Yeah, that wasn't really a disappointment at all

FINL announced earnings that beat expectations so it looks like I was mistaken about the disappointing first half.  At this point, I don't know if I'm changing my outlook or not, so stay tuned.

Earnings and a buyback

Here's the latest news about 2 stocks I've started covering.

The Finish Line (FINL)

In my article on Seeking Alpha, I expressed the opinion that the first half of this year was likely to be a disappointment to investors.  The stock closed today at $21.20, roughly even with the price on the day I first wrote about it.  My expectation has been, and continues to be, that results will disappoint investors in the near term, but towards the end of the year, I think the Macy's (M) deal will begin to show positive results.  At this point, I'm not sure whether that disappointment is already priced into the stock, and it's true, there might even be a positive surprise when the company announces.  After all, Nike (NKE) posted strong results, which could bode well for FINL.  Until I see the results, I still have a 12 month price target of about $23.30.  That could change, depending on earnings.

Trans World Entertainment (TWMC)

When I wrote about TWMC, I estimated the shares to be worth about $7 and the stock was trading at around $4.70.  The company has a pile of cash, and I believe will likely generate more despite (or more correctly because of) declining sales, and I expected that the company would return some of that cash to investors.  Today, TWMC announced a tender offer for $25 million worth of common stock at a price between $4.50 and $5.10 in a modified dutch auction.  TWMC closed at $5, up about 6% since I first wrote about it.

That's the news

Don’t Look at Bernanke, China Is Driving This Meltdown

In a world of uncertainty cash is king.

Well, no.  In case nobody noticed, the world is always an uncertain place and if you kept your money in cash, your returns would be, well, 0.  The one thing that investors should always remember is that higher returns = higher risk.  Unfortunately, most investors don't seem to realize there's risk in stocks until it's too late.  Now that I've got the preaching out of the way, though, it's time to get optimistic.  Perhaps this is what those sidelined investors have been waiting for.  The only question is, "How far does the market have to drop?"  Okay, that's not the only question.  But, it's the one I'm asking right now.

Financial crises may call for easier monetary policies: Fed's Dudley

The Taylor Rule governs the relationship between economic slack and inflation, and assumes a 2.25-percent real interest rate when policy is neutral. But Dudley said that rate is likely "considerably lower" if financial instability is impairing the effectiveness of Fed policy.

So, as near as I can tell, this is saying that most of the "rules" are changeable depending on current conditions.  Unfortunately, most people don't see it that way.  A rule is a rule, well, unless it's a law and you're a congressman.  For what it's worth, I've never seen an economic rule that holds no matter what the conditions are.  So, nothing new here.

The Fed "needs to be willing to respond to limit financial market bubbles from developing in the first place," Dudley said.

I wonder how long it took for anybody to come to that realization.  Hmmm.  Limit financial bubbles from developing in the first place.  Nah, it's way more fun to wait and see what happens when they pop.

Analysts Weigh Nike’s Prospects Ahead Of Earnings
I wasn't so much interested in what this article had to say about Nike, but more about what the implications might be for The Finish Line (FINL).

On the positive, basketball continues to be a key growth driver, while running, after having decelerated, is showing improvement; however, higher price points (e.g. $160 Flyknit) seem to be pressing the limits of consumer demand. That said, growth in running is being helped by the increased distribution in run specialty stores as opposed to the mall.

Although FINL operates in mall-based specialty stores, the company is more focused on running, and does run some running specialty stores which are not mall-based.  I'm not sure that being "mall-based" is a key issue anyway.  At any rate, it appears this should be somewhat of a positive for FINL, although I don't expect anything particularly great from the next quarter's results.  

AROW Focus Article

Arrow Financial: Safety With A 4% Dividend Yield

My latest article on Seeking Alpha.  Don't wait too long to check it out, because it goes behind a pay wall in 30 days.

That's the news

Fed Will Taper Later This Year, But Not for Obvious Reasons: Bill Gross

Lower deficits in Washington mean the Treasury will issue less debt, which could create a shortage of Treasury securities if the Fed continues QE at its current pace.

