With all the opinions swirling around on health care reform, I thought it would be interesting to assemble some prominent quotes with just a bit of commentary.  Readers of the free ZachStocks Newsletter have seen some of this material but it seemed appropriate to discuss on a broader level.  Since the situation is developing, please check back for updated content and additional health care reform quotes.  Also, please leave your comments with quotes you have found or opinion on specific health care reform initiatives.  So without further adeu, here are the talking points from both sides of the Isle.

Barack Obama:

We will pass reform that lowers cost, promotes choice, and provides coverage that every American can count on. And we will do it this year.

It sounds noble, but health care is in many ways a commodity that cannot be made more available, at a lower cost without someone picking up the tab.  This is why so many are worried about the ultimate cost of this measure as it relates to the working taxpayer.

Rep. Tom Price (R, GA)

Thursday, the Republican Study Committee has introduced legislation to positively reform our health system. The Empower Patients First Act relies on the principle that, by increasing patients’ control over their health decisions, we will make coverage more affordable, accessible and responsive, while offering more choices and the highest-quality care.

The Key point for conservatives is offering a market based approach that keeps the government from seizing control over how health care decisions are made.  Both sides claim they offer consumers choice and control.  One side has a bit more credibility.

Nancy Pelosi

I think it is pretty clear that we want a strong public option in the legislation. Insurance companies full force carpet-bombing and shock and awe against the public option — so much so that the American people doubt the plan or are uncertain about it, until you tell them what is in it.

It’s a bit disturbing how anti-business some on the far-left can be.  While insurance companies may need to make some changes, trusting a government institution to efficiently dole out health care is even more disturbing.  In my opinion the American people doubt the plan much more after they are told what is in it!

Clifford S. Asness, Ph.D.

There are large groups of people in this country who want socialized medicine and they sense that the stars are aligning, and now is their time to succeed.  They rarely call it socialized medicine, but instead “single payer health care” or “universal coverage” or something that their public relations people have told them sounds better.  Whatever they call it, they believe (or pretend to believe) a lot of wrong?headed things, and they must be stopped.

Readers of the ZachStocks Newsletter received a link to the most recent essay from Dr. Asness this morning which dispels many of the myths surrounding Nationalized health care.  While it may seem to the untrained eye that experiments in such a system have been successful in a few countries, the natural economic laws require some free market country to make innovative discoveries – otherwise the quality of care will quickly deteriorate.

John Oxendine

Their proposal would virtually devastate the private healthcare sector in this country along with competition and patient choice, by replacing it with bureaucratic planning and government control. The result of this plan and its one trillion dollar price tag will bring harm to those the president and Congress are ostensibly trying to help.

It’s amazing to see the law of unintended consequences at work.  You would think that a governing body like Congress would have enough foresight to be able to understand the long-term ramifications of such a plan.  At the same time, the American public is speaking out loudly in opposition to this bill.  What would drive politicians to continue to push for something that could cause irreparable damage and is not wanted by the people?

As a reminder, there will be more health care reform quotes posted in the coming weeks so please continue to check the link and feel free to discuss or point out additional quotes of interest.

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Some of the best performing stocks this year have been Chinese online gaming companies.  Established stocks like Shanda Interactive (SNDA), and Netease.com Inc. (NTES) have generated significant profits for the ZachStocks Growth Model, and the newly issued Changyou.com Limited (CYOU) offers potential for a new position in the near future.   The majority of Changyou.com is actually owned by Sohu.com Inc. (SOHU) who controls 68.5% of the company.

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This week has been volatile for the China gaming companies as both Sohu.com and Changyou.com announced earnings.  The numbers for SOHU came in above Wall Street expectations and above company guidance while Changyou.com reported very close to inline with expectations.  However, both stocks traded lower as CYOU announced that they would be delaying the launch of three new games.

The martial arts game “Duke of Mount Deer” was expected to be available in the fourth quarter of this year but now appears to be pushed to the third quarter of 2010.  ”Immortal Faith” was expected to already be live, but will now be released in the first quarter of 2010.  Finally, the fantasy game “Legend of the Ancient World” appears set for release in the second quarter of next year.  While it is disappointing to see these names be pushed back a bit, keep in mind that we hav historically seen successful games have profitable lifes of several years so it is probably worth a delay in order to make sure the quality will support an extended life cycle.

