Now is the time to look at the resource sector

The streets are red with the blood of disemboweled investors. Just the sort of situation that is ripe with opportunity. When emotions run high logic is a distant second.

What’s wrong with this picture?

Enormous allocations of capital have gone in to a variety of companies, including social media, discretionary technology and biotechnology that are speculative at best. Yet they have achieved lofty valuations as money rushes anywhere it may find a return.

Meanwhile, companies in the real world that have viable businesses  are languishing in the current commodity bear market.  Many trading at attractive valuations. What’s the deal?

Now is the time to look at the resource sector.

The backwards logic of QE’s supposed wealth effect

The Federal Reserve has recently admitted, through various policy speeches and interviews, that quantitative easing’s primary goal was to foster a wealth effect by raising asset prices across the board.

If that’s true, then why did the middle class largely evaporate over the same period?  Because the middle class does not own large amounts of financial assets.

Numbers don’t lie

Income inequality and wealth inequality are significant issues. The problem is growing and will continue to do so because the monetary policies enacted thus far have exacerbated the underlying imbalances in the economy.  Growing the wealth of the wealthy at the expense of the rest of the population is not only counterproductive, it’s actually dangerous.

The primary driver of US economic activity is consumption.  That means that a prosperous middle class is critical to a flourishing US economy.  Spenders that have an increased sense of wealth and rising incomes will buy larger homes, make more discretionary purchases, be better equipped to support larger families and ultimately that adds to our GDP.

Economic sanity must be restored

Favoring the wealthy and large corporations has created the problems that our economy will face in the future.  Adding to that, the enormous student debt owed by today’s generation of new entrants to a workforce with less high paying jobs will significantly hinder their ability to buy a home, car or make large discretionary purchases.  Thus robbing future demand from the economy.

This is a significant headwind for the US economy as we move forward in to a future that has been defined by the actions of today.  The only means of reaching an escape velocity whereby the middle class can thrive again is to re-examine the current economic paradigm with a focus on the future.  And I don’t mean in terms of 4 years or the next election cycle.

We can decide our destiny

The future of our country can be a wonderful one should we so choose to exert the effort necessary to make it so.  But that will mean difficult choices about spending priorities, it will mean forgiving large amounts of student debt and favoring the individual over the interests of the corporation (as a change).  It will mean bringing back regulation that strengthens oversight of Wall Street and banks (Glass-Steagall would be a good start).

Most importantly, though, we need to focus on our country.  Minimizing participation in global conflict and putting forward programs to rebuild our nation’s infrastructure.  Our roads, trains, power lines, water pipes and broadband delivery systems can all use a massive investment to bring the US back to being a global leader. A position we have earned, but have failed to maintain.

Seesaw market creates opportunities in volatility

There is a lot of emotion charging the market, creating exaggerated moves both up and down.  One day everything is fixed, the next everything is broken.  Manic depression wouldn’t even begin to describe the back and fourth being witnessed.

But with chaos comes opportunity.  And the opportunity here is finding beaten up, misunderstood and frankly cheap assets.  Right now the areas that seem to be most attractive are commodities, commodities companies, energy and energy companies.

The global markets are pricing in worldwide depressed demand.  Oil producers are pumping at frantic rates, more concerned about the flow of cash than the margin on each sale.  This has created a glut of energy supply — and with little demand oil prices have crashed below $30.00 to about $28.00 a barrel for West Texas Intermediate Crude (WTIC).

Consider the following opportunity: The US dollar has had a rally which induced a de facto tightening even before the US Federal Reserve raised interest rates.  As such, one can reasonably expect that the actual pace of interest rate tightening, with the backdrop of a softening US economy, will likely be subdued.

Markets have priced in a more aggressive interest rate hiking cycle, which is putting pressure on everything that’s priced in dollars.  Even stocks.

I think that we’re getting ahead of ourselves here.  The Federal Reserve is unlikely to let this situation turn in to a full blown 2008 panic again, unless there is a desire to bring back all the calls to audit the Fed and the political upheaval that protests and social unrest would bring.  Instead, especially given that it’s a critical election year, I believe the Fed will tap the breaks and ease off the gas, leaving interest rates at 0.25% and possibly cutting them to negative levels if the global slowdown increases in momentum.

Energy falls, stocks mauled

There’s a deflationary wind that’s been blowing this way since late 2014. It’s been strengthening since the August 24th intraday market crash in the US. And now I think it is really picking up.

What comes of this brewing storm has yet to be realized in equity markets, but energy prices (and the companies vulnerable to lower profits) have tumbled. As have the prices of mining companies and the materials they extract.

The weakness in China coupled with a slowing US and EU consumer portends to a long-term deflationary headwind.

And don’t look now, but the Japanese Nikkei market seems to be crashing…

Gold’s 2015 performance in various currencies (chart)

The Brazilian Real was walloped and the dollar was clearly a standout winner. Gold’s relative underperformance shows against US dollars that the US dollar is still seen as a safe haven currency.

Until that changes gold will underperform as measured by US dollars. I think we’re closer a that point in time when we see positive price action then we were a year ago, but I can’t say for certain if the markets will agree until stocks move in to a bear market.

As seen in the start of 2016, when stocks were out of favor, gold caught a bid and moved higher each day stocks were sold off. Now that stocks are catching a bid, gold is selling off.

Whether or not 2016 is the year that stocks enter a bear market remains in question. I am inclined to think that we have only seen a prelude for the downside in stocks that could occur this year.

An open letter to Barracuda Networks (CUDA) management

I am a recent investor in Barracuda Networks (CUDA).  Needless to say the earnings miss and subsequent market reaction between Thursday evening and market close on Friday was quite disconcerting.

