Vince Farrell of Scotsman Capital-Verbatim

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From: vince farrell [
Sent: Wednesday, February 20, 2008 5:27 PM

Despite worse than expected inflation readings on the CPI today, lackluster housing data, the high price of oil, and a dismal op-ed piece in the WSJ by Martin Feldstein, a respected economist who said in effect the Fed is hamstrung in its efforts to turn the economy cause it's different this time, the market had a respectable day. When stocks don't go down on bad news, that's good news.

I think players focused on the release of the minutes of the Fed's meeting that gave a downbeat forecast on growth, but said inflation is expected to slow in 2008. A 50 basis point cut in the Fed Funds rate at the next meeting on March 18th seems likely which is what the market wants to hear. But beware, volume was light and that's not good if the market is to go higher. Volume is a weapon of "the bull."

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Transocean reported a very good quarter that exceeded estimates and the stock was strong, closing up $9 to $138.73, or almost 7%. Consensus earnings estimates for 2008 are $14, and by 2010 the consensus rises to almost $20 per share. With $14 in earnings this year the P/E is less than 10 times and, if $20 is accurate, the multiple on 2010 is less than 7 times. I think it's ok to look so far out since many of their deepwater contracts are long term in nature and the eps are visible, and depend, of course, on execution, which management seems capable of delivering if this quarter is a guide.

Another driller I have talked about is Rowan. The stock was up in harmony with RIG today, rising $1.53 to $40.12. While they have a lot of equipment in the Gulf of Mexice, the company has rigs offshore Saudi Arabia, an admirable oil service manufacturing business, and some land rigs. Consensus for 2008 is $4.62, so the p/e is 8.6 times, a discount to RIG, but appropriate in my opinion. Consensus rises to $6.41 for 2010, or barely 6 times. I continue to like both names.

The consensus (my big theme today) for oil and natural gas is that oil will average $79 a barrel this year, and that natural gas will average $7.50 per mcf (million cubic feet.) But the 12 month strip (average) for gas is well over $9 and the price of oil is $100 and the 12 month strip is close to that. I think price estimate will go up during the year, although I'm still guessing that oil will have a correction as soon as the winter fades. Goldman Sachs, for what it is worth, is estimating an average of $95 for oil this year.

From: vince farrell
Sent: Wednesday, February 20, 2008 8:54 AM

Jan Hatzius, the head economic honcho at Goldman, had some dismal forecasts the other day. He figures that home prices are going to drop another 10% this year and that would mean 15 million mortgages, or 30% of total mortgages, would be on homes where the owner had "negative equity" in the house. Hope he's wrong. And I think he might be. The number of applications for refinancing of mortgages has tripled in the last four weeks which means that lower interest rates are starting to help. M2, a broad measurement of money in the system, is up $130 billion the last three weeks. This can be convoluted to explain, but accept that the Fed is pumping money into the economy and it seems to be welcomed. Let's see how this plays out.

I read in the paper the other day that BBB rated Collateralized Debt Obligations (CDO'S), which are collections of subprime mortgages, are 10 times more likely to default than BBB rated corporate bonds. Moody's Rating Agency says no, no. They are only 8 times more likely to default (Saturday's Wall Strret Journal.) What gives ? What are the alleged rating agencies up to ? Are they totally incompetent, corrupt, or what? How can you give something 8-10 times more likely to default the same rating ? Enraging !

With the back up of leveraged loans on bank balance sheets, financial M&A is not likely to come back anytime soon. Those heavy loans will have to be moved to clear the way for lending activity to resume. The only way to move them would be to sell at a loss, which estimates figure to be 5-7%. The banks can keep them and probably will get all the money back at maturity, but then they won't be able to make new loans.With $1.6 trillion in cash on corporate balance sheets, however, expect a lot more of Strategic M&A, like the Microsoft bid for Yahoo.

The Consumer Price Index was just released and it was "hotter" than expectations at +.4 on the headline and +.3 on the core, which excludes food and energy. Year over year the headline is +4.3% and the recent high was in 2005 at +4.7%. The core year over year was +2.5%, stronger than the 2% upper end of the Fed's target. Before we get overly excited, remember that inflation is a lagging indicator and before we start with doom-type forecasts of "stagflation", remember that the stagflation of the late 1970's and early 1980's had both inflation and unemployment in the double digits.The numbers released today along with oil near $100 will cause the market to sell off. I still think we need to test the January lows of arond 11,600 on the Dow vs. 13,400 now.