2007 Wrap Up

This month and the first half of January 2008 I am working on a project for Microsoft; I have not had time to write blogs, though a lot of interesting things have happened with the stocks I cover. So here's a quick summary of 2007, recent events, and my thoughts on 2008 before I dive back into Windows Server 2008.

2007 was a good year for me, but not for my stock portfolio. Fortunately I resisted the temptation to try to flip houses in 2005-2006, which would have left me bankrupt. Instead I paid down my mortgage, which guarantees me about 5.5% in long term savings. So while my residence has declined in auction value, there is still a lot of net worth in it. I live in California, I've seen a couple of downturns, and as they say, you can't make new real estate near the ocean. So I'm not worried. My apple trees brought in a good crop this year, and that is a good metaphor for how I think about investing. I planted the first ones 9 years ago and now just about all I have to do is water them 4 times each summer and I get top-quality organic apples to eat or trade. The best investments may require a long time frame.

My portfolio is another matter. It was an evil year for me; I did worse than the market. There were two major killers: AMD and Marvell (MRVL).

AMD had just introduced Opterons when I made my initial investment. It looked like an Intel killer for a while. Then it bought ATI at the same time Intel tried to crush it with a price war, resulting in a string of net losses. In 2007 the quad-core Barcellona Opterons were supposed to save the day, but they never came. Now AMD says Q1 2008; we'll see. On the other hand the law suit against Intel is probably worth more than AMD's entire market capitalization today. But lawyers, judges and juries are a tricky thing. Intel was caught red handed, but will hide behind their lawyers as long as they can.

Marvell has been a profitless wonder story, which is alright with me. In 2006 they acquired Intel's mobile processor division. The costs from that and heavy investment in research has meant GAAP (and even some non-GAAP) net losses. But revenues have climbed rapidly, and Marvell management says revenues will continue to climb in 2008, but promises to hold research costs steady. Today's bargain stock price will seem cheap if management delivers on that promise. If they screw up, or if the macroeconomic picture gets worse, then the price could fall further.

The massive stupidity of both lenders and real estate investors is creating turmoil that can benefit those who were more conservative and have cash to spend. Most (but not all) stocks are cheap right now. Real estate varies by geographic area; I would not call it cheap, but low ball a house you like and chances are the owner will bargain with you. The global economy is strong with a few weak spots, but that it as usual. Agriculture is strong; land prices in Iowa and other grain-production area are actually rising. Note that sovereign investment funds are jumping in to use cash to buy U.S. assets. They may make some mistakes, but I think foreign investors will see the value in U.S. assets (stocks, bonds, and real estate) first because the dollar is weak and they can be less emotional from a distance.

The main economic problem for the U.S. is the Republican Party's "No New Taxes" pledge. It has been good for partisan politics, but bad for the nation's economy. There is still plenty of government waste, and imperialistic adventures are bleeding the U.S. dry. But mainly low taxes are the cause of the deficit. Pay now or pay more later is a rule for taxpayers. Say half the Bush tax cuts for the wealthy were eliminated. Couldn't the billionaires live with that? They'd still be paying lower tax rates than at any time since World War II, but the deficit could be eliminated and there might even be some money for infrastructure that is not Congressionally earmarked crud.

One last note: Celgene (CELG). Boy, did I think I was smart to buy this company earlier this year. Then they announced an expensive merger. Okay, I could live with that. Recently there has been speculation that a rival will cut into their Revlimid franchise. Ouch! I can't decide whether to buy more stock because it is cheap or to be cautious here.

My best stock in 2007: Microsoft (MSFT). Despite all the mud slung at it, it does a number of things way better than any of its competitors. Internet bandwidths are just not sufficient to allow serious office productivity to run on the Internet. After years of Google hype, when you look at Google numbers, all its revenues come from ad sales. That is great, it is a great, profitable, and useful company (this blog is run on Google). But it is little or no threat to Microsoft's core business, or Adobe's for that matter. Modern PCs are supercomputers; those who know how to use this amazing tool can run circles around those who use them as glorified typewriters.