For the second quarter Sohu.com earned $0.89 per share, and analysts are expecting full year earnings to reach $3.72.  Looking towards 2010, earnings are expected to come in at $4.16 and yet the stock is only trading in the low $60’s.  The price represents a meager 15 times expected 2010 earnings.  At the same time, CYOU is trading more than 20% below its recent high, in the mid to high $30’s.  This, despite the fact the company is expected to earn $2.72 this year and $3.25 in 2010.  For the amount of growth we are seeing in these stocks, I am a bit surprised the multiples aren’t in the low to mid 20’s.

Gaming growth may be lighter than in 2007, but is still robust and predictable

Looking at the industry, there is significant historical growth which is expected to continue over the next several years.  While we may not see 70 or 80% industrywide growth, expansion in the high teens to low 20’s (as an annual growth percentage) is actually fairly impressive.  It may be that investors are disappointed with the slower growth rates, but considering the overall global economic picture, this industry is more stable and offers more growth than we can see in many other areas.

The recent weakness in these two stocks may turn out to be a great buying opportunity.  SOHU is also getting some bad press because of the weakness in its brand advertising business.  It is clear that this part of the company is under pressure as ad spending has been soft.  Yet, the majority of future growth will likely come from the gaming side, and there may be an opportunity for SOHU to spin off the less exciting business or sell it  to a more competitive player like Baidu Inc. (BIDU)

Options on both CYOU and SOHU are relatively pricey due to the high level of volatility.  As a short-term investment, one could currently buy SOHU at $63.30 and sell the September $65 calls for $3.70.  This gives you an 8.5% return in seven weeks if the calls are exercised, and gives you a bit of protection if SOHU trades lower.

Similarly, one could buy CYOU for $37.35 and sell the September $40 calls for $3.00.  If the calls are exercised the return is 15% in just seven weeks and $3.00 of protection on this stock is helpful as $35 looks to be a pretty firm support level.

Covered call writing is a great tool that we use at my firm Sound Counsel Investment Advisors in order to mitigate some of the risk and increase income.  Depending on your risk tolerance, tax status and other factors, it may be an attractive way to reduce risk in your portfolio.  But when trading options, you must understand the benefits and drawbacks in order to determine if the process is right for you.  Please email me if you would like more information on this investment process.

The Chinese online gaming industry is evolving fast and finding new attractive ways to generate profits.  At this point it appears we are far from market saturation but quality games will end up taking the lions share of gamers attention.  So it is important for CYOU to create a quality product, and then market it skillfully to reach the broadest audience.  I think that the talented management team is up for the task.

FD: Author has a long position in SNDA and NTES in the ZachStocks Growth Model

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It’s a busy day for the Commodity Futures Trading Commission (CFTC) as testimony is heard regarding the controversial proposal to limit position sizes on all finite commodities.  The two primary investments affected by this discussion are IntercontinentalExchange (ICE), CME Group Inc. (CME).  Earlier this month, ZachStocks discussed how further limits to position sizes could have unintended consequences and actually increase volatility instead of helping to stabilize wildly swinging markets.

Jeff Sprecher, the CEO of IntercontinentalExchange voiced a similar perspective in his remarks to the committee today:

While well intentioned, these measures often fail to achieve their desired objectives or, worse yet, lead to unintended consequences … that would otherwise be discovered in properly operating markets

The primary evidence presented by the pro-regulation side of the argument is the drastic swings in energy prices over the last 18 months.  But extreme volatility in energy markets is much more affected by economic concerns (which have been more volatile in recent quarters than any time in the last 70 years) than by manipulative trading practices.

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Consider the “peak oil” arguments from just over a year ago.  Oil companies were finding it more and more difficult to produce oil and natural gas with the same cost structure.  As low hanging fruit (or easy to drill fields) were slowly bled dry, the cost to discover and produce each marginal barrel of oil (or gas equivalent) was rising.  Technology advances and alternative energy helped to offset this some, but the evidence pointed to rising costs (and therefore higher prices) for traditional energy sources.  It was only natural for energy prices to skyrocket.

