Notebook 01.24.13

On board the train heading out of a cold NYC.  Had a super cool day at the Oktay Technologies SDN conference.  They had an A-list line up of speakers with the CEO of Arista, Martin Casado of Nicira/VMware and others.  I presented yesterday’s blog post in PPT format.  That is enough networking for the day.
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Notebook 12.18.12

The last few months have been a blistering pace at Plexxi and it has impacted my time to write.  Writing is important to me as it is my method of thinking in depth without the interruptions of email, calls, text and tweets.  Outside my window a Biblical rain is falling and I have Zac Brown playing.  As with past notebook entries, here is collection of topics I have been reading and thinking about over the past few weeks.
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Writer’s Block Leads to Stock Picking…

I had dinner in NYC with an old acquaintance from my stint on the buy side.  During dinner I was asked what I like long and short.  Admittedly, I have been in more cash, HY credit and some gold for the past six months and I have not really thought about equities.  There I was almost half way through my second Manhattan at Keens (wow, what a bar at that place) in midtown talking stocks.  It was pretty fun to just rattle off tickers and sectors.  It seems like a long time since I just talked stocks and positions.  In rapid fire, here is a summary of some longs, shorts and thoughts.
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HPQ and Product Cycles

If I told you that HPQ had 349,000 employees at last report would you be surprised?  I did not attend HP’s analyst day this past week, but I did read a few of the headlines with surprise.  Here are few that I thought were noteworthy:

  • HP CEO Whitman says company is now a diversified IT company
  • HP’s CEO: We are number 1 or 2 in each of the major markets
  • Hewlett-Packard CEO cites management changes as slowing down company
  • HP’s Whitman says turn around will take time

On CNBC the day after:

  • Hewlett-Packard CEO Whitman says ‘very comfortable’ with make-up of board
  • Hewlett-Packard CEO Whitman: I don’t think company is too big

I have written a few times on my blog about HPQ.  The last entry of note was over a year ago in September 2011 here.  At the time I wrote “This is an interesting chart when you consider that it is framed by $25B for Compaq in September 2001 and the iPad shipping in January 2010.  Assume for moment that the credit crisis did not happen and the chart is down a bit in 2008 and then peaked in 2010.  HPQ acquired EDS in 2008.  They did this because they were believing in the ongoing propagation of Moore’s Law and the enterprises would consume more network infrastructure and having the ability to influence or control the decision making process in regard to that consumption was a good position.  Kind of interesting that the peak in HPQ equity coincided with launch of the iPad, which marks an important transition point for the PC market in the same manner that the iPhone marked a transition point for the mobile device market.”

In November 2011, I wrote the following on HPQ “Meg Whitman, CEO of HPQ on CNBC: I think companies should give Y/Y guidance only and report a monthly set of numbers, which would be a subset of financials and unaudited.  I think this would take a lot of emotion out of quarterly results as well as the channel check drama.  With that said when companies stop giving guidance or provide less transparency, I do not see how this is helpful and I sell or short the stock until I can trust the management team.  I listened to Meg Whitman’s comments on CNBC yesterday.  She said there was a lot of complexity and cost in HPQ and she wants to strip it away and simplify the company (my take away from her talking points).  Leo was there 9 months, so did all this cost and complexity come from him or did Hurd oversee it?  I viewed Hurd was an acquisitive cost cutter and when he was ousted the management team at HPQ was quick to tell investors that Hurd and stripped the company down to the bare bones and there was no investment in innovation and growth.  Apparently I am confused.”

Here is updated version of a weekly chart for HPQ going back to the time of the Compaq acquisition.  A year later and HPQ is going full on RIMM.  I have a colleague at work that has a thesis I have heard him tell many times.  His meme is about the large tech companies (e.g. IBM, HPQ, DELL, and OCRL) have been on a binge to become diversified IT companies.  If you look at the history of tech acquisitions post the LEH bankruptcy it supports his meme.  We joke about every Board Room having a white board full of categories on the Y axis and the big players on the X axis.  Management teams are focused on filling in every box: IT services, cloud, storage, networking, tablets, mobile, big data, little data, dumb data, etc.

In terms of HPQ, I think it is good that the CEO is comfortable with the BOD because that has been one BOD full of drama since the Compaq deal.  I am not sure investors could take another decade of drama, pre-texting, spying, tattle telling, etc.  I am not sure if the CEO thinks the company is too big, too small or just the correct size.  I suspect that the leadership team and BOD are all trying to determine what size is correct as well.  What I do know is the PC market has turned against the company, printing has gone with it and the EDS business is not a grower.  The rest of the business is a just a bunch of parts and they may be 1 or 2 in each market, but they are not great markets.  As for being a diversified IT company, whatever happened to the diversified IT companies of the 1970s and 1980s?  You know…IBM, EDS, NCR, ATT, Amdahl, CA, Tandem, Wang, DEC and DG.  I am not sure being a diversified IT company is a good thing, but as usual I could be wrong.

[Note…it is Monday morning and I already see the break-up, sell off, sum of the parts notes coming out of Wall Street.  I would not be buyer on any sum of the parts, break up value or IP value notes.]

 

/wrk

* It is all about the network stupid, because it is all about compute. *

** Comments are always welcome in the comments section or in private. **

SDN: What it Means, Max Hype Level Achieved and Code Words

The SDN washing is reaching new heights.  Apparently, I missed the memo that all companies were doing SDN two years ago.  The WSJ published a piece on SDN.  With all the SDN washing and the WSJ article, I think we might have hit the peak (i.e. inflated expectations) of the Gartner hype cycle for SDN.  As another example, here is an email that is representitive of about five emails I have received over the past month requesting the same.  The ironic aspect of this email is readers of my blog know that I have been posting the answers to these questions for over year.

——————–

Hi William,
I work at XXXX with XXXX, I think we may have actually met [in the past]. I came across Plexxi in my readings on SDNs. I am trying to work the implications across the value chain of SDN, for instance where will it be adopted, what does it do to traditional networking world, what are the implications for chipsets, modules etc.   Was keen to hear your views on it and get more familiar with Plexxi; any way we can try a call soon? Thanks.

Regards,

———————–

My view of SDN is different than most.  That was the subject of my post prior to Structure.  When I look at how SDN is defined today, I call it the neoclassical definition or view of SDN.  Neoclassical SDN is concerned with the separation of control plane and the data path and how there can be APIs that allow a central controller to inject forwarding decisions.  I think there is a little if any chance of mainstream adoption for neoclassical SDN.  What will happen is new networks will be built and they will be built using some aspects of neoclassical SDN, but components of the solution and the application of these components will be different than what is generally available at present.  My definition of SDN is:

  • Computation and algorithms, in a word math. That is what SDN is.
  • Derive network topology and orchestration from the application and/or the tenant.  This is how SDN is different from switched networks.
  • Ensure application/tenant performance and reliability goals are accomplished.  This is part of the value proposition.
  • Make Network Orchestration concurrent with application deployment. This is what SDN is for.
  • A properly designed controller architecture has the scope, the perspective and the resources to efficiently compute and fit application instantences and tenants onto the network. This is how SDN will work.

All of the SDN articles and emails coming out the research world are really code words for an soft economy.  Business is soft, so let’s blame and hype SDN.  Much the recent SDN talk is really dancing around the underlying point of SDN.  SDN is not about network programability.  SDN is not about APIs.  SDN is not really about retrofitting legacy networking equipment with APIs and replicating old technologies in new wrappers.  The problem that has been growing over the past 18 years (note this is the era of switched networks) is the problem of IT OPEX.  There is no Moore’s Law for OPEX in world of IT.  Companies have dealt with it through several strategies with one of those strategies being outsourcing.  The thinking here was that companies could cap or at least predict their IT OPEX by outsourcing networks over to firms who would manage their network as well as others; thus allowing the outsourcing firms to get to scale.  The companies outsourcing get a fixed operating cost line, reduce headcount and create a lean organization.  Good in theory, but the result has not been as expected – it has been disappointing.  This is clearly my view that is only validated by my in person observations of the market.

