Five Things You Need to Know: Here's a TIP: Investors Are Banking on Inflation

Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Here's a TIP: Investors Are Banking on Inflation

Caught the following headline on Bloomberg when we walked in this morning: "TIPS' Yields Show Fed Has Lost Control of Inflation."

The gist of the story is that the yield on the five-year Treasury Inflation-Protected Security TIPs) is negative for the first time ever, and has been trading that way since Feb. 29. The real yield is currently -.20%. Five-year TIPS are now yielding about 2% less than five-year Treasuries.

What does this mean? Does a negative yield mean a Treasury Inflation-Protected Securities holder has to pay to own the security? In a way, yes. It means if you buy TIPs here you are essentially paying the government to do so because the yield is less than the Treasury equivalent.

Now why would anyone do that? Because TIPs are designed to provide protection against inflation. Investors can still earn money from TIPS with sub-zero rates because the principal rises with the CPI. TIPs pay interest twice a year at a fixed rate and that rate is applied to the adjusted principal; so, like the principal, interest payments rise with inflation and fall with deflation.

When TIPS mature an investor is paid the adjusted principal or original principal, whichever is greater. What the current negative yield situation means is that investors believe headline inflation is going to remain elevated and are willing to give up the real yield for the inflation-adjusted return of principal.

TIPS have returned 6.2% this year, compared with 3.7% from Treasuries, according to tracking indexes compiled by Merrill Lynch (MER).

On the one hand, buying TIPs here might seem a bit like fighting the Federal Reserve, though not in the way one might typically think of "fighting the Fed." The bet on TIPs would be that the U.S. central bank is sacrificing price stability for higher growth, allowing inflationary pressures to continue to build.

That's the conventional wisdom to be sure, and we disagree with it. It's true, the Fed is not fighting inflation; they're fighting deflation. TIPs holders better hope the Fed doesn't lose.



2. Barron's Joins the "Tinfoil Hat Club"

Last week when sitting around wearing my tinfoil hat and pondering the potential nationalization of Fannie Mae (FNM), little did I know I would soon be joined in the "tinfoil hat club" by Barron's. The weekly newspaper was out this weekend with a pretty wonky story on Fannie Mae ("Is Fannie Mae Toast?") and the possibility the mortgage giant may be "the next government bailout."

"Just maybe a bailout of Fannie, in effect a nationalization, would be a good thing," the article said. "A retooled Fannie could pursue its important social mission without the distraction of trying to please Wall Street. Of course, it's doubtful if this happens that the shareholders would be along for the ride."

It certainly appears at least some shareholders have reached that conclusion as well, which is really what prompted the Five Things piece on the nationalization of the GSE's in the first place. Fannie Mae and Freddie Mac (FRE) are down more than 40% since the beginning of the year.

As for nationalization being "a good thing"? Well, Barron's will have to remain in that particular club without us.



3. The Next Real Estate Bubble?

First residential real estate. Now, increasing signs of stress in commercial real estate. Next? Perhaps the farm. According to an interesting piece in the New York Times over the weekend ("A Global Need for Grain That Farms Can’t Fill"), the flood of money into American agriculture is leading to rising land values and a renewed sense of optimism in rural America.

A separate Associated Press story noted that farmland values rose 16% in parts of the upper Midwest, the largest increase in nearly 30 years. USDA officials found that the average value of an acre of Wisconsin farmland, about $2,250 in 2002, had jumped to $3,366 in 2006.



4. Apparently, We Aren't Going to Just Sit Home Twiddling Our Thumbs Every Day

Amusement park operator Six Flags (SIX) may not be the most important stock in the universe at around a buck 65 a share, but we took a listen to their conference call this morning mainly because we were interested in their take on a consumer recession and what that means for discretionary entertainment dollars.

Mark Shapiro, Chief Executive Officer noted the headwinds right off the bat: "From October 15th to the end of 2007 the stock market was down 15%, driven by the credit crunch, driven by the housing bubble, driven by oil prices, driven by a retail sector that was down really across the board from a Christmas shopping standpoint, just overall it's the same climate
that we're experiencing right now," he said.

True enough. But what caught our ear was the inventiveness in Shapiro's pitch that Six Flags is somewhat recessionary proof. Despite the economic headwinds, what ends up happening historically is the long-distance vacation, the big-ticket items are what get sacrificed, Shapiro said. The short, close to home and affordable vacations usually historically ramp up.

"We just believe that people are not going to stay in their house every single day just twiddling their thumbs," he said. "Recent results from BJ's (BJS) and Costco (COST) indicate the consumers are essentially trading down for specialty stores, they're trading down from department stores, they're looking for lower price alternatives and we believe Six Flags is such that it is exactly a low-priced alternative."

Fair enough. So does that mean the company gets hammered when the economy improves and people can afford to vacation again?



5. Anti-Consumption Sentiment Turns Against the "Good Consumers"

Ran across a fascinating piece in the Washington Post that merges neatly with our thesis that as social mood darkens, consumption will increasingly be targeted as a societal evil. What was unexpected, however, was that the target in this anti-consumption piece wasn't the Neiman Marcus set, but "good consumers."

"Let us buy Anna Sova Luxury Organics Turkish towels, 900 grams per square meter, $58 apiece. Let us buy the eco-friendly 600-thread-count bed sheets, milled in Switzerland with U.S. cotton, $570 for queen-size.

Let us purge our closets of those sinful synthetics, purify ourselves in the flame of the soy candle at the altar of the immaculate Earth Weave rug, and let us buy, buy, buy until we are whipped into a beatific froth of free-range fulfillment.