Then came the most devastating global economic recession seen in decades.  Growth assumptions were severely cut (partly as a function of higher prices of commodities such as energy – and partly because of unsustainable growth assumptions in the first place).  As consumption, and by extension the future estimates for consumption, dropped, the price of energy products came crashing back to earth.  Fundamental economic laws state that when demand for a product decreases, the price will naturally fall.  So once again, the price of traditional energy products declined sharply – but more as an extension of global economic forces than due to “evil speculation”

Now I’m not claiming that prices are always accurate or that traders had no part in pushing prices higher or lower.  But an active market with heavy interest on both the buying and selling side will by definition lead to efficient prices given the information that is available at the time.  Traders with keen foresight or better information need only to take the other side of a trade in order to profit from their perception (from both a long-term and a short-term perspective).  So if prices really are out of line with reality, then it would behoove a large trader to begin building a large position which will profit when prices move back to sustainable levels.

CFTC Chairman Gary Gensler stated that Congress should move “urgently” to prevent market players from moving to the over-the-counter (OTC) market or to foreign exchanges.  Yet, increasing regulations by capping position size will likely create an even greater incentive for participants to create their own “side bets” or off-balance sheet agreements in order to profit from price movements, or hedge financial risk.

The assumption that the government can accurately determine value or steer prices towards a “correct” range is absurd.  While it is important to make sure that one player or group of players cannot buy up all of the supply and then hold resources hostage (known as “cornering” a market), the oil and natural gas market is large enough to make this virtually impossible.  Instead, regulators appear to be using fear as a tool to argue for heavily regulated markets.  The anti-business, anti-capitalistic bent of the current administration is sobering and could cause much more harm to free markets and economic growth.

FD: Author has a long position in ICE in the ZachStocks Growth Model

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Solar stocks were up in unison Friday after an earnings announcement from SunPower Corporation (SPWRA).  The company not only beat estimates for its second quarter, but also gave encouraging guidance for the rest of the year.  Revenue came in at $298 million which is up roughly 40% from the first quarter, but still well below the level seen last year when solar stocks were in vogue.  Analysts had been expecting revenue of $263 million so the report was certainly a positive surprise

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Earnings were also much higher than expected, coming in at $0.24 per share versus the $0.14 expectation.  Part of the strength was due to the mix of business as the company saw a 76% increase in module sales (as opposed to full solar systems).  During the quarter, SPWRA was able to significantly reduce its inventory levels which had been a major concern for investors.  The inventory days (number of days it would take to sell all current inventory) was cut nearly in half which puts SunPower in a much more flexible financial state.  It is expensive to be carrying so much product, and usually results in lower pricing power which has plagued the industry in recent quarters.

While many solar investors concentrate on companies serving China, SunPower operates primarily in the United States and is much more active in the rooftop segment as opposed to more extensive ground based installations.  At this point, SPWRA appears to be in the sweet spot as the larger installations are still taking time to plan and build.  However, funding appears to be in place to provide incentives for rooftop installations which have been picking up in sunny parts of the US.  If this particular portion of solar energy continues to shine (pardon the pun) we could not only see more units sold, but more importantly, the sharp slide in pricing could be muted which would lead to better profitability.

According to Thomson Reuters, the average analyst forecast for earnings in 2009 and 2010 are set at $0.95 per share, and then $1.74 next year.  While these numbers are relatively impressive (given the difficult market and continued concern over excessive industry inventory), some analysts are beginning to raise their expectations.  Ramesh Misra at Brigantine Advisors recently upped his 2009 estimate to $1.25 and expects 2010 earnings of $2.42.

If this estimate is close to being correct, and the market  places a relatively reasonable multiple of 20 on this dynamic growth stock, investors could quickly see the stock close to $50.  While that price is a far cry from the euphoric $150 we saw at the height of what can only be described as a solar bubble, a price of $50 would still represent a 60% gain from current levels.

Looking at the financial strength of the company, it appears that SunPower has its act together.  During the second quarter, the company was able to raise $450 million by selling equity and convertible debt.  This is an excellent demonstration of the liquidity and capital which is once again available to functioning and profitable solar companies.  While the convertible debt will certainly carry its price tag of interest expense, the flexibility which allows SPWRA to invest in its business and maintain healthy capital ratios will pay off for shareholders.

Within the industry, many solar stocks have responded positively to the news.  The ZachStocks Growth Model has positions in First Solar (FSLR), LDK Solar (LDK) and Yingli Green Energy (YGE) – which are showing unrealized gains of 36%, 75% and 123% respectively.  While all three of these names have yet to report second quarter earnings, the positive news out of SunPower has the entire sector trading higher as investors expect similar results from competitors.  A word of caution is in order because there could certainly be differences in how each individual company is operating.  Political, geographical, and operational differences will cause each stock to behave a bit differently so investors would do well to avoid lumping them all together in the same broad category.