When I look at how SDN will develop and I look at companies like Nicira, I understand the implications on the network.  The problem being addressed is the problem of OPEX and in part CAPEX in terms of customers asking do I need to upgrade now or can I wait?  In terms of SDN, the inverted Moore’s Law curve for IT OPEX is the driving force around the concept of SDN.  SDN is one possible tool to reduce OPEX.  The interesting part that I have found over the past 6-12 months is that IT leaders are exploring SDN as means to deploy new networks, but differently and for the first time in more than a decade they are thinking about tackling the OPEX curve and SDN holds promise as a strategy or tool in this objective.  As we close out the era of switched networks (1992-2012) and begin the next era of networking we have part of the market that will go for IT outsourcing to the cloud provider.  I still see this market segment (outsourcing group) as the broader SMB market served by cloud providers.  The high end of the market will build and deploy their own data centers using the post neoclassical definition of SDN.  I think the real SDN market develops in two segments: cloud providers and high-end enterprises deploying a hybrid utility compute DC.  My time line looks like this:

  • 2012 is the proof of concept (POC) year for SDN.  In 2012 we will see the first SDN proof of concept networks in the deployment range of 250-1000 10G servers.
  • 2013 is the year that at scale SDN builds start transitioning from POCs.  I think we will see SDN networks that scale up to 10,000 10G servers by mid to late 2013.
  • 2014 is the first big bang year.  2014 will be the year that we go to hyper scale and build DCs with 100k 10G servers, minimal hops, no OSR in a post neoclassical SDN world with controllers.

As always, this is just a blog and it is very possible that I am incorrect.

/wrk

DEC, OpenVMS, Miles Davis and Being Swayed by the Cool

I joined my first startup in 1989.  I was the fourteenth employee.  Down the street in the Old Mill was the headquarters of Digital Equipment Corporation (DEC).  They had 118,400 employees, which was their peak employment year.  In the late 1980s, DEC was dominating the minicomputer market with their proprietary, closed, custom software.  DEC was a cool company and the fifth company to register a .com address (dec.com); a decade before NetScape would go public.  DEC was one of the first real networking companies outside of the world of SNA.  Radia Perlman inventor of spanning tree worked at DEC.  Most recently her continued influence on networking can be seen in the development of TRILL.

The continued rise in microprocessor capabilities would prove to be an insurmountable challenge for DEC.  DEC had built over the years a massive, closed software operating system with a non-extensible control plane that was extended across proprietary hardware.  This architecture would be eclipsed by the workstation and client/server evolutions.

To counter the these threats, DEC considered openning their software ecosystem by adding extensibility and programmability including a standardized interoperability mechanism (API).  The idea of opening the DEC software ecosystem would culminate in 1992 when DEC announced an significant update to their closed, proprietary operating system.  The new software release would be called OpenVMS or Open Virtual Memory System.  The primary objective of OpenVMS was allow for many of the different technology directions in the market to become one with the DEC ecosystem.  It made a lot of sense.  In 1992, workstations were the hot emerging trend of the market, the Internet was only two years removed from ARPANET control.  Windows 3.0 was two years old and anyone who used Win 3.0 knows it was a huge improvement over 2.1.  The rack server was a decade away.  Some companies still chose OS/2 over Windows.  The Apple Newton (i.e. iPhone) was a year away from release.  Here is a summary of DEC’s OpenVMS release:

—————————————————

OpenVMS is a multi-usermultiprocessing virtual memory-based operating system (OS) designed for use in time sharingbatch processingreal-time (where process priorities can be set higher than OS kernel jobs), and transaction processing. It offers high system availability through clustering, or the ability to distribute the system over multiple physical machines. This allows the system to be “disaster-tolerant”[10] against disasters that may disable individual data-processing facilities. VMS also includes a process priority system that allows for real-time processes to run unhindered, while user processes get temporary priority “boosts” if necessary.[11][12][13]

OpenVMS commercialized many features that are now considered standard requirements for any high-end server operating system. These include:

—————————————————

In 1997, five years after announcing OpenVMS, DEC was acquired by Compaq; a personal computer company.

/wrk

Market Thoughts, the End of the Cold War, Credit Crisis of 2008

My wife and I were privileged to have her uncle, John Maresca stay with us for a few days last week. He was in town to speak at his 1959 Yale class mini-reunion.  I immensely enjoy his company which is far too infrequent.  I was able to indulge myself in three days of continuous discussion of geopolitics, history, the Cold War, economics, politics, books and the general history of the world post the Second World War.  I spend my days working in the technology business; the three days Jack was with us was a rare over indulgence in my favorite subjects.  Jack even stayed up late to watch the Celts fall to the Heat in game 2 with me.  The subject of his speech to his Yale class was that the war of his generation was not Korea, not Vietnam, but rather the Cold War 1945 to 1989.  We were honored to sit at a table with a two-time survivor of an attack on the WTC.  In the course of our discussions, I provided Jack with my mini-thesis on the economy of the US post 1989 till today.

The basis of my thesis, which I have hinted at before on this blog, is rooted in the expansion of credit without an accompany expansion of higher capital ratios and reserves.  I bring this up because in course of my many discussions with Jack, I said that I thought Greenspan, Larry Summers and others were the team that failed theUS.  On one had they oversaw a great expansion of credit and debt, but they did not oversee an accompanying expansion of capital reserves.  All of this has been discussed before, I would simply say that if the money multiplier stays were it is, we well have a lot of Friday’s like last week ahead of us.  I posted some charts from the St. Louis Fed.  If you look at these charts and see the expansion of credit, it makes CEOs who talk of productivity gains in the 1990s look like fools.  Do not underestimate what expanding credit debt levels can do make everyone feel good and look like geniuses.

Back in August 2011, I posted my notes from a meeting on Wall Street from March 14, 2008; which also written about in the book The Big Short, by Michael Lewis (see pages 228-230).  The portion of my notes under “XXXX, Former Fed Person” are from Alan Greenspan and the portion before it under “XXXX, Hedge Fund PM” is from Eisman.  I am revealing the names because I want to highlight a few of the notes:

  • AG: The complexity of the models are still too simple to capture human nature.  That is the problem.
  • AG: During the euphoria bankers would tell me they were under pricing risk, but they were forced to play the game.  Was that a BOD level problem?  Why were bankers forced to play the game and under price risk in the market like the others?
  • AG: 20 years ago it seemed that banks were very cautious on how they booked reserves.  The mathematicians took over and said your reserves are wasting money and today it seems the banks are low on reserves.  Part of this accounting issue, some of this is a philosophical style.  Earnings and profitability pressures to mark to market have caused more problems than have capital reserves.
  • SE: Banks in the US are under capitalized, no reserves, pace of credit problems are accelerating, they have not come to grips to with their problems and I would not own a single bank in Florida.  The only good news is the banks in Europe are in worse shape.
  • SE: Capital market problems are worse.  Rating agencies have no idea what they are doing.
  • SE: The buyers of structure mortgage products are structured mortgage people.  It is Ponzi scheme.
  • SE: What is a SIV?  It is 5% cash, 5% Treasuries and 90% asset backed paper, which is leveraged 20 to 1 based on ratings from the ratings agencies published in the paper…what a joke.
  • SE: We are going through the greatest de-levering in the history…there are a lot more Carlyles and Thornbergs…there is not a real solution but to take the pain over time
  • SE: Nothing is going to stop the de-levering process

Four years later with the Europe experiment on the brink of failure, the gains of the Europe Economic Union, which were possible through the stability provided by the winning of the Cold War, now look to be at risk.  I wrote some of this before, but not is such direct terms.  In the past I wrote that “it is clear that many nation-states are working through the stages of political change or revolution fueled by the global credit crisis of 2008.”   The question I should ask my wife’s uncle is: will I be writing a history of the Second Cold War in thirty years?

