signals and clearly, that has not been enough. I still don’t see them as good entry points for both fundamental and technical reasons so it’s likely that I won’t change anything at this point.

Blackstone’s initial offer had implicit cap rates at about 6% and with the Vornado bidding war, the final figure is closer to 4%. While 6% was consistent with some other deals, the premium on “the largest LBO in history” seems over the top. Regardless, the bigger factor for me to consider is the new metrics that are being applied across the REIT universe. As is usually the case, the entire sector is getting bid up based upon EOP’s deal so I am spending a lot of time trying to figure out whether my analysis still holds or whether I should cave in and jump on the bandwagon.

One of the things that keeps coming up to justify higher REIT prices and private equity premiums is the replacement cost, but unless you are an expert on real estate construction, it’s tough to make those kind of assessments. Cohen & Steers, EOP’s largest shareholder, had insisted that replacement cost was equivalent to $60 per share and they did a good job getting close to that figure. I have no idea how to estimate replacement costs on other publicly traded real estate and prefer analyzing Net Asset Values estimated by research firms that specialize in this area. One source is Green Street Advisors who said REITs currently trade at a 7% premium to their underlying property values. That’s not historically high given that the premium was 33% in 1997 before the slide in REITs (1998 to late-1999) when they leveled off at a 20% discount to NAV.

The primary reason I don’t like this sector at these prices has nothing to do with steel, brick and mortar - it has to do with the cash flow valuations. Specifically, the multiples being used today are not consistent with historical norms for this sector. According to Invesco’s excellent report, REITs were trading at 10.6 times Funds From Operations (FFO) in 1994 and they are now almost twice as expensive with a Price to FFO multiple of 18.5 (12/2006.) While the S&P PE has declined since 2000, the P/FFO ratio has risen dramatically and is significantly higher than its 10-year average of 12. Having REITs trading at a premium to market multiples seems unlikely, but that is what we have now. In fact, if you do a derivative of the PEG ratio for REITs, you’ll see a “P/FFO to Growth Ratio” of 3.08.

If you don’t trust those measures, just look at REIT dividend yields compared to the 10-year Treasury. Since 1994, REIT yields on average have traded at a 120-basis-point premium to 10-year U.S. Treasury bond yields and over the past 10 years, it’s 142 basis points. Currently, the average REIT yields 3.78% according to NAREIT, about 100 basis points lower than the Ten-year Treasury note of 4.75% (they have never been this low on a relative basis). The last time REITs had payouts less than Treasuries (1998) they fell 17%. Lastly, over the past 15 years during instances of flat or inverted yield curves, REITs have underperformed the S&P 500 by about 15 percent. No matter how you look at the relationship between Treasury and REIT yields, it’s not good.

Historically, REIT yields have exceeded the S&P 500 yield by several hundred percent with some periods having an 800 bps spread. The current average REIT yield of 3.78% is still more than twice as high as the average stock in the Standard & Poor’s 500 with yields of just 1.8%. However, the current REIT yield is half the 8% it paid in 2000 and well below the 10-year average of 6.26%. With typical FFO and dividend growth rates of about 6%, it’s tough to see the yield improving substantially unless the REIT share prices decline. I am not saying that I expect prices to drop precipitously and immediately, but the odds that the market will be able to ignore the factors I mentioned in this post are very poor. So if you insist on speculating on the REITs, make sure you consider the individual stock and its:

• Premium or Discount to NAV,
• Price to FFO multiple,
• Dividend Yield vs. S&P 500 Yield, and
• Dividend Yield vs. 10-year Treasury.