There was a time when I thought this very thing, but then thought, "Nah, there's got to be something wrong with that idea."  And there clearly must be something wrong with that idea if Bill Gross thinks the same thing.  Seriously though, think about it.  The last I heard the deficit was going to come in at about $600 billion this year, which means the Treasury would be borrowing $600 billion.  But the Fed is buying about $1 trillion a year. But wait, it isn't as simple as that.  Yes, at the current deficit, Treasury needs to issue $600 billion annually in new debt.  But, according to this guy, the Treasury also rolls over half the outstanding debt every two years, or (on average) a quarter every year.  With the current debt level at about $16 trillion, the Treasury basically rolls over on average $4 trillion in debt a year.  Of course, the act of rolling over debt is not something that occurs evenly over the course of time, so at any time, the Fed might be buying more Treasuries than the government is issuing, but over the long run, counting roll overs, the Treasury will be issuing more debt than the Fed is buying, and will be for a long time, unless the Fed raises the amount of government debt it's buying.

By the time the Fed actually does reduce its bond purchases, the move might be anticlimactic.

I expect this to be true.  In fact, I would venture a guess and say that markets will over-react before the reduction, and then correct in an apparently illogical way as market participants rush to purchase Treasuries in a flight to safety, driving yields back down even as a BIG buyer leaves the market, and, most importantly, everyone knows they're leaving the market.  This is the same kind of behavior that happened when S&P lowered the U.S. government's credit rating.


Wall St. edges up after credit outlook raised

S&P raised its U.S. sovereign credit outlook to "stable" from "negative", and put the likelihood of a near-term downgrade of the rating at "less than one in three."

 And as I'm writing this, Yahoo Finance is reporting that the 10-year Treasury yield is up.  While this isn't exactly an upgrade, it implies that S&P is becoming more positive about the outlook for U.S. Treasuries.  This in itself should cause yields to fall.  A better credit profile = lower interest rates, except when you're talking about the U.S. government apparently.

'Almost Every Major Asset Class in the World Is Overpriced': Analyst

Negative real interest rates have helped boost corporate profit levels and made it difficult to determine proper price-to-earnings ratios.

It isn't difficult to determine "proper price-to-earnings ratios."  Unless you're dead set on investing now.  In the long-run, I think investors should just expect a reversion to the mean when it comes to valuation multiples.  Of course, investing based on the mean reversion thesis would result in very few, if any, investment opportunities.  The market is, and has been for the last decade or so, a trader's market.  Sometimes there have been long-term investment opportunities but for the most part, there hasn't been an overabundance of appreciation in stock prices.  However, I wouldn't really call this a bubble in the normal sense.  PE ratios are high, but not that high.  Valuations aren't really all that out of whack.  But, there are some "bubbly" statistics out there.  See the next news item for details.

Investors Rediscovering Margin Debt

As of the end of March, the most recent data available, investors had $379.5 billion of margin debt at New York Stock Exchange member firms, according to the Big Board.

That is just shy of the record $381.4 billion in margin debt set in July 2007.

 I think this is a pretty sure fire sign that stocks don't have much higher to go unless some new money comes into the market.  So, the real question is what happened to all the investors who were waiting on the sidelines for a better market entry point.  The next article addresses that question, at least in part.

Investors are back with a vengeance

Investors have been rushing off the sidelines this year and show no signs of letting up.

So, it looks like there is, perhaps, some more upside.

While some have moved off the sidelines amid fear of missing any further upside, a larger group is waiting for a pullback to "better time" their entrance into the stock market, he said. And that group is just getting increasingly frustrated as stocks continue to grind higher.

In the end, whether stocks continue to "grind higher" is largely dependent on the frustration level of investors who are still waiting on the sidelines.  So, given that the margin level is high, and given that there is still significant money on the sidelines, there is potential for extreme swings either up or down in the general market.  Or, markets may stay relatively flat while we play a kind of game of financial chicken; who's going to give in first?  People who have maxed out their margin accounts or those that are waiting for a better entry point?  I don't think anyone can answer that at the moment.