2007 Economic Outlook

What will the economy do in 2007? While there are some dangers, and unexpected events may change things, I think the U.S. economy will do just fine in 2007. The world economy will do better.

I have followed the statistics and the predictions of government agencies, investment banks, and assorted pundits. In 2005 I made a pretty good prediction (read it). For 2006 I was busy and wrote nothing down. If you are an investor you want to know not just how the economy will do overall, but how individual sectors will fare. Though I am a math guy and like to make models, I think the human brain, mine anyway, is still best for modeling complex systems like the economy. So this is what I think:

China and India will continue to boom. With increasing domestic consumption they will continue to be positive drivers for the manufacturing and intellectual property side of the U.S. economy. Electronic chip makers who can produce the best technology and get good prices for their chips will continue to do well.

The commodities boom as a whole is not so much over as adjusted to the market. New mines and processing facilities that were created in response to higher prices will keep a lid on commodity prices overall. Only specific goods where their are genuine global shortages that are difficult to rectify with new investments will see significant price increases. That said, petroleum is a wild card. Capacity seems adequate for now, but purposeful production cutbacks will probably keep oil well above $50 per barrel. A major war could send prices far higher.

The housing market in the U.S. is going to recover in 2007, but more slowly than predicted because prices have not, and probably will not, drop enough to accelerate the demand side. I would not look for significant increases in new house construction until the second half of the year.

Retail as a whole will have a modest year. One good thing about people not buying houses is that they tend to have more cash around to spend on other things, which will offset in part the decreasing wealth effect from people using their house appreciation as income.

Interest rates will stay in a narrow range. If housing does pick up in the second half and manufacturing and services stay strong, which is likely, look for rates of 6% and higher by the end of the year.

I think the bond market is wrong, at least for the short run. I am not known for being overly optimistic about the economy, but that is based on realism. I called the imbalances of the late 1990's. Now that things are more in balance, the fools who told you that the stock market had nowhere to go but up in 2000 are overestimating the chances of recession in 2007. Bond rates are mostly too low, not because inflation is likely to heat up significantly, but because the Federal Reserve will eventually raise rates to keep inflation at bay.

The stock market as a whole is not overvalued right now. Of course some individual stocks are. But there are plenty of stocks that are undervalued, too. This is an ideal field for picking individual stocks.

Construction Workers and the 2007 Economy

I am not as worried about the 2007 economy as some, despite my reputation for gloom and doom. I acknowledge the downside risks, of course. In one particular, construction worker employment, I think the risk is typically overstated.

No doubt that the construction of new housing has slowed down and is not likely to perk up significantly in 2007. But did you or any of your friends try to get a contractor to do major repairs, additions or alterations in 2005 and 2006? Everyone was busy; pricing verged on extortion; projects started months behind schedule and sometimes ended years behind schedule.

So while there is not pent-up demand for new homes, I think there is plenty of pent-up demand for construction workers. Overtime will be cut back (if it has not already been) so many workers will have smaller paychecks. In California many overworked Mexicans may simply take a nice vacation back to their hometown, where many are building a house of their own. There will be increased competition in the repair, alter, and addition market, which will be great for frustrated home owners.

Real estate workers (dirt pimps, my friend John calls them) are seeing smaller paychecks, but that is just part of the game. Many new real estate agents who came on board in 2004 and 2005 would never have survived under normal positions. It's disappointing to have a real estate license and be lining up for a job at WalMart or Target, I'm sure, but good times will come again and at least you'll already have the license. Smaller paychecks should remind people of the importance of saving during good times, a lesson much of America seems to have forgotten.

I believe it is a bit early to be buying stock in home construction companies, given the uncertainty going forward, but if you do buy now at least you'll be buying the stock for way less than what people were paying for it back in 2004 and 2005.

Live and learn. A down cycle is just a good time to mentally flip the chart and see it as a rising inverse. Laid off by a big construction company? Hopefully you saved some money during the boom. Get your contractor license, print up some business cards, and knock on some doors. Do good work, put your customers before yourself, and soon people will be knocking at your door. Adapt and thrive.

I'll be on vacation a few days, then back to share more with you in 2007.