During the conference call on Thursday, January 7th, Barracuda Networks CEO BJ Jenkins stated that a ‘faster than expected‘ migration to hybrid and cloud-based solutions was a catalyst for weaker than expected billings.

The problems, from my standpoint as an IT veteran and tech investor, seem to be in planning and execution.  There are a number of shortcomings which I can see that may give pause to Barracuda’s long term growth prospects:

1: Employee retention, compensation and work environment morale complaints are considerably higher than the industry average.  This leads one to believe that productivity would also be impacted:

https://www.glassdoor.com/Reviews/Barracuda-Networks-Reviews-E39922.htm

2: Product prices that may scare away small businesses.  Thus pushing them in to subscription-based cloud offerings as an alternative.  I have dealt with this problem first hand with many of my clients who are inclined to move from on-site equipment in to cloud-based solutions.

Something has to give, whether it’s the core product price or the energize update price.  A discount would incentivize higher sales.

3: Slow, inexperienced front line support.  From an IT consultant who works with Barracuda Networks products and support regularly, I think that there is room for improvement.  I recently called in Barracuda Networks for support on a VPN product.  The first person I spoke to clearly had no technical knowledge whatsoever.  This, combined with the long hold time to reach an actual technician was a less than optimal customer experience.  Fortunately the technician who eventually came on the line was helpful.

4: Lack of trust.  I cannot emphasize this enough.  In the wake of all of the data breaches, espionage and with Barracuda Networks trying to gain a larger foothold in cybersecurity, trust has to be a number one priority.  Some years ago a remote backdoor was discovered in Barracuda Networks products and the management effectively stated it was not a big deal.

http://krebsonsecurity.com/2013/01/backdoors-found-in-barracuda-networks-gear/

From an IT consultant’s perspective that’s a very, very big deal because we have a moral obligation to warn our customers against using such backdoored products.  After all, backdoors rarely stay secret for long.  My advice is to get ahead of the trust issue.  Ensure the public knows that Barracuda Networks would never install any backdoors, remote management or other sorts of potential security vulnerabilities.

Believe it or not in my network of IT contacts, there are many that still to this day refuse to buy or endorse anything Barracuda-related because of the issue not being publicly addressed to satisfy their quandaries.

5: We need true, industry disrupting innovation.  Not incremental improvement.  A renewed focus on virtualization, cybersecurity, threat detection and mitigation is path forward that will be greeted by the highest revenues.  IT spending has plateaued and in all likelihood so has the US equity market.

What will make Barracuda Networks stand apart from its peers is innovative, unique and cost effective solutions to the growing data breach epidemic, keeping virtualized environments secured from attack, working on automated threat mitigation strategies and showing these technologies as Barracuda Networks’ core focus for 2016.

In closing, I hope that this information is found to be constructive. I am cautiously optimistic that Barracuda Networks can turn itself around and rebuild value lost to investors.  It will take a lot of hard work, ambition and some calculated risk taking to reach that point.  And once there, even more to maintain it.

This message was sent to Adam Carson, VP of Finance and Investor Relations at Barracuda on January 9th, 2016.

China halts, dollar faults, buyers bolt

Storms are brewing. The wind will carry them from the east to the west. Be careful out there.

Thursday will be another difficult day in stocks and risky credit markets. The dollar is no longer being seen as much of a safe haven. Gold is catching a bid, but for how long?

This time it’s different

The last time the market crashed, commodities were booming until they weren’t — and then equities tanked even more.

This time commodities are ahead of the business cycle as represented by equities.  At least in the US.

It seems as though we are confronting a new era. One where many other asset classes, including commodities, credit (bonds) and foreign currencies may be first in line to suffer from headwinds in global economic growth.

But that doesn’t mean that stocks will lag too far behind.  It just means that investors have been given every single warning indicator possible that something is amiss.  The question is, will anyone pay attention?

Stocks, dollar topping. Commodities closer to bottom.

It’s my opinion that the stock market rally, which lasted from early 2009 until late 2014 by many accounts, is largely over. Charts show a consolidation churning over the last year that gives reason to believe that the bull market is long in the tooth. The momentum in stock market buying has significantly stalled on a technical basis.

Fundamentals don’t look much better as earnings haven’t been particularly stellar in retail, materials, energy, construction and industrial equipment.

The dollar rally, which brought the dollar from about 78 in 2011 to just over 100 in 2015 seems to be topping out as well.  There’s not much conviction over the 100 level and the long dollar trade is quite lop sided with bulls outnumbering bears by the highest levels in years.

Meanwhile, commodities have been sold off to lows we haven’t seen in years if not decades in some cases.  The very stuff that drive economies, trade and the basic fundamentals are selling off as if the abundance of supply and lack of demand now is a permanent situation.

Markets always look ahead, until they don’t.  And sometimes they get a bit emotional both on the way up and the way down.  That emotion can drive exaggerated reactions.

The biggest emotional reactions tend to happen during periods of excessive greed during a top or excessive pessimism during a bottom. These emotional extremes can drive prices in to areas where opportunities may be realized by taking the opposite position.

That is to say, sometimes being a contrarian, while risky, can also pay off big.

I’m of the belief that this is one of those times.  The emotions are running high with stock and dollar bulls as well as commodity bears.  In fact I think it’s reasonable to speculate that many of these trades are tied together: long the dollar and stocks and then short commodities (and their equities) to maximize alpha.

It’s been a great trade for several years — there’s no doubt about that.  Most funds participating in such a trade have delivered outsized returns.  But now that positioning has matured, the gains have been largely realized and taking the opposite position may be more lucrative and less risky.

It may be time to consider going long commodities and taking a short position against equities. But don’t do anything risky without talking with a qualified investment professional. Good luck investing!