High returns = high risk

Madoff: Don’t let Wall Street scam you, like I did

If investment looks too good to be true, it is, says Ponzi scheme architect.

Unfortunately, too many people believe that that statement is only true for other people.  High returns involve high risk, period.  If you're getting high returns, you are, in fact, taking on high risk.  You just don't know it.

What really happens when QE ends?

Markets have apparently been speculating that the Fed will begin to taper quantitative easing (QE) sometime sooner than was previously anticipated. (See: Stocks plunge as Fed minutes hint at cutback for more detail.) What bothers me is that a lot of people don't really seem to understand what the result of Fed tapering will be. So, let's see if we can work this out.

When the Fed sets the Fed Funds Rate, it typically uses open market operations to manipulate short-term interest rates. Basically, when the Fed wants to lower interest rates, it buys treasury bills to lower the yield on short-term government borrowings. Because banks are limited in what they can do with excess cash, a lower yield on T-bills makes overnight loaning to other banks more attractive, and banks will be more willing to loan to other banks when the alternative (T-bills) offer a lower yield. In this case, the T-bill rate is the driver behind the Fed Funds Rate.

In theory, all other things equal, if the Fed lowers the yield on T-bills, the yield on longer-term government borrowings will follow, so the Fed doesn't normally get involved with those. But in the wake of the last recession, the Fed, for multiple reasons, decided that long-term rates (especially mortgage rates) weren't falling enough to spur growth. So, they decided to take a more direct approach, purchasing long-term treasury bonds, which have a more direct effect on mortgage rates. As near as I can tell, this isn't the official explanation for QE, but it's the one that I think explains the reason for QE best, and certainly does actually address the effect of QE. Forget about money supply; it's about interest rates.

Generally speaking, then, the effect of QE is to flatten the yield curve. Has it worked? You tell me. Here is a chart of showing the Treasury Yield Curve currently, as well as in November of 2008, before QE1. (Source)

Yes it has, because the green line isn't as steep as the blue line. And one effect is that we've seen historically low mortgage rates, rates that we'll likely not see again in any of our lifetimes. Low mortgage rates help to pave the way to stabilizing the real estate market, and, in my opinion, the latest QE has done that a little too well.

But the point of this post is not so much what's happening in the markets now, but what to expect when the inevitable end of QE comes. The recent market reaction to rumors about the Fed maybe tapering earlier than expected shows a high level of uncertainty. Pretty much, every asset class dropped, indicating there must have been a substantial move into cash. Why cash? Because the value of cash is not dependent on interest rates at all, but nearly every other investment in the world is. Even gold.

Now, I know there are some people thinking that what I just said about the value of cash not being dependent on interest rates is just plain wrong, and that the end of QE will make cash more valuable. All other things equal, it will, but not because of the interest rates; it will be because of the difference in the supply of money. Other countries have turned on their printing presses as well, and if one stops, it will likely see an increase in the value of its currency as the supply of other currencies relative to that one currency grows. At least in the short-run. Longer term, there are other factors that will affect the value of the currency, but interest rates just isn't one of them. As usual, that's my opinion, based on the current workings of the global monetary system. Things change, though, and I could change that opinion at any time.

Okay, back to the topic at hand: the effect of ending QE. The first thing we should see is a steepening of the yield curve, and we can check that out using the same graphing utility on the Treasury's web site.

This time, I figured the beginning of the year as being as good a starting point as any, and as we can see, this time the blue line (January) is less steep than the green line (Current). Why? Because of speculation that the end is nearer than investors thought it was in January. (Almost) Nobody wants to be holding those long bonds when the Fed stops buying. This chart also shows something which is vital to a discussion of the effect of ending QE: rates under 2 years hardly budged. So, here we've found evidence that when people say interest rates are going to sky rocket with the end of QE are misstating what will actually happen. Some interest rates will likely increase, but not all interest rates. In other words, the yield curve will get steeper.

