Vince Farrell of Scotsman Capital-Verbatim

From: vince farrell [mailto:vfarrell@scotcap.com]
Sent: Monday, February 11, 2008 2:31 PM
To: 'James D. Brown'
Subject:

I caught the following quote from a Bear Stearns research piece this morning, " I think the subprime thing is yesterday's news...I think we are now double counting subprime losses", said Jamie Dimon, the correctly respected CEO of J.P.Morgan Chase. I think he's right about the subprime, but there is a lot of other stuff going on. I was on Squawk this morning and a guy from Pimco offered the thought that housing prices had another -15% on the downside. If so, then we'll have some prime losses to contend with. I talked this morning about the dramatic slowdown in the expansion of consumer revolving debt and it's worth noting that credit card default rates are up a lot. Credit is deteriorating, but not on the corporate side. Balance sheets are in excellent shape with only 11.7% of cash flow going to debt service, the lowest in decades says the Wall Street Journal. But as long as banks want to/need to shore up their balance sheets, credit will be tighter than usual and the economy will feel it.

When would all this be priced into the market? Jason Trennert of Strategas gives it a shot in his research release today. Over the last 40 years (and yes, I remember them all) the "average" recessionary decline in earnings has been -17%. That would give us a new eps level of around $74 for the S&P 500 index. You have to make a stab at a fair price/earnings ratio to put on this, and I would agree with Jason 17x would be appropriate, so a downside target of 1260 results.We are at 1335 as I write this and the January intraday low was 1221, so maybe we have already accomodated a recession into the market. Also, when the market can take a blow-up like the American International news of this morning and keep the fallout to that stock only, there is room for optimism.

Another friend, Fred Dickson of A.G. Edwards, notes that the yield on the S&P 500 is 2% and the yield on the two year treasury is 2.85% for a ratio of 70%. Only twice since 1978 has the ratio breached 70% and both times the market was 25% higher two years later. I am not a trader (I have tried only to have most trades turn into long term work out situations), so a 25% gain over two years looks fine to me.

Exxon is planning on drilling 5000 wells in the Pieceance Basin (Pee-ance) in Colorado over the next few years in the search for natural gas. I think they should look to the floor of the NYSE and spend their money buying some premier natural gas names. The one I/we own at Scotsman Capital is EOG Resources. It has the best name change ever to its credit having been Enron Oil and Gas. The results have been excellent (as have the results for Devon and Apache as well) especially the reserve replacement figure of some 250% of production for last year. The majors have replaced less than 100% of production for some time now. The market cap is less than $25 billion which is a good bit less than XOM spends each year on share repurchases.I have no inkling of anything at all, but if I were an investment banker (and thank God I'm not. The lifestyle is too intense) I would be fishing in this group. Beware, EOG is at a 52 week high.

Joe Kernan is a man among men. He's just back from having made the cut at the Pebble Beach Pro Am, and, on air, leaned on a guy to give me an invite to next years event. Forget that I more "commit" golf than play it, and forget the guy said maybe I could caddy next year, the attempt was noble and I won't forget it.