And let us never consider the other organic option -- not buying -- because the new green consumer wants to consume, to be more celadon than emerald, in the right color family but muted, without all the hand-me-down baby clothes and out-of-date carpet."

The aggressive cynicism in the first three paragraphs is also a bit surprising. There's no attempt to gently persuade going on here. The commentary is forthright and harsh:

"Consuming until you're squeaky green. It feels so good. It looks so good. It feels so good to look so good, which is why conspicuousness is key."

It speaks to the magnitude of the shift in social mood that we may be seeing.



http://www.minyanville.com/

New-found fear of debt rattles shares

Fashion can be very fickle. Twelve months ago companies were under pressure from investors to take on debt and gear up their balance sheets. Fast-forward to 2008 and investors are fleeing stocks with high debt levels.

The worry is that these companies will struggle to refinance debt or that the economic slowdown will dent their ability to meet interest payments and keep banking covenants.

Nowhere has this flight from leverage been more in evidence than in the case of Yell. Shares in the Yellow Pages publisher have fallen 51 per cent since the start of the year, making them the worst performer in the FTSE 100.

Aside from concerns about the outlook for the advertising market, the main reason for the poor share price performance is worries regarding Yell's balance sheet.

Yell is highly leveraged. Net debt was five times earnings before interest, tax, depreciation and amortisation at the end of December. Put another way, 70 per cent of its enterprise value is debt.

Analysts fear a further downturn in the advertising market could see Yell breach covenants (although they can only guess what the covenants are because the company has never disclosed them).

Of course, Yell is not the only company affected by the new-found fear of debt. Shares in Premier Foods have halved this year amid concerns that the maker of Branston Pickle and Hovis bread would need a rights issue.

Premier moved to address those fears this week and provided full details of its banking covenants, which have been renegotiated, and increased available credit by £225m.

Investors soon found another company to worry about. Shares in Johnston Press, the regional newspapers group, fell more than 15 per cent on Thursday and Friday on fears it could breach banking covenants. Broker UBS said that was possible if revenues fell a further 5 per cent this year.

So which other companies' share prices could weaken (or weaken further) on debt concerns?

In a research report, Morgan Stanley said the deterioration in money and credit markets would weigh on companies that need short-term funding and have low fixed-charge cover.

Fixed-charge cover is earnings before interest and tax divided by net interest payments, rent and operating leases. Companies with low cover should in theory have less cash available to invest in growth and pay dividends.

Companies with low fixed-charge cover include Ashtead, Avis Europe and the retailers DSG International, Debenhams and HMV. In terms of funding, Morgan Stanley identified HMV and Avis as stocks in which short-term funding costs equated to 5 per cent or more of total assets. Other companies that screened poorly on this measure were Rentokil Initial, Helphire Group, Dairy Crest and, surprisingly, BTGroup

More broadly, companies that have a high multiple of net debt to equity include Debenhams, Rank, Next, Enterprise Inns and Mitchells & Butlers.

Investors in these companies will hope debt comes back into fashion soon. But, as with flares and kipper ties, they could wait some time. * Yell's recent performance is all but certain to cost the company its FTSE 100 place when the results of the quarterly review are released on Wednesday. Other companies for the chop are Rentokil and Taylor Wimpey, the housebuilder.

One of those three places will be taken by Eurasian Natural Resources Corporation. Although it is valued at £14bn, the Kazakh mining company is something of a mystery to many brokers and investors. That will change pretty quickly. ENRC is one of the world's largest producers of ferrochrome but has a small number of shares that can be traded. This seems likely to make it one of the most volatile stocks in the FTSE 100, unless, of course, one of its pre-float backers decides to cash in. ENRC has risen 95 per cent since listing in December.


http://www.ft.com/

Sterling Construction: Banking on a builder

America is crumbling, and we’re not talking the economy here.

The U.S. infrastructure needs upgrading worse than that old computer running Windows 98. Just a few of the problems faced by state and municipal governments are packed roads that can’t handle 21st-century traffic, century-old water and sewer lines continually springing leaks, and airports lacking the long runways needed to handle the biggest jets leaping to the skies.

Even with budget shortfalls knocking on the doors of government at all levels, elected officials know they must keep the customer satisfied by paving the potholes and keeping the water and sewage flowing for consumers and businesses. Sterling Construction Company, Inc. (Nasdaq: STRL) has been lending its expertise to all sorts of public projects in the building and rebuilding of Texas and the Southwest.

Mom and Pop might suck it up and put off some of those big home improvements during the current economic downturn, but they’re going to give government officials an earful if they’re repeatedly sitting in traffic jams or finding a sewage backup in their basement.

That’s where Sterling Construction comes in. Primarily operating through its Texas Sterling Construction business, which traces its lineage back more than half a century, Sterling has been winning a healthy stream of contracts from state and municipal government for transportation and water infrastructure projects in the Longhorn state.

Last month, the company announced its latest deals: it was the low bidder on a $26 million road project in Collin County, Texas, north of Dallas, with completion expected in the fall of 2010, and it was the apparent low bidder on a $55 million rebuilding project for the North Texas Toll Road Authority that will continue into the summer of 2010.

Three analysts surveyed by Thomson Financial have a favorable view of Sterling Construction with either a “strong buy” or “buy” rating on the stock. The recent median 12-month price target from Thomson is $26.50. On Thursday, Sterling closed at $18.40.


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