I think that the United States stock market will continue to run.

The collapse of the foreign sovereign debt market has made U.S. treasuries relatively more attractive. In addition, bond investors will be looking to U.S. companies with high credit ratings and low debt/equity ratios instead of sovereign debt in general.

This could have long lasting effects, and set off a reflexive chain of events. As investors purchase the bonds of U.S. companies, the yields on these bonds will decrease, making it much easier to sustain larger levels of debt than it has been in the past.

Further, the larger amounts of credit available to companies will allow them to grow at a faster rate. Thus, the companies can shore up their balance sheets and issue new bonds at the same credit rating to continue to grow.

The relationship with stocks will also be reflexive. As the companies grow, their stock prices will also increase. This will decrease the debt/equity ratios of the companies, and make the companies bonds look even less risky.

This situation depends on the companies in question being able to grow their earnings using their credit. Thus, we should look for companies that have growth opportunities, but have been limited thus far because they have not been willing to issue new debt.

Some companies that come to mind are TMO, Thermo-Fisher Scientific, which was one of the first companies to issue new debt at low interest rates following the U.S. downgrade, and CAT, Caterpillar, which relies on high debt loads to fund their manufacturing. CAT is currently sitting on a large backlog of orders.

These are not recommendations necessarily, but they are starting points for further research.

This situation could grow untenable if the companies have no further room to grow. I believe that a collapse in many non-Asian emerging markets is imminent, as a result of the contraction of European credit. Ironically, this could spark a short term rise in U.S. stocks in early 2012, as money managers to pull funds out of riskier emerging markets, like Eastern Europe, and put them into more secure growth stories, like China, or value stocks in America.

But longer term, this may hurt American companies that do business overseas, by contracting their growth opportunities. Further, the high U.S. unemployment will eventually limit U.S. consumers ability to spend, unless new solutions are found. Thus, the situation on a longer term than 1-2 years may not continue, but I believe that the stock market can continue to rise for the near future, on a debt-fueled growth spree.

I sold my Apple shares a few weeks ago, and I am growing more convinced that it was a wise decision.

Why? I am not convinced on the performance of the stock for the foreseeable future.

I still believe the company has great prospects, and will continue to make a lot of money. But I do not believe that the stock price will continue to rise as it has in the past.

Apple has continually benefited from a positive relationship between expectations and reality. The company provided guidance that was conservative, and analysts began to ignore the guidance. But, for several years straight, analysts’ expectations proved to be conservative as well, as Apple continually blew away earnings expectations.

However, this is changing. Because of its continued earnings beats, the analyst community has gotten used to less and less conservative expectations. And now, the company has changed its earnings guidance policy.

The change was noticeable on the prior earnings conference call. Apple revised guidance upwards for Q4, which caused analysts to overshoot that guidance. As a result, Apple did not beat the analysts expectations for Q4. The stock subsequently dropped from the 420 range to sub 400.

Apple management pointed to the delayed launch of the 4S iPhone, and upped guidance for Q1 2012, based on high expectations for 4S sales.

Now, this puts tremendous pressure on the company to perform. Analysts will still expect higher earnings than the guided figures. If Apple cannot meet these figures, it could set off a drastic change in events.

Why drastic? Because the fundamentals of Apple’s operation are directly tied to its stock price. Ever since 2001, the fundamentals of the company and the price of the stock have enjoyed a positive reflexive relationship.

Apple has been a net seller of shares every quarter. As expectations increase for the company, the stock price increases, and Apple can issue shares at a higher price, raising more capital for research and development and operational costs.

Apple’s continued growth drives costs higher and higher, but so far, these costs have been mitigated by the simultaneous rise in stock prices. However, if stock prices should begin to fall, operational costs will become a larger and larger burden on the company, and could begin to drain its vast cash reserves.

Now, of course, Apple is not wanting for cash. Its $81.55 billion would be able to cover its 2011 operational costs ($19.5 billion) four times over. However, it partially financed those costs with $831 million of stock issues.

Recent news seems to point to 4S sales not being as robust as previously anticipated:

http://www.forbes.com/sites/ericsavitz/2011/11/09/apple-reportedly-tells-iphone-parts-makers-to-delay-shipments/

“sales of the iPhone 4S have not been as strong as those concluded in the pre-sales period”

Right now, the risks to the stock price are too large. Though Apple would seem to be a value play at its current prices, it does not pass a sufficient margin of safety. There are far better opportunities in the current market. We will have to wait and see if results can again surpass expectations for Q1 2012 to tell if the Apple juggernaut can continue.

I hate to harp so much on one stock, but I just reviewed the Q2 2011 conference call, and I am even more convinced that we will see a quick pop in the stock after IMAX announces earnings for Q3.