Still, the picture for solar producers is getting clearer and as the industry works through excess capacity and demand begins to pick back up there could be opportunities for significant further gains.

FD: Author has a long position in FSLR, LDK, and YGE in the ZachStocks Growth Model

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Interactive Brokers (IBKR) reported earnings late last week and although both revenue and EPS were both below levels from last year, the stock shot up 10% on Friday.  For the second quarter, revenue was $332.1 million compared to $395.5 million in the second quarter last year.  But since analysts were only expecting $274 million, the number was considered impressive.  On a similar note, EPS came in at 31 cents for the quarter compared to $0.44 last year.  But the figure beat estimates by 2 cents.  The move shows just how quickly stock prices can rally when depressed expectations are beat.  Many CEOs have taken advantage of  this phenomenon by employing the “under promise, over deliver” stragegy.

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Looking deeper into the numbers, IBKR has built an impressive business platform with an impressive market making segment as well as one of the most attractive brokerage platforms available to both individuals and institutions.  The market making business saw income rise from the first quarter which makes sense given the rebound in equities and more predictable trading during the second quarter.  Still, this business was lower than last year which is most likely a function of fewer market participants as many of the larger hedge funds and active traders are either dealing with smaller orders, or have been wiped out completely.

IBKR has stuck with a more traditional approach in this business, making markets in exchange traded products which are cleared products.  This means that countperparty risk has been minimized and it is unlikely that the company could be caught in a situation where a trading partner would default on the other side of a trade.  As markets have become more liquid, the bid/ask spread has contracted making profit per trade relatively low.  But the risk for trades in this environment is also much lower.

The brokerage side of the business has performed very well due to strong growth in the number of accounts.  As retail investors are taking more ownership of their investment process, the discount brokerage has attracted a good bit of capital which appears to be trading relatively actively.  Compared to last year, the number of customer accounts has  increased by 18%, and the number of Daily Average Revenue Trades (DARTs) was up 11% to 317,000.  If the company is able to keep these trends in place, it certainly points to better profitability in coming quarters.

At this point, analysts are expecting 2009 earnings to come in at $1.27 for 2009 which is down 42% from earnings in 2008.  While this is disappointing, many other brokerages are facing much larger challenges in posting profits, or have even closed up shop or been acquired.  Next year earnings are expected to rebound to $1.88 per share although it is difficult to put too much confidence in these numbers.  After all, who really knows what volatility will look like over the next 6 quarters or whether we will see another major disruption in the markets.

Still, at current prices, it appears investors are pricing in a worst case scenario and are paying little attention to the potential growth of this dynamic company.  The fact that IBKR remains profitable and is growing customer accounts during this difficult period certainly points to strong potential for growth over the next several quarters.  As long as the market making segment does not experience a sharp loss, we can expect the company to maintain current profitability levels as a worst case, and potentially grow by double (or even triple) digits.

The ZachStocks Growth Model took a position in the company too early – buying at $17.99 in January.  Although the ride has been volatile, it now appears that the position will soon turn profitable and could lead to sharp gains.  Interactive Brokers appears to be a “heads I win; tails we break even” kind of a position.  With a multiple below 10 times next year’s expectations, there is room for both the multiple as well as the earnings figures to expand.  If both of these metrics are revised higher, it would have a significant effect on the stock price.

FD: Author has a long position in the ZachStocks Growth Model

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Wednesday after the close, Chipotle earnings were released.  The company turned in some very impressive results with revenue of $388.8 million (up 14.1% from last year) and earnings of $1.10 which handily beat consensus estimates.  The second quarter earnings were actually 48.6% higher than last year which one would think would have a positive effect on the stock.

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As I write, a few minutes before the official market open, CMG is trading down $3.50 or so in pre-market trading.  This despite the fact that the broad S&P and Dow futures are pointing to a slightly higher open for equities in general.  It appears that behind the Chipotle earnings headline number, there are a few details which have investors concerned.