/wrk


Notebook 05.12.12: CSCO, INTC, SDN, OpenFlow, Cash

It has been awhile since I thought about CSCO in terms of the equity value.  I read many reports on CSCO post their Thursday earnings call and most reports generally like the long term prospects of the company and think CSCO will do better as the macro economic conditions improve.  Over the past year, I have written a lot about CSCO and it is all in the blog archive.  Here a few thoughts on CSCO post their recent earnings call.

Chart: Below is a 10Y weekly chart of CSCO.  Technical charts do not predict the future, but they do show a sentiment trend from the past and it is possible to map the trend to events.  The three red circles from the center to the lower right represent the price peaks from mid-2007.  They are a series of lower highs.  There is a five year wedge developing and the astute observer will note that this wedge looks to be resolving around the Oct/Nov time frame, which is the end of CSCO’s Q1 FY2013 and early November reporting date.

NewImage

It should be noted that wedges do not necessarily resolve to the negative.  Below is a 10Y weekly chart of INTC and the breakout of a long downward channel is visible.  I pitched INTC as part of the 1G to 10G server transition to the CEO and tech analyst at Alger in September 2011 when I interviewed for a position with the firm.  I wrote about it here.

End of the Switching EraI am firm believer that we are at the end of the 20 year run of the Switching Era (1992-2012) in networks.  The network is changing and that is going to have an affect on CSCO.  They will buy innovation through Insieme and/or others.  The new networks will start small this year, barely noticeable to CSCO and become visible by mid 2013 and they will have a real affect on CSCO in 2014.  All you need to know is that then entire global base of networks are up for replacement.  CSCO will win their share, but it is possible and probable they will lose share in this cycle.  The last cycle was the evolution of shared LANs to switched LANs driven by GbE and CSCO used M&A and product cycles (Cat 5k/6k) to win the vast amount of market share in that era.  If you want to be long CSCO, forget about macro conditions, telepresence, transformational connected communities, cloud, big data, mobility and all the other crap.  All you need to be comfortable with is the knowledge that CSCO will win and upgrade the core of networks in the next five years.

NewImage

OpenFlow/SDN: I have written a lot about SDN and OpenFlow and what it all means or might mean or does not mean in the past month.  The real question you have to ask about CSCO is why do they fail at internal innovation?  CSCO confirmed the Insieme investment ($100M with right to buy for $750M) last month.  They have used this proven method in past to great success.  No arguments from me on the validity or success of the strategy.  The question I would ask is why does CSCO have to use this method?  I accept that it works, I accept that it is proven — but AAPL does not use this strategy.   A person who thinks about companies might ask:  why does a company with an annual R&D budget of $5B need to use the spin in strategy?  Is $5B too little to fund innovation with so many legacy product lines to support?  The other odd data point is the Insieme team is building a product for the heart, I repeat the heart of the Cisco franchise.  Switching is not some adjunct part of the company.  Switching is the business in which the company made the very first acquisition.  I know that great innovation has been done by companies taking teams and separating them from the core business such as IBM with the PC.  I get it.

On the other hand if you add up all the venture capital in the next-generation of networking companies in the US it has to be around $200M give or take $50M.  CSCO invested $100M in Insieme, provided space and have a call option on Insieme for $750M.  Was it not possible to do the same internally for $250M over two years, which is 5% of the annual R&D budget?  Did anyone on the BOD even ask the question why the company has to go outside the company to build something innovative for company’s core franchise?  This leads back to the 10Y chart.  If the company has to do something special to accelerate a product solution in the core franchise of their business, two unspoken facts must be true.  (1) There is a bigger threat to their core switching franchise than they are willing to identify and (2) they cannot drive their internal teams in the their core franchise to innovate.

I have read speculation that the whole OpenFlow/SDN movement will die in a few years.  As I posted earlier, changes in how networks will be designed will have little to do with OpenFlow in my view and SDN is just a poor term.  Networks have always been about software.  We have all been through various software debates in networking.  How many people remember APPN versus APPI?  Back in the early 1990s, CSCO was all about APPI when they were going against the monster incumbent IBM who was willing to license APPN for $400k.  Interesting comments from CSCO this past week complaining about Huawei using on site support people to lock out competition.  I felt the same way in the late 1980s and early 1990s, but I used to complain about the teams of IBM employees at every F500 company selling SNA.  Where is IBM today in terms of networking?  Market share can shift from the company with 80% share.  Perhaps more of you remember tag switching and Ipsilon Networks; today we have MPLS.  Side note on IBM.  It may be unnoticed by many people, but IBM acquired a company called BNT in October 2010.  I continue to read speculation that IBM is going to rebuild their networking division.  The same division that CSCO destroyed in 1990s and then purchased in 1999.  More than a decade after IBM exited the networking business, why would IBM want to get back in the networking business?  You can come up with your own answer, but I do not think the answer is: more of the same.

Cash: CSCO has not filed their 10Q for the Q3 FY12 yet, but if we look at the 10Q filed on 2.21.12 CSCO had $41.7B of cash off shore and $5B of cash in the US.  I do support CSCO’s position that US companies domiciled in the US should be offered a cash repatriation holiday perhaps with some sort of on-shore investment requirement.  I would call it bring home cash for US jobs.  How is that a bad?  I think it is terrible that US companies are using off-shore cash for  foreign investments when that cash could be used in the US.

As always this is just a bunch of speculation by me.  I am sure I not in possession of all the relevant facts and it quite likely much of my speculation is incorrect.  For new readers to my blog, Notebook posts are a collection of data points and theses that I am thinking about.  I was inspired to write Notebook posts after reading Alchemy of Finance.

/wrk

Abstract Networking Thoughts: ONS, Sad State of DC Networking, Random Market Thoughts

I will be spending the upcoming week at the Open Networking Summit (ONS) in CA.  With all the SDN buzz over the past year, this week’s ONS appears to be a good test of the hype.  Will the energy be sustained by the event or diminished?  Will the event be a repeat of 2011 or will fresh, new ideas and progress with SDN be showcased?   Personally, I do not look forward to industry conferences, but I am looking forward to this conference.   I will try to blog some thoughts during the conference or each night.

Sad State of Data Center Networking: An interesting post this past week over on the Packet Pushers website concerning the sad state of data center networking.    The second paragraph entitled the Inconsistent Network makes a lot of sense to me.  I have been in the networking business since 1988, when my boss at the time explained how spanning tree works.  What I have found to be true in networking across the enterprise-service provider continuum is that selling in the transition zone from legacy to emerging solutions is where the most value can be created.  Selling legacy technology is a simple theta calculation.  Selling the future in which the proposition is all or nothing, or forklift upgrade or a limited solution set is not a big winner.  How vendors address the transition zone is the difference between winners and losers.  I will be looking for indicators of how SDN vendors intend to sell into the transition zone at ONS.

Random Market Thoughts: Market rips on Thursday fueled by the global growth recovery China GDP vibe and the market declines on Friday fueled by the global growth recovery stalled China GDP disappointment vibe.  This is why all the “trader talk” is stupid talk.  If you are actively trading equities in this mess, good luck.  I trimmed my exposure heading into earnings, but still long a few equities such as FNSR, as I think inventories are lean, bad news priced in and any uptick in CAPEX should benefit FNSR.  I starting shorting oil and gas this week and feel good holding this through the summer.  GOOG reported this past week.  I think my call on GOOG over the past year was correct, but another class of stock is confusing.  When stocks becoming confusing, my reaction is to not be involved.