I have already expounded on the reasons for IMAX’s drop YTD – the poor quality of films for the first half of 2011. But I believe that the two biggest contributors to IMAX’s revenue this year will be Transformers and Harry Potter, which both occurred mostly in Q3. Indeed, Rich Gelfond mentioned in the conference call that IMAX had already generated $88mm in revenue in the first 28 days of Q3, as compared to a revenue of $98mm in Q3 2010.

Thus, IMAX is likely to post some pretty impressive year-over-year growth figures next week. This is still a risky trade, because the consensus earnings estimate for this quarter is .18, which suggests that the market already expects a 20% year over year growth figure. But, at its current valuation, I still think, even if IMAX only meets expectations, we are likely to see a pop.

I may buy some more shares in the next week, because I think this might be the last time that shares are this cheap.

Disclosure: I own shares of IMAX. I may buy shares in the next 7 days.

Fascinating Forbes article here about perception and reality in relation to 3-D movies:

http://www.forbes.com/sites/dorothypomerantz/2011/09/21/how-james-cameron-hopes-to-defeat-the-3-d-hype-cycle/?partner=yahootix

James Cameron’s Reflexive View

Reflexivity is based on the theory that perceptions influence reality, and reality influences perceptions. A misperception could influence reality just as much as an accurate perception.

Here is Gartner’s prediction of the public perception of a hyped trend:

As James Cameron points out, the chart represents perception, not what is certain to be reality. But, he also points out the possible risk in this scenario.

If the “Trough of Disillusionment” grows too great, that is, if the studio’s misperception about the state of 3-D persists, and the public’s willingness to spend on 3-D remains at low levels, studios may act on that misperception, and actually change the reality of 3-D movies – they will stop rolling out 3-D features.

James Cameron’s approach is to alter the studio’s perception by re-releasing a blockbuster, Titanic, in 3-D, at great expense of time and money, so that studios will follow suit. Perhaps it is working; Star Wars, Episode I: the Phantom Menace, is scheduled to be re-released in 3D next year.

I am not as optimistic as Cameron on the future for 3-D as an omnipresent technology. I believe that the roll-out of cable television in 3-D will not be widely accepted until 3-D technology no longer requires glasses to view. Since Cameron mentions that television is instrumental to 3-D technology becoming ubiquitous, and since the state of 3-D television and 3-D movies influence each other, I believe we are far from that time currently.

I think that the real reason behind this trough of disillusionment is that the studios have simply not rolled out movies that were visually stunning enough. No movie has come close to what Avatar did in terms of visual effects.

For a movie to be truly worth the extra cost of 3-D, they have to play with depth perception. Vast shots, landscapes, and explosions all hold promise. But perhaps most promising is outer space.

No Science Fiction movies with wide mainstream appeal have hit theaters this summer. I feel that the kind of fandom that Science Fiction engenders is unrivaled across the genres. Sci-Fi fans are probably more willing to spend extra to improve their experience.

This is why I think that a Star Wars 3-D reboot is a great idea. The fact that the Phantom Menace is coming out next year only reinforces my idea that the 2012 upside for IMAX is enormous.

Conclusion

If the theaters continue to avoid the kinds of movies that 3-D truly benefits from, this could translate into increased disillusionment, and decreased spending by studios on 3-D conversions. This constitutes a MAJOR RISK to IMAX. In fact, this misperception may have already started a reflexive process to the downside of 3-D movies, that may be unavoidable, even with the 2012 movie slate.

If studios decide to continue 3-D re-releases of an old franchises, and the likely blockbusters of 2012 (Avengers, Hobbit, Amazing Spider Man, Dark Knight Rises, Men In Black III) are successful in 3-D as well as 2-D, then perhaps this reflexive process can be undermined.

Time will tell on this one. I am considering purchasing more shares of IMAX, believing we are only in a “testing” period of the public’s fascination for 3-D movies that will end when more appropriate 3-D movies come out.

Disclosure: I own shares of IMAX.

I took a nibble on ICE. Okay, I took more than a nibble.

I started out with about a third of the position size I wanted ideally, given the right prices. However, I don’t think prices are as good as they can get on ICE right now. However, I am reminded of the old Buffett saying: “A good company at a moderate price is better than a moderate company at a good price.” I am also reminded of Peter Lynch’s advice in One Up on Wall street: If a stock you like is too expensive, buy a small position so you can track it, and add to it later if it gets cheap.
So I took a small nibble at first. But I couldn’t help myself. I wanted to put more in – my gut was telling me to. So I doubled my initial position.
I just hope that an international disaster in credit default swaps doesn’t take out ICE’s guaranty fund. That is the risk here. But this source of risk is actually one of tremendous upside as well. Banks hedging risk and speculators are bound to be gobbling up credit-default-swaps on the European debt right now, and as long as massive defaults do not occur, the tremendous volume could be very profitable for ICE.