One of the metrics which management appears to be most proud of is the strong operating margin of 26.0%.  This is a full 360 basis points higher than the company saw last year and was driven by three main factors.  First, there was an increase in menu prices which began showing up in the numbers a couple of quarters ago.  In the second quarter of 2008, however, the menu prices were still at their old levels.  Secondly, the company has been able to use its labor more efficiently (cutting back on wages or the number of hours worked) which certainly helps to keep costs low.  Finally, the company significantly cut back on marketing and promotional spending which had a temporary effect of reducing expenses.

While the end result was impressive, the means to get TO this earnings level appears unsustainable.  Obviously if you significantly cut marketing and promotional spending, over a short period of time you will begin to see sales dwindle.  For that reason, management noted that 2009 marketing spending will mirror 2008 as a percentage of revenue.  And since the second quarter was so light in this area, you can bet that the promotional spending will be very high in the third and fourth quarter.  This will drive margins lower.

At the same time, management is guiding for 120 to 130 new store opeingins in 2009.  With only 50 completed in the first half, that means investors can expect at least a 40% increase in new store openings in the second half.  These new stores typically have lower margins until they have been opened long enough to become well established, and there are significant store opening costs associated with the locations.

Analysts are currently expecting earnings of $3.05 for 2009 and $3.53 for 2010 although I have already started seeing some revisions higher.  Still, with the stock near $90 (actually closer to $85 this morning) it appears that investors are pricing in solid growth.  What investors may be overlooking is the risk to margins associated with the new openings and higher spending on marketing, as well as the difficult consumer environment.

A generous multiple of 20 times 2010 earnings would put the stock at $70, and I expect that if the recent rise in the market begins to stall, the multiple on a growth stock like CMG could quickly drop to 15 which would bring the price much closer to $50.

So far our catuion on CMG has been a bit early as the stock has remained rangebound since our May 7th article.  But after more than doubling from its low, the stock looks vulnerable and will likely have difficulty providing any positive returns for investors over the next several quarters.

FD: Author does not have a position in CMG

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Amedisys Inc. (AMED) has had a challenging year so far.  The home healthcare provider has seen its stock cut nearly in half from its high in February, and while many stocks were enjoying triple digit gains off their March lows, Amedisys simply made up about 50% of its decline.  Still, the company is on solid footing and appears to be building a foundation which could lead to siginificant leverage in the coming quarters.

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Part of the reason Amedisys stock has been weak is investor fear over Obama’s healthcare reform plan which could significantly reduce Medicare spending in certain situations.  But many of these fears appear to be relatively unfounded as Amedisys could actually benefit from a reform to the Medicare system.  Since Amedisys actually saves Medicare money in many cases, its services could become even more valuable as Congress looks to find ways to cut costs and still deliver appropriate care.

The company’s primary business is providing in-home health care and hospice services to acute patients.  As technology advances, it is becoming easier to provide quality service in the home with a few key side benefits.  First, there is much less risk of infection when patients are treated at home.  Second, patients are more comfortable and often heal more quickly when they are treated at their own residence.  And finally, the costs associated with treating a patient at home can be significantly less than costs associated with a hospital stay where the patient is occupying a bed and using the entire resources of a hospital staff.

It’s tough to argue with the trend towards Home Health and Hospice care.  In 2006, Medicare spending for home health reached $14 billion with hospice coming in at $9.2 billion.  Those numbers are expected to reach $36 billion and $20 billion respectively in 2017 as you can see in the chart below.

Amedisys has proven to be a disciplined growth company and has used its resources very wisely over the past 18 months.  Coming into this period, AMED had a very strong balance sheet with low debt levels and plenty of access to capital.  During the liquidity crisis, the company was able to opportunistically buy out competing firms and expand their footprint by a large margin.  Making these acquisitions at an opportunistic time allows the company to grow their revenue base very quickly, while still keeping their costs relatively low.

While acquisitions have played a big part in the company’s recent expansion, management is committed to starting up new offices in areas where they can see a strong return on investment.  Typically it costs $250,000 to $350,000 to open a new location and it takes about 18 months to recoup that cost.  By the end of the second year of operations, a typical start-up will generate $1.5 to $2.0 million in reveune.  So it is clear that these start-up locations can have a strong impact on earnings in the coming quarters.  In 2009, the company has set a goal of opening 40 home health locations and 5 hospice locations which will likely begin generating profit in late 2010 and early 2011.