 

/wrk

* It is all about the network stupid, because it is all about compute. *

** Comments are always welcome in the comments section or in private. **

Arista at Networking Field Day, Insieme Follow-up and Markets

The Tech Field Day team posted videos from most of their meetings last week.  I was an avid viewer during the week, but I was sure I missed some points so I went back and watched a few selected videos.  One of the videos I watched was from Andy Bechtolsheim, co-founder of Arista Networks.  I heard Andy speak at the Flagg 2012 High Performance Computing Linux for Wall Street conference on Monday and it was a good opportunity to compare notes.  Here are three paraphrased points and three quotes from the video.  The quotes are at the 7:40 mark of the video:

  • We are not aware of a single production OpenFlow network
  • OpenFlow does not interoperate with legacy infrastructure
  • Really hard to change how networks are built

Networks have evolved pretty slowly from a protocol perspective.”  I agree and have written the same here.

Reality is people spend a lot of money on networking gear. Once it is installed it works. Don’t touch it, you may break it.”  I have been writing about this for more than a year and I called it out in my Tubthumping post.

Once people have adopted a certain network topology they are highly unlikely to change it unless there is really something better comes along.”  I agree with Andy and have written much the same, but this is the point at which we diverge and I choose The Road Not Taken.

Insieme Follow-up: My two posts on Insieme here and here are by far the most popular posts I have written.  As expected they generated a lot of reader reaction.  In my first post I offered up a couple of possible product strategies.  I tend to think that the Path 1 strategy is the most likely direction.  Use custom ASICs in a new Leaf/Spine product set (note if you watch the AB video I linked to in the first paragraph, Andy talks about this network architecture being the state of the art and locked in for years as networks are slow to change).  The new Leaf/Spine product set will have the ability to hook back into the legacy Nexus (~10k installed customers), but have very high bisectional bandwidth for storage.

For years it has been speculated that CSCO would buy a storage company like NTAP, but with the rise of flash, SSDs (note there are ~14 storage startups targeted at the home-enterprise-cloud provider markets), CSCO could add storage to the Nexus platform with the new Insieme product line.  Let us assume the company has product plan hashed out and they are aggressively recruiting the product development team.  If we assume January 2012 start, we could expect this product in 18-24 months and the 18 month assumption is if everything goes perfectly.  Most likely is we would see the product in 1H 2014.  What we would see is a new Nexus compatible set of switches, 100G ready, but using ASICs that allow for very high cross-sectional bandwidth and some sort of CSCO storage product.  Yes, I think this team puts CSCO squarely into the storage game against incumbents and startups alike.  UCS now gives you networking, blades (Romley) and storage.

I think the days of getting a significant (e.g. Cerent) integration and cost advantage through an ASIC are over, but using an ASIC does provide deterministic supply advantages.  Back to the Andy video, he says that Arista prefers to use merchant silicon from all suppliers and in his talk at the HPC he had several slides onMoore’s Law and riding the merchant silicon wave and predicated 16/32/64 core silicon in years to come.  As the Leaf/Spine architecture holds (remember (i) slow rate of network architecture change and (ii) once the network is installed do not touch it) some competitors will ride the merchant silicon cycle and a few will do ASICs.  Using ASICs does remove one from the pack and having to be tied to the product development cycles of chip suppliers (BRCM, MRVL and INTC), but at the same time there are suppliers like Pica8 and Cumulus Networks who are thinking ODM hardware from Asia-Pac and bring your own OS.  It looks like the battle will be joined with CSCO/Insieme thinking closed architecture, ASICs, one stop shop for network-compute-storage and at the other end of the spectrum are the white box/DIY/Open Flow abstraction layer companies with several companies in the middle focused on specific application use cases and even putting FPGAs with APIs in the switch data path.  As always this is all speculation and probability is in favor of me being in error.

Market Thoughts: We have ha a bit of sell off.  As I wrote a few days ago I had been trimming exposure into rally.  I let the APKT position go on Monday and I hope to buy it back.  I have some shorts on and would like to go back to being long oil and gas, but I took profits in those positions a few weeks ago and now I am just waiting for entry points.  We have earnings starting soon and I really do not like having any large positions into earnings events.  I am content to read the news and react.

/wrk

* It is all about the network stupid, because it is all about compute. *

** Comments are always welcome in the comments section or in private. ** 

SPX Technical Chart for 2012

A slow week in the world of technology has afforded me the time to look at some charts which I have not done in a few months.  Sometimes separation from daily data points provides the ability to see trends and perspectives not visible on a daily basis.  I spent some time looking at a three year chart of the SPX asking myself if I should be putting more cash to work in the market in equities.

I thought last year’s market was easy to figure out.  The US economy was going to disappoint and all you needed to do to figure this out was talk to people in the real world. Europe was going to blow apart and as such there was going to be a lot soft revenue numbers when Q1-Q3 numbers were reported.  This brings us to 2012 and what will the market do.  The easy and accurate answer is I do not know and no one else does either, but I think there are few trends and events to think through in the context of the market charts I posted to the left.

1. I think Q4 reports on balance will be a neutral to positive.  I think a lot of companies (mainly tech) had a decent Q4 based on end of year demand and this is positive based on reduced expectations.  I think forward guidance will be soft, but most investors will give it pass saying it is still early in the year.  A few more semi companies will come out, blame floods inThailandand report they under shipped demand, thus pushing the problem out a quarter, kind of like Congress.

2. Congress and the Election.  The election is a wildcard.  Congress will do nothing meaningful ahead of the election.  If Obama is reelected the market will not like that and we are in for another four years of nothing.

3. Problems inEuropeare still unresolved. Francewill be downgraded, ECB will print and the low economic activity will just keep the world muddling through. Greeceprobably withdraws from the Eurozone and maybeFranceandGermanyget into a good old fashioned row and we see one side or both mentionAlsaceandLorraine.

4. I do not foresee a broad economic pickup ahead of the election.  The trends are better, but uncertainty in policy will keep most CEOs on the far side of conservative for 2012.  I think the SMB market adopts a similar approach for 2012.

5. QE3 is a wildcard for the year.  I think if the market starts to sense the Fed expanding their balance sheet then the SPX could see a 150-225 point rally.  I only think we get QE3 is the economic numbers start to trend negative again so a 200 point rally in the SPX might start from 1075 bringing us right back to where we are today.

6.  If I look at the two charts I posted (3 year and 2 year) this is what I see in no specific order:

– QE1 and QE2 boxes clearly show the market rallies on QE, so if the economy is bad enough to force the Fed into Q3, put money to work and take the gross up buying higher beta tech stocks

– The SPX has put in a series of lower highs (four) since the market peaked with the end of QE2.  This is not a good trend and not something that has really happened in three years.

– We are currently completing a wedge and it looks like the SPX will break to the upside or the downside with Q4 reports.  That puts a lot pressure on Q4 reports.  Currently it appears that the market is setup for a breakout to the upside, but this could change with any bad news out ofEurope.

– 1125 seems to be the key support line from the 666 and 1074 lows.

Net conclusion…I would trim exposure on any rally in the next couple of weeks and wait to see how European politics play out post the holidays and how guidance will be in Q4 reports.  If I am forced to pick tech equities in this market, I would be focused on companies with high GMs delivering a software product in an appliance or compute element.  Just random thoughts and most likely I am wrong…happy New Year.

/wrk

* It is all about the network stupid, because it is all about compute. *

** Comments are always welcome in the comments section or in private. ** 

Notebook 11.02.11: Datacenter Switching, Packet Switching, Market

A few weeks ago I wrote a post in which I referred to keeping a notebook and how George Soros’s book the Alchemy of Finance reminded me of the value of keeping a notebook and that my blog is really a distillation of my notebook accessible by all.  Today I am creating a new category and entry format that I will use on occasion.  The notebook format will be for days when I want to cover multiple subjects without focusing on a specific topic in detail.

