The Rude Awakening
Wall Street, New York
Tuesday, October 3, 2006 ------------------------- - A quirky pair-trade for the housing-induced consumer-
spending slump, - Watered down Starbucks, another way to jolt your
portfolio, - Wall Street without its morning cup-o-Joe, the
markets so far and lots more...
------------------------- Over-caffeinated and under-rested, Joel Bowman reports... If, by some miraculous chain of events, we manage to be
ahead of deadline in the morning, we take the opportunity
to do some people watching on one of the busiest corners in
Manhattan. We saunter around Broad and Wall Streets,
relaxing after a few hours work and enjoying the commotion
as the rest of "The Street" hurriedly cram into elevators
bound for the skies of Downtown New York. Rush hour in this part of town is a spectacular blur of
blackberry fondling, tie adjusting, cigarette puffing and,
yes, Starbucks gulping. It is difficult to imagine the
scene with any of these actions omitted...yet, if American
consumers continue to lose their grip home-equity
lifelines, an under-caffeinated workforce may be just
around the corner... --- Investing in Metals ---
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to bat for you today http://www.isecureonline.com/Reports/RTA/ERTAGA01 ---------------------------- Buy Spam, Sell Frappuccinos
By Eric J. Fry "Buy Hormel, Sell Starbucks," suggests Stephanie Pomboy,
the freethinking mind behind MacroMavens, an elite Wall
Street research service. Ms. Pomboy offers up this quirky pair trade as a way to
play the housing-induced consumer-spending slump. Now that
home prices are falling, she reasons, American consumers
will not only feel poorer, they will also lose access to
the home-equity lines that have been fueling their
consumption. As a result, they will become less inclined to
buy $5 espresso drinks, and more inclined to buy low-cost
foods of various types. (Since your editor's complimentary
subscription to MacroMavens lapsed long ago, he catches
Pomboy's insights only sporadically and always secondhand.
We must thank the Monday edition of Barron's therefore, for
the latest glimpse into the mind of Pomboy.) 
"The deflation of the housing market is sure to wreak far
more havoc than its dot-com predecessor," Pomboy predicts,
"shaking the very foundation upon which the U.S. consumer
and financial system (with its record real-estate exposure)
now rest." If, therefore, the free-spending – but overly indebted –
American consumer begins to spend a little less freely,
which industries would feel the pinch? And which would
benefit? Your editor would not quarrel with Pomboy's suggestion to
short Starbucks, the purveyor of pricey coffee drinks,
while simultaneously buying Hormel, the purveyor of
inexpensive forms of "meat and meat by-products." But
neither would he rush to implement this trade. As a hard-
core Starbucks consumer, he could not easily imagine a
financial condition so dire that he would abandon his daily
cappuccino. (His children would go without shoes first).
Nor could he imagine a household budget so stretched that
he would purchase a can of Spam...and actually eat it. 
That said, he suspects Pomboy is on the right track, which
is why he finds her second suggestion far more compelling:
Sell financials; buy gold shares. The "sell financials"
half of the trade is easy enough to understand. Demand for
new mortgages is drying up faster than a movie star in
rehab. At the same time, delinquencies and defaults are
increasing on the trillions of dollars of mortgages that
that the lenders still hold on their books. "Contrary to popular perception," Pomboy writes, "the banks
have not shrewdly offloaded all their mortgage risk. They
still hold $3 trillion in direct mortgage loans (or 43% of
total assets) and have another $1 trillion in mortgage-
backed securities, bringing their total real-state exposure
to a record-high 55% of assets." Therefore, Pomboy would be a seller (or short-seller) of
regional banks, credit card companies and sub-prime
lenders. Simultaneously, she would be a buyer of gold and
gold shares. Here's her thinking: As inflation fears give
way to deflation fears, the Fed may begin slashing rates
very soon. But the Fed's efforts will be for naught, "as
over-extended consumers resist the cheap-credit bait." Even
though the Fed's upcoming easy-money cycle will fail to
revive the swooning American consumer, however, it will not
fail to undermine the value of the dollar. As a result,
gold will rally. Because your editor sympathizes will Pompoy's outlook, he
would like to offer a California-inspired variation of
Pomboy's "housing bust" pair trade: Sell Countrywide
Financial (NYSE: CFC)/Buy California Water Services (NYSE:
CWT). Both companies conduct the bulk of their business in
the Golden State. Countrywide is the largest mortgage
lender west of the Mississippi. California Water is the
largest water utility west of the Mississippi. But the
similarities end there. 
At 24 times forward earnings, CWT would not likely dazzle
any value investors. And yet, we would consider CWT a
better value than CFC, a stock that sells for a mere 8
times earnings. Why would we shun the statistically cheap
CFC in favor of the pricey CWT? In a word, "drought" – a
mortgage-lending drought, that is. As the housing bust
continues busting, the "E" component of CFC's PE ratio will
atrophy, if not disappear entirely. The housing boom is
over...and we suspect the bust will last a very long time.
Coincidentally, "a long time" is also the likely duration
of demand for water in California. Water has always been scarce in California. And now that
the state's population – both legal and illegal – is
booming, water has become even scarcer. That's one reason
why CWT has enjoyed a long history of rising rate increases
and rising profitability. Over the last four years, the
company's "revenue per customer" has increased more than
20%, producing a 45% jump in net profit. Not surprisingly,
therefore, CWT has easily outpaced the S&P 500 over the
last several years. Water may not be sexy...but it is very profitable. [Joel's Note: We here at the Rude Awakening like to make
profits during good times…but we LOVE to make profits when
everything goes sour. So now that you've read a few ideas
about how one might profit from the coming
housing/consumer-spending-bust, we like to hear from you,
the faithful readers of the Rude Awakening. If you've got
an idea about how to profit from this dire situation,
please fill us in. Specifically, we'd like to receive
suggestions for a "housing bust" pair trade. Pick one stock
to sell short and one stock to buy, as a way of benefiting
either from the housing slowdown or the consumer spending
slowdown...or both. You can send in your savvy market-stompers to
aussiejoel@the-rude-awakening.com --- Special --- A Shocking Financial Prediction From the #1 Ranked Advisory
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