Amedisys receives referrals from both hospitals and individual physicians.  However, compared to the national norms, the company recieves a greater weighting of physician referrals which are usually more acute situations.  According to the company’s presentation, their average patient is 82 years old, and is taking an average of 13 medications.  These patients tend to have higher Medicare reimbursement rates as the care is more intense.  This obviously leads to a more profitable business model and allows the company to provide a higher quality of treatment to those who need it most.

When considering the quality of care, Amedisys appears to be a step ahead of the curve.  The company monitors its outcomes on a number of different criteria including categories such as “Improvement in Pain, Improvement of Surgical Wounds, or Improvement in Management of Oral Meds.”  In nearly every case, Amedisys has a better score than the national average.  These results will go far in lobbying for continued Medicare support.

The stock has rallied sharply off its low in June as investors are beginning to realize the strength of Amedisys’ company as well as the reduced potential for the healthcare reform to hurt revenues.  But even after the recent 30% run, the stock still appears extremely under-valued and is trading with a single digit PE.  If the company is simply able to maintain current earnings levels, the stock would still appear relatively attractive.  But given the history of 60 to 85% increases in revenue and 45-60% increases in earnings, it appears that investors are being overly cautious.  I would expect the stock to be a great buying opportunity anywhere below $50 and possibly much higher if the company’s investments begin to generate significant cash flows.

FD: Author has a long position in the ZachStocks Growth Model

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There was an interesting pice in Barrons this past week entitled “Expect a Rally as Waders Dive In.”  The basic assumption was that investors who have been sitting on the sidelines over the past three months (or have been participating but with the majority of capital in “safe” investments) may now be forced to throw in the towell and buy despite the difficult economic environment.

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Relying on both technical assumptions as well as a healthy dose of investor psychology, the article does a great job explaining why investors who are skeptical of the economy may commit a hefty amount of capital despite their reservations.  The buying spree could quickly drive markets higher and feed on itself…  at least for a period of time…

In the stock market, the waders might soon be getting in, setting up a new — if only temporary — leg up for stock prices. The jumpers got in first, during the spring, when the water was the coldest and the doom greatest. So far, they’ve been having fun as the waders watched.

At ZachStocks, we could definitely fit the category of jumpers.  Many of our long picks from this spring turned out triple digit gains for investors within months (or even weeks in some cases).  A couple examples include LDK Solar (which we recommended on March 13th), and Verso Paper (from March 25th).

But while fitting the category of “jumpers” at the beginning of the rally, we are also guilty as charged in the “waders” term as our exposure has been paired back in recent weeks.  Our assumption was that employment numbers would continue to be a drag on the economy and weigh down stock prices (particularly retail shares).  It now appears that we could be vulnerable to missing a larger move due to our risk aversion during a tough economic time.

“Deeply oversold, worsening sentiment and positive internal divergences almost always provide the foundation to stock-market recovery,” notes Douglas Kass, a general partner of Seabreeze Partners, an oft-noted bear. Kass, who correctly called the bottom in March and even the June-July pullback, expects some sideways summer action before a liftoff in the early fall — as the waders finally get in — with the Standard & Poor’s 500 index rising to 1025-1050, a double-digit jump.

It is always a bit concerning to find ones self squarely in the middle of popular sentiment.  Investing has a natural bent which favors contrarians, but at the same time being contrary with no logical backup is suicidal.  At the beginning of a large stock move, it is actually beneficial to position yourself in line with the herd so that as more and more people decide to catch the trend, they are buying what you already own.

But the key is offering a contrarian opinion at the end of a trend in order to get out with your winnings before the entire house of cards comes crashing down.  It was our intention to get out of vulnerable equities in late June and early July in order to exit the euphoric trend which appeared to have little economic data backing it up.  But as earnings season has sparked more interest in equities, it now appears we may be vulnerable to missing the second significant move higher.  While I would much rather miss an opportunity to make money, than get stuck in a losing series of trades, there may be some attractive opportunities from a risk/reward standpoint for us to capture a good portion of this next move.

In coming months, Kass says the fear of being out will overcome fear of being in. Kass believes the March low of 666 on the S&P 500 might mark a generational low, but please don’t mistake Kass — or us — for bulls. Huge bull rallies inside bear markets are hardly unusual. The long-term market headwinds haven’t gone away, he notes. In addition to the macro concerns Roque cited, Kass lists an elevated savings rate, which lowers consumption; spreading wage deflation; the devastation of the construction and real-estate industries, once big job creators; and a reduced securitization market, a former growth engine, as factors that will weigh on stocks for years.