Datacenter Switches and Mobile Devices: I was sitting through a presentation from a merchant silicon team last week.  They were going over their designs in detail as well as roadmaps and application examples.  They put up a slide matching chips to switch reference designs.  A customer could choose chip A and build 48x10G switch or chip B with 48x10G and 4x40G design, etc.  I was looking at the slide and thinking where have I seen this before and then it occurred to me: the mobile device market.  One of the reasons I have been negative on the mobile device market is it really down to four operating systems: IOS, Android, Windows and RIMM.  Apple is a fully integrated (vertical) and closed system.  That is the most valuable franchise in mobile devices.  RIMM has the oldest OS that was designed to solve problems from ten years ago.  If you want to design a smartphone today, the process is to pick an OS: Android or Windows.  Then you get a reference design from QCOM or Mediatek, etc.  The real value is in the user interface (UI).  I know marketing, manufacturing, distribution all matter too, but the mobile device market is bifurcated into Apple (the closed OS with ASICs) versus the Windows or Android OS phones with developer built UIs and merchant silicon (reference design) mobile device companies.  I am crossing analogies to explore a thought path.

Will the switching market go the way of the mobile device market?  Will CSCO someday have to make a choice like Nokia or will they go the way of RIMM?  Will a new company or legacy company quickly rise to take share because they built a vertically integrated switching solution like the iPhone?  Will the rise of merchant silicon and reference designs create a vast market of white boxes driving down price points in which the differentiation and value is in the software, i.e. the customer UI?  Just a thought path I am exploring.

Packet Switching and the Network: I found this article on Blackberry’s SWAT team interesting.  Here we go again with the network being the problem and not the solution.  Perhaps we all need to review Paul Baran’s paper on distributed networks from 1962.

Market Thoughts: The market is basically un-investible.  You can pick individual stocks here and there, but Europe is a mess and not getting better.  There was a long stretch of peace in Europe from the close of the German wars of unification in 1871 to 1914; forty-three years of economic expansion and living standards improvement.  Europe is completing a 60-65 year cycle and countries are thinking more about dissolution than union.  It will be interesting to watch how European politics play out over the next year to see if any old stresses emerge from their slumber.  I am not sure which way the FOMC plays QE III, it seems the market wants it, which must mean the economy is bad and therein lays the problem.  The market is not a self sustaining entity – it is propped up by artificial entities thus making it un-investible.  The governments and central banks should have let a lot of institutions that were over stretched go down, but rather they transferred their liabilities to the public side and we are still living with the cancer.  Just look at GM.  I think I am one of the few people to think of the Corzine MF Global irony this week.  Corzine was head of Goldman-Sachs when LTCM went down forced by bond spreads that went against the firm driven by the Russian default of 1998.  The book to read is When Genius Failed.  Lowenstein infers in the book that Corzine always wanted Meriwether as a partner.  Thirteen years later they can share stories of failure caused by a global sovereign credit crisis.

/wrk

* It is all about the network stupid, because it is all about compute. *

** Comments are always welcome in the comments section or in private.  Just hover over the Gravatar image and click for email. ** 

October 2011 Earnings 1.0

Here is the start of my October 2011 earnings thread.  I am already a bit late having been positive on GOOG from the past, I did tweet it last week.  A few reactions so far:

GOOG: Sticking with my GOOG call from April, not much to update.

INTC: I have been positive on INTC based on my web 3.0 thesis.  It will be interesting to see if results were strong enough to break INTC out of the ten year down channel on a weekly basis.  Need a close above $22, but a close above $23.16 on a weekly basis would be a strong signal as that is the 38.2% Fibb going back to 2002.  I pitched this stock and thesis to a PM in NYC in September and he laughed at me.  Who is laughing now?

AAPL: I still like the product cycles and would be a buyer as it settles.  It is all about product cycles.

JNPR: JNPR was defiantly on the mind when I was thinking about my web 3.0 thesis and Moore’s Law exhaustion.  I read about fifteen reports on JNPR this morning, which is probably ten too many.  I would start by saying I think the company is in the midst of (i) product, (ii) market and (iii) leadership transitions.  These three forces need to harmonize for the company to go on a run and I do not see that happening for some time.

INFN: The company is making a bet on 100G and that they have the ability to scale their business to be a supplier in size to tier 1 service providers.  One cannot criticize the company for not taking on difficult endeavors.

APKT: Waiting on the official results after the pre neg which I posted about here.

YHOO: I think this stock is un-investible.  Negative product cycles and poor leadership; are there any other questions?

PWAV: I posted some thoughts on that last night.

MACRO: The market is really difficult to deal with on a daily and weekly basis.  It reminds me so much of 2008, even though I see people on CNBC who say it is not 2008.  I have posted on this in the past, but I will add when the market swings on reports from news outlets like Reuters, CNBC, WSJ and government officials and central bankers, we might as well appoint a Committee of Public Safety and start the Reign of Terror.

I will endeavor to post additional updates to this tread over the next few days.

Stocks of interest in the next few days:

10.19: RVBD, WDC

10.20: NOK, ERIC, T, STX, MSFT

10.21: GE, VZ

/wrk

* It is all about the network stupid, because it is all about compute. *

** Comments are always welcome in the comments section or in private.  Just hover over the Gravatar image and click for email. ** 

Content Delivery Networks (CDNs) #3

I have written a fair amount about CDNs here, here as well as a post specific to over the top (OTT) video here.  Last week it was with some degree of skepticism that I read this article in Bloomberg about AKAM being an M&A target of IBM or Verizon.  I know nothing about that speculation.  What I do know is a lot about service provider networks, CDNs, networking technology and how content is moved around the internet.

Starting with the premise that it “…may finally be cheap enough…” thesis regarding companies.  I have objected to this notion in the past as a lazy thesis on equity prices.  I do not understand why people really think if a stock price declines, then suddenly some other company is going to jump in and buy it because now it is cheap.  The stock price declined for a reason.  Ask the team at HPQ how well that PALM deal worked out after they waited for the stock price to decline.

The next flaw in the article is the notion that website acceleration and video consumption is one and the same.  As I have pointed out, this is a lazy thesis in which a detailed understanding of how content is provisioned, distributed and consumed is missing from the quote.  This is called context.  People often confuse the initial technology solution provided by AKAM, which was an extremely intelligent and clever idea, with “bandwidth explosion” as quoted in the article.

When I hear grand standing comments such as “bandwidth explosion” without some form of statistical reference I just ignore it.  The initial solution that Akamai provided had more to do with providing distributed (i.e. localized) HTML content and querying for content from uncongested sources via alternative routes than exploding internet bandwidth usage, video, the internet will collapse, blah, blah.  The argument can be made that if the internet worked well enough, meaning that service providers provisioned high capacity service to local users and removed over subscription ratios in the hierarchy of the internet structure, thus flattening the network structure, then there would be little need for a distributed CDN as actual service providers or content providers (e.g. AAPL, GOOG, MSFT, YHOO, AMZN) would easily deploy this capability with little need for third party CDNs.  That is one of the reasons why we have seen the rise of centralized CDNs (e.g. Limelight) and software companies like PeerApp.  It is also the reason why we see a rise in SSDs, flash and the ability to deploy huge amounts of storage in the network.

Let us all keep grounded in reality.  Akamai is a tremendous company and they have extremely valuable intellectual property.  The network is changing and that is why I think AKAM would want to be acquiring companies.  They need new solutions and technologies that address how the internet is changing as their legacy solutions become less relevant.

/wrk

* It is all about the network stupid, because it is all about compute. *

** Comments are always welcome in the comments section or in private.  Just hover over the Gravatar image and click for email. ** 

Market Thoughts 08.21.11

It has been almost two weeks since I posted on my blog.  Work and holiday have gotten in the way of posting content I that I think is worth reading.  I have always been against posting content from others for the sake of posting.  I am not a content aggregator.  Two posts today: one on the market and one later on content delivery networks (CDNs).

