RIMM: BP 2010 Redux?

Totally different industries, headquarters an ocean apart, and stocks plagued by completely opposed idiosyncratic factors.  So what, pray you, do these stocks have in common?

I don't blame you for asking yourself this question after reading the title of this entry, but bear with me - it may well be worth your while. As I am sure you all remember, BP's Macondo well blew out in late April 2010 and leaked uncontrolled throughout the summer, in what turned out to be the largest oil spill in history. To no one's surprise, BP's stock was pummelled as a result. However, its price performance over the course of the disaster was somewhat surprising in that it levitated in early Q3, even as the disaster dragged on without a solution in sight - see chart.

So what happened here? I recall quite clearly that there was no news justifying a 30% appreciation during the month of July. Therefore, it appears to me that institutional investors dumped this stock ahead of quarter-end, anticipating having to present fund holding to investors and not wanting to have to defend holding this environment-trampling dog of a firm. As we transitioned into Q3, the sellers were exhausted and investors who had done their homework and did not face the same transparency requirements (read: hedge funds) stepped in and began snapping up this stock, which proceeded to return 30% over the next month.

Now let's have a look at RIMM's chart: 

So now it's my turn to pose a question: Who's will be left to sell heading into Q3? With a forward CFO yield of nearly 25% (based on the firm's reduced guidance), it appears that there is upside potential here (admittedly not as large as in the case of BP).  Therefore, a long position with a tight stop strikes me as a trade with an attractive risk-reward ratio.

Clearly there are very important differences between BP in 2010 and RIMM today. The former was a company with a strong core business which had a massive NPV-negative event, while the latter's massive NPV-negative event was weakness forecast in its core business.  I am not here to claim that RIMM is a strong long-term investment - that depends on whether Mr. Balsillie & Co. manage to right the ship. However, I do think that there is a good short term trading opportunity here for a10-20% upside.

Disclosure: I went long RIMM today.

Working Assumptions and Predictions

Well at long last, it is time to get this blog started up again.  Third time the charm?

I suppose the best (and easiest) way to go about this is to articulate the assumptions which impact my worldview and expectations of how the global economy will evolve moving forward:

1) Greece and Ireland are insolvent. The only way out of their current situation will be debt restructuring. The current policy is quite clearly to roll maturing privately-held debt onto the books of the solvent core EU members, in anticipation of a restructuring at a later date. It is unfortunate that the precarious state of the European banking sector does not allow policy makers to force a restructuring of privately held debt (and let the cards fall where they may) but that is the status quo, and the current policy strikes me as the least-bad of policy makers' options. Domestic politics in both the core and periphery nations are the biggest threat to the current policy prescription, but I am guardedly optimistic that it will be sustained until a restructuring is a containable event. I think it is incredibly unfair that German taxpayers will have to shoulder a considerable amount of this burden, but it is a necessary evil.

Once the EU emerges from the slow burn of the peripheral debt crisis (if it does at all), there will have to be a dramatic move towards fiscal union in order for the common currency to be tenable. However, I fear that the electorate in member countries will be unwilling to accept this and therefore am not confident in the long-term sustainability of the Euro as a currency. That being said, I do understand the significant benefits of regional integration and expect regional currencies to be a more common phenomenon moving forward (say on a 50-year time frame)

2) The emergence of the Tea Party in the United States has made a responsible discussion of the U.S. budget deficit a near-impossibility before the next presidential election. Any Republican presidential hopeful must pander to the hard right's overzealous anything-but-tax-to-fix-the-deficit dogmatism and cannot be seen as cooperating with Obama on anything if they are to succeed in the Republican primaries. Diddo for any Republican who will be seeking re-election in the near term. Fortunately, I don't see this as cataclysmic for the Treasury market.  Perhaps some risk premium will be priced in (and rightly so), but I do not foresee a Greece-like spike in yields anytime soon (sorry Gross et al).

3) I don't believe the hype about China. Yes they have grown 10% annually for 30 odd years. No, it cannot be sustained for the next 30. Anyone who tells you otherwise is either a fool, or has an ulterior motive for doing so.  Over the last 3 years, there has been an unprecedented surge in lending without enough/any analysis of borrowers' credit worthiness. The result has been massive investment in what will turn out to be overcapacity and totally unproductive infrastructure. We are already witnessing the first ramifications of this in the form of spiking non-performing loan ratios, and it is going to get much worse before it gets better.
That being said, I am a long-term China bull - a chart of fixed capital per capita in China vs the West is all I need - but there are going to be some pretty nasty surprises in the short term, which will shift long-term output projections downward.  Trend growth will also prove to be closer to 7% than 10%.


4) There has been an accelerating shift over the last 150 years from a world where capital was very scarce and real interest rates were high, to a world where capital is abundant and real interest rates on high quality investments are much lower.  This is the necessary by-product of enormous gains in economic efficiency, which has lead to higher aggregate savings as an ever-expanding proportion of the population produces more than they consume and are thereby able to save for the future. While the implications of this shift are surely enormous, they are also not immediately apparent to me. If financial markets manage to allocate this capital more efficiently, it should allow for more entrepreneurial ventures and positively impact total factor productivity. Holding inflation constant, this will allow for more leverage across the economy, from the consumer through to the government, as the cost of debt service declines. This final dynamic strikes me as one of the most under appreciated dynamics at play in the global economy and warrants significant analysis by both private and public decision makers.

5) Finally, over the long term, as there is a transition to a more multi-polar world, I expect a re-emergence of realpolitik and a shift to the right across the Western world as a number of liberal ideals which (while both admirable and generally desirable) will lose priority in a more adversarial global community.