So if the next leg up really is in force, there will be opportunities, but they will most likely be outside of retail stocks which are affected by consumer spending / savings rates, employment statistics, and other sentiment gauges.  Investments in commodity and trading sensitive stocks may give us the best bang for our buck, including sotcks like Potash Corp, Blackstone Group, and ReneSola.  Retail stocks may still make for good short positions, but the opportunity may have to wait for a few weeks or months as investor sentiment continues to evolve.  In the end, investors who are willing to be flexible and open minded will likely collect the largest portion of available gains in this volatile year.

FD: Author has a long position in BX, and LDK in the ZachStocks Growth Model

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You don’t have to be a Darwinist to believe in natural selection…

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As a young man growing up in the heart of the Bible belt – a southern kid raised just outside of Atlanta, I was brought up in a fundamentally conservative Christian home.  The values and beliefs have stuck with me through decades including a natural love for order and design.  I view our world through a lense that accepts our universe as the orderly creation of a truly amazing God.  And yet, with this fundamental belief, I still don’t have a problem with the concept of natural selection.  Honestly, this process makes perfect sense in so many facets of our world.

Now this article isn’t meant to debate the subtleties between creationism and evolution – I’m simply not qualified to debate the issue.  Instead, I’m drawing a parallel between the natural order of our tangible world and the reflecton within the business world.  In a capitalistic society, there is a “survival of the fittest” concept that actually makes for a stronger and more creative economy over the long-run.  This doesn’t mean an economy won’t experience growing pains – and for those who find themselves in a different category than the “fittest” the concept can be brutal.  But the process of weeding out these uncompetitive businesses is actually a positive step for the general public.

The Problem of Over-Population

Some of my fondest childhood memories are campouts with my Dad on the banks of Lake Allatoona.  We would often steel away on a Fiday afternoon up to our favorite campsite at Red Top Mountain and spend the majority of the weekend fishing and hiking through the woods.  Since deer were protected in the national park, we were always sure to see a doe followed by a few spotted fawns and occasionally if we were lucky there would be a nice buck lurking in the shadows.

However, while the state park was a haven for deer with very few natural (or un-natural) predators, there were a few summers when the deer population got so large that it outgrew the resources available to feed all the animals.  It didn’t take too many seasons for the deer to become malnourished and a danger to themselves.  In the end, the Department of Parks and Recreation had to temporarily lift the ban on hunting in order to thin out the deer population and create a more healthy environment.

The parallel is clear for the US banking industry.  For years, our policy decisions have led to great profit opportunities for small, medium and large banks.  But eventually the industry grew so large that it became necessary (and profitable) to use excessive leverage and risk in order to turn out even bigger profits.  At the height of the banking bubble, many institutions were walking around malnourished with low levels of capitalization but no natural predators.

The proliferation was clearly unhealthy and left the banks vulnerable to any weakening conditions.  So in the last 18 months as reality has re-entered the market, quite a few weakened institutions have had to face the facts and either close up shop or join forces with a stronger partner.  The process appears harsh and drastic, but the reality is that as we allow natural selection to pick off the weaker players, a much stronger banking industry – and by extension a stronger economy will emerge.

This week the attention has been on CIT group which is the primary lender of choice to many small and mid-sized businesses.  As I write, it is unclear whether the company will get an 11th hour capital injection from bondholders, but it is clear that the government is not interested in bailing out the troubled bank.  The hunting ban has been lifted.  CIT is a deer in the hunter’s scope and will likely be picked off.

An Argument for Small Businesses

One of the best arguments against allowing CIT to fail is the pressure that many small businesses would face without access to their CIT credit lines.  For instance, an apparel retail company counts on a line of credit from CIT to buy next season’s inventory.  While CIT will likely be taken over by another well-capitalized bank, this new institution has no requirement to honor and fund existing credit lines.  The retailer may be up the creek when it comes to buying the product line which is supposed to make his Christmas.

But quite honestly, even small businesses should be better prepared for such an event.  Part of any competitive business strategy includes negotiating for the best terms with suppliers, bankers, property managers and a number of other relationships.  It seems natural to expect that issues could come up between my business and the bank and so I should have another plan of attack in case trouble brews.