The past week was interesting with a European bank borrowing some short term funds, Verizon labor union on strike (note they are returning to work as they are apparently closer to a new deal), hot CPI reading, horrible Philly Fed number and so on.  I occasionally glanced at CNBC during the week and heard a number of people claiming it is not 2008.  In 2008, Verizon juiced CAPEX in the 1H because of a pending labor disruption.  Looks like VZ did the same in 2011.  In 2008 counterparty risk concerns put fear into the markets.  Ditto for 2011.  In July 2008 Chris Cox, head of the SEC banned short selling of banks.  In 2011, the Europeans did the same.  How is it different?

Some brief thoughts on the market:

1. Hope is not a strategy.  That is how I think of the strategy that Bernanke-Obama-Summers-Geithner deployed in early 2009.  Launch QE1 and later QE2.  Force the US banks to capital raise (that was good), insert a large stimulus into the economy (not so good) and force the economy to generate momentum sooner and achieve break-out speed (i.e. hope).  I think forcing the banks to raise capital is good, they put a floor under various asset classes with QE1 and QE2, but the economy has lagged and that is the problem.  We had a credit crisis and we are still impaired as we have not cleared the bad credit; just my simple way of looking at it.  Here is a chart that shows M2/Monetary Base as reported by the Federal Reserve in H.6 and H.3 reports to produce a money multiplier.  I also added the Fed’s reported total assets.  Bloomberg does a similar calculation here.  As an equity investor I want to be able to model the forward business expectations.  Kind of hard to draw positive conclusions from that chart; which is the reason why many economists have reduced their GDP models.  Here is a simple rule to remember: GDP declines, EPS expectations are reduced and multiples contract.

2.  I still hear and read people saying the market is cheap.  I ask what is the EPS expectation for the SPX, various indexes and individual equities?  If numbers are being cut, how is the market cheap?  I think there are aggressive cuts coming to earnings expectations for equities and if this is true the market is not cheap – it is figuring out the new multiple and this will produce big swings until the new consensus is formed.

3. I read various reports over the past week on the risks of a global recession (Joachim Fels) as well as sector notes on tech saying that enterprise and service provider spending is slowing down.  One report blamed it on (i) European stresses, (ii) Federal spending slowdown and (iii) deteriorating macro conditions.  Again, it really does feel like 2008 and I am not saying the SPX is going to 750 – but it seems we transferred all the private sector stresses of 2008 to the public sector and three years later we are still dealing with the stresses of an unresolved credit crisis; it is just infecting governments instead of corporations.

If you are still reading at this point, I started thinking along above lines back in May.  In early June I was worried about the three dislocations meeting and they did.  By mid June I thought I could connect the dots and this was validated.  More evidence of this mess emerged in July and I thought it was folly to invest through the July earnings cycle.

/wrk

* It is all about the network stupid, because it is all about compute. *

** Comments are always welcome in the comments section or in private.  Just hover over the Gravatar image and click for email. **

Two Roads Diverged, Welcome to Downgrade Week

I am travelling this week to CA and on holiday the following week, so postings will be in frequent.  I did get an excellent email question about CDN networks on Friday and I will endeavor to post about CDNs in the next several days, expanding on my response to the reader.

I will be curious to see how Asian markets open and how the US markets do tomorrow.  I ended up selling all my long positions on Friday and shorting the Euro.  I think that will be okay; the bad news is I covered my SPX short, because I was stupid enough to look at the TV when Simon Hobbs was screaming “game changer” on CNBC about the Italian fiscal concessions.  I know, I should never let reporters and screaming TV hosts affect my judgment.  This morning I received one email declaring “Bust out the DeLorean, back to the future – destination 2008.”

There a lot of opinions as what matters, what does not matter, what is priced in, what is not priced in, who wins the AL East the Sox or the Yanks (I will be at tonight’s game) and so on.  I count eight afternoon conference calls hosted by various economists and equity strategists on the meaning of the downgrade from the S&P who pretty much missed the entire housing melt down and global credit crisis.  I plan to listen to none of them.  I might be a bit jaded, but I posted my notes from the Friday before BSC went bankrupt and I will say that denial is a powerful state of mind.

As for how the markets are going to respond, I have no idea and anyone who tells you they know, should look up the meaning of hubris.  The SPX chart is really perplexing with last week closing with a Doji and that is fitting.  I think bears and bulls are all fired up and markets need to be pushed around to determine who wins.  I think multiples are too high, so people who scream that equities are cheap must be using 2016 numbers.  When GDP declines; equity multiples will contract.  For all the dividend champions, just remember dividends can be cut at the whim of the BOD and some people have made a career out of calling for a dividend cut.   The result of all the European mess, QE and US downgrade is unpredictability.  Equity investors dislike unpredictable macro events and my supposition is that equities will do worse until the economy improves.

From a near term historical perspective, it will be interesting to compare and contrast the UK and the US.  Both countries voted in new governments post the global credit crisis and for the first time in thirty years the governments have diverged paths in terms of spending versus fiscal prudence.  Prior to Obama and Cameron, the leaders of the US and the UK had been united from an economic policy perspective.  Bush and Blair, Clinton and Major and it all started with Reagan and Thatcher.  Much of what I blog about is networking technology – not economic theory, but the two are tightly woven together.

1984 was the year that AT&T was broken up – but it was also the year that British Telecom (BT) was privatized.  In the U.S. market, AT&T had existed with little meaningful competition until the formation of MCI.  In the UK Market, British Telecom held unchallenged control of the stagnant market for telephony services.  There was no competition in the UK telecom market and BT existed as a classic government managed bureaucracy in which its employees were more concerned with pensions and work hours than customers and services.  As the Conservative Government of Margaret Thatcher took control, they began to mandate new fiscal policies and BT was the first government entity to be targeted for privatization.  Prime Minister Thatcher infused competitive life into the UK telephony market by allowing for the creation of competitors to BT, such as Mercury, and then forced the privatization of BT.  British Telecom was forced to stand on its own as a for profit company – with no government subsidies.  The shifting economic policies of the western nation-states from state ownership to privatization, set in motion the initial inertia that would culminate in a great revolution in the mid to late nineteen nineties.  Revolutions take time and governments that are entrenched in market ownership do not easily relinquish control of economic assets.  BT was not the only major telecom service provider to be privatized.  From the early 1980s through the late 1990s, a wave of telecom privatization in excess of $154 billion dollars as well as market deregulation expanded throughout the industrialized world.

Within the United States, the desire to reform the government came in the form of deregulation.  Momentum in thought leadership was building and a policy shift by western nation-states from economic polices perceived to be routed in Keyes to the adoption of economic policies grounded in Hayak and the Chicago School had rescued the western world from the economic malaise of the 1970s – only to bring about opportunity for great success and great failure.  Prime Minister Margaret Thatcher and President Ronald Reagan had started this process in the 1980s.  By the 1990s, the energy and telecommunications industries were being deregulated or reformed, which opened previously closed markets to competition.  There is no doubt that the reform of government policies played a critical part in laying the foundation for a massive investment in the internet, telecom and technology markets that would explode from 1984 to today.  Today, we are left dealing with the after effect of government spending.  Which path was correctly chosen will be known in time.

/wrk

* It is all about the network stupid, because it is all about compute. *

** Comments are always welcome in the comments section or in private.  Just hover over the Gravatar image and click for email. **

Memories of 2008 and the Market

I almost posted this yesterday, but I became too busy with work to finish.  Here is something that I started writing in the past year about my experience on buy side in 2008.  On a day like this, it might be helpful.  In early March 2008, I got an email from our DB broker inviting me to a one day conference on the credit cycle.  It was going to be and hosted by DB’s bank analyst Mike Mayo.

