Chingo De Dinero

So, I just reviewed the GE quarter announcement, and I am a little worried that bad things may be coming.  Many analyst expected the dividend to be cut to keep the financial stability to keep the AAA rating.  This did not happen, what this means is that S&P or another credit rating agency could cut the rates, which will increase the cost of borrowing (Moodys will probably not cut it due to the ties with Sir Warren).  After this happens, GE will be in big trouble…with so much debt, the additional cost of borrowing will hit earnings, resulting in a decrease in investments in the various businesses, resulting in deterioration of their competitive advantage, which will hit the top line and start a nasty cycle.

If you look at the numbers, most of the cash generation is from the industrial side, which will probably tighten up mid way through this year.  Addtionally, you have to wonder how the current loans made by GE are…since many of them are through credit cards.  They do have a reserve for losses, but if it is large enough is a good question. If there is some unexpected weakness in the loan portfolio, along with a slowing industrial side, mixed with additional costs to renew debt…you are talking major trouble.

In looking at the actions of management, it looks like they are trying to build confidence, which could be a last grab at keeping the AAA and stoping the downward spirl.  Not cutting the dividend and raising money from Warren are two examples of management trying to get in the publics eye to prove everything is okay.  Although, I did see the recent debt having to pay 7%…a little high for how much debt is out there.  Lets see when it gets a little worse if we hit the slippery slope.

One of the best ways to get a good bargain stock is to buy something with short-term negatives when their future is bright.  That is the case with Aracruz Celulose (ARA).  If you fallow the Brazilian Real, you will know that it dropped 30% vs the Dollar very fast.  One of the casualties was Aracruz Celulose.  The reason being ARA uses hedge contracts to sell Dollars and buy Reais in the future.  Why would they do this, because most of their revenues are in Dollars and most of their expenses are in Reais.  So, to keep earnings fairly constant, it is beneficial to enter into these contracts.

Did they enter into more contracts that their future business can support, maybe.  If they do not use hedge accounting, they have to show the loss on the financial instruments right now, even if they have future cash flows that are the opposite of the hedge.  Even if they use hedge accounting, they can only do it for so far in the future, while the exposure to the Dollar to Reais still there.  Basically, what I am getting at is they had these hedges, which with the depreciation of the Real lost a lot of money, but on the business side, this will lead to higher profits.  So, if you have some time, for the short term problems to clear, there could be a ton of upside.

On a side not ARA owns a ton of land, which usually is not fully valued within the Balance Sheet.   There could be a lot more value than people think, and a lot of earning potential in the future.

I am not sure about others, but the majority of this financial crisis, I have seen on TV, and not in real life.  Is there a slow down?  I don’t doubt, but if you look at the facts there are three reasons why it does not have such a strong affect:

1.  The GDP has just begun to dip and the dip is not so large, so really this year’s consumption is not so different than last year’s.

2.  The cut back that we do have is on discretionary funds.  The point I am trying to make here is that in the past a larger portion of our income went to things we really needed, food, shelter, etc.  Now, we have to buy the 25 KUSD instead of the 35 KUSD…this is much different than having to skip meals due to a lack of food.

3.  Unemployment is still low.  It is true that we are not at full employment, but we are not much over it.  If you need a job, you can get one.  It may be at a grocery store, or flipping burgers, but something is out there.  If you are worried about finding work to feed your family, no need to worry, those jobs are there.  The unemployment now, keeps us from getting our dream jobs, but not from putting food on the table.

Here are a few reasons why I do not think the “crisis” is so bad.  It may get worse, but I think we have a ways to go before people really feel pain.  In my opinion, I do not think this will happen, the economy should turn early in 2009, and we will be back on the upward path.  Lets hope I am right!!!

If you have followed the Yen lately, you might have heard the reason for its appreciation is the unwinding of the carry trade.  The main idea for the carry trade on currencies is to borrow in one currency, transfer to another, invest, then in the future, transfer the funds back to pay off the loan, and you will have some left over.  The reason for the leftover is the higher interest rates in the currency you invest in over the one you borrow in.  This was popular with the Yen and Dollar because the Yen rates were so low, and the risk of default for the Dollar are so low.  This works, and is very profitable as long as the currency you borrow in does not appreciate vs the one you invest.  Since Japan wanted to keep their currency weak to help exporters, investors could get a big paycheck.

This has since changed a little since the Yen has appreciated greatly vs the Dollar.  This means that investors started to lose money, which resulted into them closing their position…ie sell Dollars to buy Yen, which resulted in more appreciation.  In the end, a plan that seemed safe and highly profitable turns into a big money loser.

The key to a good carry trade is to find a safe currency which should keep its strength and pays a good rate, and a currency which has a government who wishes to keep it from appreciating, and has a very low interest rate for borrowers.