As a small business owner myself (Sound Counsel Investment Advisors), I have a solid agreement with a custodian who holds the majority of my clients assets.  I reached this arrangement because of the quality trading platform, the low commission costs, and the quality of service I receive.  However, if this company were to disappoint me through a change in rates, poor technology, or a breakdown in customer service – there is almost no limit to the number of other custodians I could turn to with my business.

Part of the problem with CIT is that customers have believed that the bank will always be able to serve their needs.  While of course deposit accounts are protected by the FDIC (within the standard limits), there is no guarantee that the company will always be able to serve its customers lending needs.  I find it disappointing that the current administration has made so many decisions that fly in the face of free markets.  And while the current administration isn’t the only one who has caused damage to our economy, it does not appear that we are turning in the right direction of allowing free markets to “naturally select” the winners and losers of this economic crisis.

The decision to not bail out CIT is one of the first positive steps I have seen and I applaud the governments willingness to allow the scenario to play itself out relatively untouched.  While there will be disappointment and some difficulties for many businesses as a result of the likely bankrputcy, the overall economy will be strengthened in time through the process of natural selection.

FD: Author does not have a position in CIT

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The past few days have featured rising markets as economic reports turned out to be less negative than expected and a few major companies have beat earnings expectations.  One particular sector showing strenth is airline stocks – but not likely the ones you are thinking of.  While large boehemiths like Delta Air Lines (DAL) and AMR Corp (AMR) – the parent of American Airlines – have remained rangebound, some niche airlines such as Allegiant Travel Company (ALGT) and a few non-US airline stocks listed on US exchanges have seen strength.

Investment Commentary You Can’t Afford to Miss

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It’s been quite some time since my fund invested in Gol Intelligent Airlines (GOL), but the company’s investment prospects appear to be improving by the day.  Most recently, the stock broke above resistance around $6 and has rallied more than 20% this week alone.  Investors are quickly realizing that earnings could pick up significantly – with the potential to reach 2006 levels when the stock crossed above $40 to mark its all-time-high.

So what is driving the stock price higher?  While it appears investors are now pricing in some relief from the global economic depression, the rebound over the past week is likely more a function of an announcement of an agreement with American Airlines.  Gol Intelligent Airlines operates almost exclusively in South America and while they are a leader in their own field, the company may now be able to pull in more revenue from international travelers coming into South America and Brazil specifically.  According to the agreement, GOL and AMR will offer a recipricol frequent flyer program which allows customers of each airline to use miles to book tickets on either airline.

It will be interesting to see what kind of additional revenue this agreement produces for both AMR and GOL over the coming quarters.  Since GOL is a much smaller player, it would stand to reason that GOL has more to gain as a percentage of revenue than AMR.

At the beginning of the year, GOL investors had significant concerns regarding the long-term viability of the company.  GOL was burning through cash and posting an operating loss as late as the first quarter of 2009.  With a significant amount of debt and interest expense, this was a deadly combination.  However, it looks as if the company has options to raise capital both through a potential stock offering in Brazil as well as a tentative agreement with existing large shareholders who may be interested in providing capital depending on the terms.

The recent spike in oil prices has been a significant headwind for airlines (pardon the pun).  But if higher oil prices come as a function of economic demand, that will likely correspond with higher demand for airline tickets – resulting in higher revenue.  It is a bit difficult to figure out exactly what GOL’s hedging techniques are because the english section of the company’s website is limited.  If anyone has information on the hedging techniques, I would ceretainly appreciate comments so that we can all be enlightened.

After posting a tremendous loss in 2008, the company is expected to pull out a small gain of $0.29 per ADS in 2009.  If all goes well, analysts expect these earnings to double to 0.57 the following year which would significantly increase the confidence of many investors.  GOL operates in an important niche, serving Brazil – offering 640 daily flights to 60 destinations.  The company has 108 aircraft so it is positioned well to take advantage of any uptick in travel.  And yet the stock is trading at just 12 times expected earnings for next year.

If GOL is able to prove to investors that it has access to capital and can sustain its debt levels, I expect the multiple to increase signficantly.  It may take time to get earnings back to levels seen a few years ago, but with a strong platform and a talented, experienced management team this is certainly a possibility.  GOL is worth watching as a potential investment which will benefit from strength in Brazil.  The stock also offers good diversification away from traditional US stocks which may be vulnerable to any number of issues such as inflation, currency fluctuations, sustained unemployment and more.  I would consider buying GOL here and up to $10 provided the news flow remains positive.

FD: Author does not have a position in GOL

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