The pre-start gathering was reserved; almost somber.  In some ways it felt like a wake.  It was the morning of March 14, 2008.  The hallway chatter was done in small knots of people who knew each other.  There were about 250 people in attendance.  Looking back on my notes, I remember all sorts of snip nits of conversations.

“Well you go to work end up 20% down, go home find out that your house is worth 20% less and go to bed thinking you will live 20% less too.”

“ Greenspan thinks the correction is 18 months long…the good news is the S&P told us we are half way home, only nine more months to go.”

“Remember the good old days when a recession would last 6 to 9 months and a bear market was 2 quarters – now it just goes on and on.”

“Does your calculator allow you to input 100 trillion?”

As people were still gathering and finding their seats, the conference host Mike Mayo, an outspoken bearish financial analyst made the introductory remarks.  “We are in the capitulation stage now, fear has taken over and it will not be long until the full bottom is realized.”  When most of the attendees were seated, the first speaker was introduced.  Her name was Karen Weaver and she had built a reputation as a bearish analyst of scrutinized products at Deutsche Bank.  She analyzed products like those that brought down the Bear-Stearns hedge funds nine months ago as well as Sowood Capital.

Her first slide set the mood for the day “Two big questions facing investors today: Where is the housing market going and who are clients 1-8?”  The tension in the room was immediately cut in half.  Everyone needed a laugh.  She gave a salient overview of the mortgage issues.  The Government is trying to stabilize home prices, keep people in homes and prevent mortgage losses.  The problem is how do you get a six sigma move in a structured product that historically had very little historical volatility?  In the near term we have $230 billion of debt to be funded, $138 billion is not syndicated, $32 billion that is syndicated is not closed and $60 billion is not funded.

What follows are my direct, but edited notes from that session.  I am posting them because when I look back on the conclusions about the private sector, it shows that so many smart people got it wrong.  When you turn on shows like CNBC and Bloomberg as well as the 5,000 investment web sites and 10,000 gold investment web sites, I think everyone should remember that smart people are often wrong, every person has an agenda and no one knows all the data to predict the future.

I do know that much of private sector debt has been transferred to the public sector some ~40 months later and the numbers are much, much larger.  In mid-2008, Bank CEOs were out defending their companies and stock prices.  In mid-2011, Prime Ministers and Central Bank Presidents are our defending their banking institutions and countries.  When times are good, you never hear these people make a speech or give an interview tempering expectations.  Only when times are bad do they grandstand to promote the positive.  I highlighted some bullets.  Remember, these raw notes are from March 14, 2008; BSC was still in business and for the non-investment professional reading these notes, they can be cryptic with a lot of assumed knowledge of financial products.

————————————————————

XXXX, Leveraged Lending

  • How do you get a six sigma move in a structured product that has had very little historical volatility?
  • $230B of debt to be funded…$138 funded not syndicated…$32 syndicated not closed and $60B funded not closed.
  • Mark to market is the issue…it can go lower…AAA related mortgage paper can go lower…80 yields 10-12%

XXXX, CMBS Research

  • US commercial RE market is $3.2T
  • CMBS is $800B of this market
  • CMBS spreads have moved to levels never seen before…AAA spreads in 1998 LTCM crisis were +100bps….now 800 to 1500bps spread
  • AAA 240, AJ 705, AA 895, A 1085, BBB 1965, BBB-1 2050….implied sum losses 35.6, 17, 12.5, 11.2, 10.2, 9.1….historical losses from the 1990s were 2.3 -3.2…today is 10X historical averages and 4x worse losses
  • 1986 Life Insurance losses on commercial mortgage…in a 10-year span 32% defaulted…which led to a 10% loss…
  • We are expecting to see significant price declines in commercial RE…10-15% declines
  • We do not expect to see price declines leading to negative equity as is occurring in subprime
  • We will see softening…but this is not the early 1990s in commercial RE
  • No real deterioration on commercial mortgage loans
  • Very little correlation between commercial mortgages and residential subprime

XXXX, Fundamental Credit Strategy

  • Housing boom is going to take a long time to even out…
  • Fed may let inflation sort the problem…which means a few years of pain
  • Bearish macro, bearish property…but not credit markets because FOMC will be intervene
  • Secular bear market for equities that has been propped up by earnings
  • FOMC will not let credit market unwind leverage on their own…it would be a global crisis if let to unwind on their own
  • Credit spreads at these levels is a perfect short, but FOMC is going to be interventionist so not a good short

XXXX, Global Markets

  • How many more Carlyles?  Answer…we do not know.
  • Look for single strategy hedge funds that are leveraged, with fixed income strategy basis that are big enough to matter.  The answer whether you go top down or bottom up is 24 to 50 funds.
  • Why is this happening?  Real simple answer…under calculation of the risk of default.  It is always the under calculation of the risk of default: LTCM, Milken and now leveraged funds owning collateralized mortgages in which they under valued risk and did not have enough cash reserves to absorb margin calls because they were levered 20-30 to 1.
  • We are now in a prisoner’s dilemma for these funds: 8 in a room with one guard…prisoners sprint for door…two make it and the rest are certain to die or be wounded.
  • Two decision points are colliding:  Hedge Fund managers need to decide if they want to sprint for the door…credit managers need to decide if they drop a margin call on under capitalized funds…it is all of game of risk assessment and who moves first…
  • We are approaching terminal value…at some point price points attract long term money
  • We are in a war between highly coupled systems with leverage and liquidity trying o find equilibrium…
  • Timing the bottom only depends on your time horizon
  • The question is: will portfolio managers take the risk of Bear Stearns?  Why take the risk, you can go somewhere else.

XXXX, CEO and Fund Manager

  • What we are doing in the market right now is losing a lot of money.
  • These things happen every 2-5 years…
  • NOW is the chance to make a lot of money if you have cash.  2 and 20 funds who send out statements every month cannot afford to lose money each month, that is why they avoid BSC, but the long term investor with cash to invest is going to make a fortune if they put money to work over the next few quarters.
  • We have been ramping our positions in financials…I have been buying BSC since JAN and today they got their financing and it will work.
  • Bear is not a fraud…Barings, Drexel, Refco…these were frauds…Bear is not a fraud.  The FOMC will not let Bear fail.
  • Very similar to 1989/1990…I have never seen such a similar market as now compared to 1989-90
  • Wow….80% of the room are equities investors…only 5 are long financials
  • USD concerns me the most…perfect correlation between commodity price increase and decline of USD…biggest negative in overall market
  • Question from audience: BSC is down 16% today, are you still a buyer and long?  XXXX…yes.

XXXX, Hedge Fund PM

  • If you have a lot of capital, you are going to make a lot of money, but not in financials
  • Banks in the US are under capitalized, no reserves, pace of credit problems are accelerating, they have not come to grips to with their problems and I would not own a single bank in Florida.  The only good news is the banks in Europe are in worse shape.
  • Capital market problems are worse.  Rating agencies have no idea what they are doing.
  • The buyers of structure mortgage products are structured mortgage people.  It is Ponzi scheme.
  • What is a SIV?  It is 5% cash, 5% Treasuries and 90% asset backed paper, which is leveraged 20 to 1 based on ratings from the ratings agencies published in the paper…what a joke.
  • We are going through the greatest de-levering in the history…there are a lot more Carlyles and Thornbergs…there is not a real solution but to take the pain over time
  • Nothing is going to stop the de-levering process
  • If you have capital, you have no problems.  The problem is products and funds were funded on minimal capital and high leverage. That is the problem.
  • Even if banks stay solvent, the de-levering process is going to consume earnings.