So what. Right? It is a kind of big deal depending on what investments you have in your portfolio. If you are invested in companies with little or no debt, then the impact should be minimal. However, there will be some slight decline as the risk premium rises (and perhaps whatever proxy for the risk-free rate investors are using). But for most companies with little debt, there should be no major impact on that company's results. For companies with a lot of debt on their balance sheet, it could be another story though. It really depends on how each company's debt is structured. If a company has a lot of long-term fixed rate debt, then it shouldn't be impacted as much because it has a low rate locked in. Maybe. Sometimes companies issue "putable" bonds to get a lower rate. These, of course, are not safe against interest rate increases.

One of the things that makes me believe that people in general don't understand QE is the volume of articles, blog posts, and comments that QE is somehow a way of bailing banks out, or making life easier for banks. There may be ways for banks to "game" QE that I'm unaware of, but generally speaking, QE is actually makes life harder for banks. The reason is clear when you consider that banks generally borrow short-term funds and loan long term, pocketing the difference in rates. A steep yield curve benefits banks because the spread is bigger, similar to a store that can raise prices while their cost remains the same can increase gross margin.

But, and there's always a but isn't there, the end of QE might not be that great for all banks (or other financial institutions that make money in similar ways). It's possible that the loans (or investments) made by the bank will lose value, making their collateral worth less and forcing the bank to pay higher interest, or perhaps issue more stock, or... well, lots of bad stuff can happen. If the loans a bank makes are fixed rate, then the value of those loans will fall; but if the loans are variable, then the value should stay the same because the borrower will have to pay a higher interest rate. However, this may not be true; if the variable rate loan has a floor (minimum) rate, and the borrower is currently paying the "floor" rate, then even if rates go up, the borrower may not be required to make higher payments, and so, the value of that loan will still decline.

Hopefully, this gives you some kind of idea of the complexity surrounding QE and its end. Because of this complexity, I've decided to start writing a series of articles that I'll publish on Seeking Alpha covering a variety of types of financial institutions. In case anyone was wondering, this is what I've been working on lately and the reason I'm posting less frequently.

My latest on Seeking Alpha

Trans World Entertainment: Who Says You Have To Grow Sales?

My latest article on Seeking Alpha!  This one will only be available for 30 days, after which it will only be available to paid subscribers.  So, check it out!

That's the news

Bernanke offers wisdom but no hint of Fed moves

"I wrote recently to inquire about the status of my leave from the university," Bernanke said. "The letter I got back began, 'Regrettably, Princeton receives many more qualified applicants for faculty positions than we can accommodate.' "

Bernanke felt the need to add in a footnote to the printed copy of his speech that this remark was a joke, since his leave from Princeton expired in 2005.

I think Mr. Bernanke should just always put footnotes telling us when whatever it is he's saying is just a joke.  I mean, how are we supposed to know if he was being serious when he said anything?  Even worse, how do we know that the footnote wasn't a joke?  I don't know, but I think this whole footnote thing was a bad idea.  It casts doubt on everything Ben ever said that wasn't subsequently footnoted to let us know what he meant by that.

Sprint says Dish offer for Clearwire "not actionable"

Some provisions violate Clearwire's certificate of incorporation or the rights of the parties to the existing Clearwire shareholders' agreement that includes Sprint, Sprint said in a letter to Clearwire on Monday.

Sprint owns just over 50 percent of Clearwire and has offered to buy the rest of the company for $3.40 per share, valuing the wireless services provider at $10.7 billion.

Dish recently raised its offer for Clearwire to $4.40 per share.

So, let me see if I can guess here.  The fact that Sprint owns just over 50 percent of Clearwire means that they have a majority stake in the company, so, if they want to buy the Clearwire for $3.40 a share, then nobody else should be allowed to buy the company for a higher price.  Sounds good!  Of course, if Sprint thinks Clearwire is only worth $3.40 a share, then why not sell to Dish at $4.40 a share?  Unless Sprint thinks Clearwire is worth even more than $4.40...  Hmm.

Manufacturing sector contracts in May: ISM
This should really be bad news, but of course, the stock market is rallying today because the news makes it less likely that the Fed will begin tapering on QE.