XXXX, Former Fed person and a CEO of Bank

  • In the summer 2007 we had a meeting with the Fed and head of the major banks to discuss “what could go wrong” and we all focused on geo-political issues, maybe risk is miss priced and there is a lot of leverage in the system, but it seemed all was under control.  A few weeks later it all fell apart.  Two funds in August keyed the collapse, then a fund at a major bank collapsed and the crisis was afoot.  There is clear lack of confidence in the system.  Two or three incidents in August of 2007 created the awareness of risk.
  • August 2007 was an accident waiting to happen.  Subprime just kicked it off.
  • The complexity of models are still too simple to capture human nature.  That is the problem.
  • We have never been able to capture the shift from euphoria to fear…that is why we cannot forecast recessions
  • When the total system is collapsed it is net long…when fear takes hold, it is far more devastating than a rise market because downward moves utilize achieve a force multiplier effect
  • Market stabilization may require coordinated effort by major central banks
  • It is getting very dangerous if the marking down process does not stop
  • If US home prices stabilize, the market turns.  Home equity withdrawals will be a key indicator.  When home prices stabilize, then prices can be marked to market and market turns.  The market is pricing in what seems to be extreme worse case scenario for home prices, which is why if prices stabilize we remove the contagion in the system.
  • We are in the “fear mode” of the cycle, which is greater than the actual results when market stabilizes.  All this is going to take is for one market to stabilize.
  • Look at the Resolution Trust Corporation (RTC)…when the Fed auctioned the collateral, the vulture funds made a killing before Wall Street woke up.  We dumped all our junk far faster than anyone thought we would in an inventory liquidation process.  Today, the process is under way.  We are still some months away, but inventory liquidation of properties is an important indicator.
  • During the euphoria bankers would tell me they were under pricing risk, but they were forced to play the game.  Was that a BOD level problem?  Why were bankers forced to play the game and under price risk in the market like the others?
  • We play a complicated game, if we do not take the risk people do not get compensated, shareholders do not see price appreciation.   If you avoid all the risk, soon you will have no risk to avoid.  It all goes back to compensation because we are paying cash in compensation for mark to market gains.  We had 95% of people make gains and 5% make losses.  Should the 95% take less bonus because of 5% of the people?  It is a very philosophical question.
  • 20 years ago it seemed that banks were very cautious on how they booked reserves.  The mathematicians took over and said your reserves are wasting money and today it seems the banks are low on reserves.  Part of this accounting issue, some of this is a philosophical style.  Earnings and profitability pressures to mark to market have caused more problems than have capital reserves.
  • It is so difficult to compare bank balance sheets that investors do not know what they are looking at.
  • Q…can you discuss the weak USD?  The recent weakness in the USD is the result of a gradual migration from USD to EUROs…this is really a merging diversification that people expected to happen quickly, really took years.  I do not think intervention will make much of a difference.  Intervention does not work because the balance sheets of the central banks are too small to make a difference.  There are 100 trillion arbitrageable (currency) units in circulation and if central banks take an interventionist strategy they create an inflationary effect on their balance sheets.
  • A few years ago if you would have said oil at $100 and Euro/USD at $1.50, people would have said that this was unsustainable and Europe would collapse.  Now that we are here, no one is complaining.  What we do see is some inflationary pressures and the ECB are holding rates steady, but they would actually like to raise rates.  I see no willingness on behalf of European central banks to cut rates.  The only reason they did not raise rates was to calm the turmoil.
  • Q…what is the FOMC’s ability to influence the 10-Year note?  I am arguing that treasuries are losing the ability to control currencies five years out.   Central banks cannot control long term rates.  I would say the rate of the ten year note is a global question.  Short term I think the ten year goes lower, long term it goes higher, but who knows.
  • Q…could a credit derivative market collapse cause a global recession?   It is more than just counter party risk, in some cases with Fannie and Freddie it was a question if they even had counter parties on the other side to create a hedge.  It is conceivable that these guys were trying to create transactions in which they could not find enough counterparties to hedge the risk.
  • Q…what is the affect of willingness not to lend on the US economy?  Are the credit markets anticipating this state?  AG…the decline in long term rates has enabled corporations to fund short term and given rise to earnings and created the rise in buy backs.  Stock buy backs is still rising.  The real problem that is occurring is the tightening of credit on markets that corporate market serves.  That is the problem that this impasse is creating.  If it prolongs itself, we will get profit margins easing off as they have already started.  It is still too early to tell if the economy makes it through this period with little or great affect.

XXXX, CEO of a bank

  • Just flew in from Saudi Arabia this morning, I was begging for money from SWFs.  They all wanted to talk about the credit crisis for ten minutes and then spend the rest of the time talking about Client #9
  • Capital markets have grown exponentially faster than global GDP because of leverage…leverage is the problem.
  • We are going to see most of that leverage wiped out over the next few years…capital will be king, long only fund managers with capital will be most powerful.  Why do you think people are fleeing to sovereign funds?  They have capital.
  • Organizations that rely on yield curves and financing to make earnings are dead
  • I am not calling the bottom, but we are clearly in the capitulation stage.  It will feel really bad until capitulations end.
  • Now is a great long term buying opportunity.
  • I am not calling a bottom in the credit markets.
  • I see no reason to own treasuries…that will be the next bubble to pop.
  • Clients have given us $100B in our liquidity funds…we are seeing huge pools of capital flowing into liquidity funds and when fear eases, this money will flow into equities and start to work
  • We are seeing a remarkable model change…there are going to be massive head count reductions (think 20-25% percent) and if you are not leveraged and not building complex transactions, you need less people.
  • If a bank like Bear goes under, that is a bottom signal
  • My story is so different from ten months ago, I am telling people to forget the fear.  We know who is dead and start looking for opportunities.  I like the whole MSFT/YHOO deal.  MSFT is doing a cash deal and now the PE guys are dead.  We are back to basics.  Large cap CEOs are giddy, because they see the best M&A opportunity in ten years.  This reminds me so much of 1994.
  • One thing is clear the industrial sector is doing well.  EMEA will be affected and they cannot be competitive with $1.50 exchange.
  • Credit crisis is real, going to have a few failures and we are going to have some mergers.  If we did not have sovereign wealth funds, a couple of institutions would be gone already.
  • 3 firms (financial) announcing earnings next week, if losses are as severe as anticipated, the SWF may not be there to help because they are upset with Sen. Schumer and Congress does not understand how much treasuries SWF’s own
  • The problem we have is this is a viscous cycle…Wall Street and banks are refusing credit, raising margin requirements and this is causing institutions to sell…the cycle has not broken, I do not know when it will break.  FOMC has an $800B balance sheet and they are willing to put $200B in mortgages for 28 days.  It should allow institutions to repo to the Fed.  It really did not happen this week, maybe it happens next week. The objective was to allow banks to offer better terms to leveraged players.
  • I do believe that the majority of the credit crisis is over, but it is not done yet.  Over a 2-5 year cycle, the opportunities for investors who have capital are amazing.
  • My checks in the Middle East this past week tell me that the big oil companies think oil should be $78 a barrel and the $110 price is driven by hedge fund speculators.  The firms I met with are already seeing demand reduction, which should moderate price over time.  They are not increasing production.
  • Fin services consolidation?  I think there will be fewer security firms and several will end up with banks that have capital reserves.  The failure of the Citi model is they do not have a deep and broad deposit base.
  • Capital is going to be King!  People who have capital will rule the future.  We are going back to basics wherein capital is king with certain liability bases.  BoA will be a big winner because they have 10% of the deposit base in America.  HSBC world wide looks similar.
  • Worldwide customers are not interested in treasuries at these spreads
  • I see much greater interest in diversifying away from dollar based assets
  • The next bubble will be Treasuries
  • I do not want to speak badly about Carlyle’s hedge fund, but come on 30 to 1 leverage?  The last time lenders let this happen was LTCM in 1998.  Ten years ago.
  • We are not going to go back to a robust securitization market…what will happen is there will be more equity to cushion shocks.  Every country I have gone too feels they were burned, lied to, screwed by the securitization of real estate assets.  They are not coming back.

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The reality is it is all about the economy stupid.

/wrk

* It is all about the network stupid, because it is all about compute. *

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