I own shares of ICE.

I am suffering from an abundance of stock ideas.
The recent market downturn has created so many opportunities, I am reluctant to choose.
But, as always, capital is limited, So let’s start at the top of considerations.

ICE – this has been on the list for some time. The rich cash generation and durable competitive advantage – in the form of regulatory licensing – make this a strong company with a wide moat around its business. ICE has been eating into the business of it’s main competitor, CME, for years. Keep in mind, I am bullish on CME as well, together these companies have a duopoly of energy and soft commodity trading in the US and most of Europe.
But ICE is the fast growing new kid on the block.
I am currently more bullish on Brent crude volumes, which are primarily traded on ICE’s systems, than WTI crude volumes, which are primarily traded on CME’s system. The WTI is currently a “land-locked” crude – and prices are being discounted because the oil stored at Cushing, Oklahoma is not available for easy transport to refineries at the Gulf. All pipelines from the Gulf are pumping oil from the Gulf to the inland, and there are currently none the other way. So, WTI has been dealing with a price depression because of the glut of oil accumulated at Cushing with nowhere to go.
What does this mean for ICE? Brent crude (ICE’s benchmark oil product) is carrying a price premium right now because of its sea-borne nature – it is based on North Sea oil – and easy transportability. Further, speculators are pushing up Brent prices because of unrest in the Middle East – a bet that Europe may have to depend less on Middle Eastern oil in the future, increasing demand for Brent crude.
The fact that Exxon and BP have both been eyeing the Arctic circle for new exploration activity also bodes well for Brent Crude volumes. Any new exploration in the Arctic circle is sure to have crude that is priced relative to the Brent benchmark, and should increase volumes for that product as the producers seek to hedge their prices.
I will confess, I am a little uneasy about ICE’s CEO, Jeffrey Sprecher. Sprecher is a seemingly incourigible optimist, but the attitude has served him very well in his time at ICE. However, I was rattled by ICE CEO Jeffrey Sprecher’s decision to join with Robert Greifield of NASDAQ in making a rival bid for the NYSE Euronext exchange. While the Liffe business (the part of NYSE for which ICE was bidding) has a durable competitive advantage – the LIBOR product traded on the Liffe platform is widely tracked across the banking industry – I felt that the offer was high relative to the value of the business. I also was slightly worried that ICE’s balance sheet might tip too debt-heavy, though, as Sprecher was eager to point out, ICE’s rich cash flow can handle a substantially larger debt load than it currently does. I was glad this deal did not go through, and that instead, ICE will be looking to invest elsewhere.
Another reason this rattled me so much is that it happened so quickly I wondered whether ICE management was accurately weighing the risks of the transaction.
However, I do respect Sprecher’s willingness to continue to invest in acquisitions to grow ICE, and his forward-looking vision that allows ICE to take risks to enter profitable markets well ahead of competitors, as long as ICE is not taking on serious amounts of leverage to do so.
I believe, in addition to its energy Futures, over-the-counter (OTC) energy, soft commodities, metals, and forex markets, ICE is primed for massive growth in a couple of new markets. ICE owns the largest carbon credit exchange in the world by volume (1). California has recently pushed through cap and trade legislation, and the European Union Emission Trading Scheme has been in effect since 2005. Though this market currently contributes only a small amount of revenue, in future years it holds the potential for growth.
ICE is still the ONLY service cleared by regulators for Credit Default Swap trading. Now, the rules are still being sorted through with regulators as to how this market will be governed, but one thing is for sure: CDS trades will be transferred onto a transparent exchange and clearing service, and, as a first-mover into this industry, ICE has set itself up to have the advantage over rivals like CME and whoever else chooses to enter the market. However, there are still risks I am worrying about related to this business. For example, ICE has a Guaranty Fund to cover the default of up to 2 of the largest Clearing Participants. However, if a major credit default event occurred, would ICE be liable for defaults over and beyond the 2 largest? Granted, this could only happen in a second “financial armaggedon” type scenario, but it is something good to know. I will have to comb over some conference calls to see if this has been covered. For more information on ICE’s CDS clearing business, see (2).
Another exchange battle with CME is occurring in Brazil. CME has traded stock with BMF Bovespa, the leading Brazilian exchange, in a 5%/5% swap. This has primed CME for the explosive growth that Brazil is experiencing. However, ICE has bought into Cetip, a second Brazilian clearing firm, and plans to create competition to BMF Bovespa in electricity trading. this could be a potential source of growth, but, of course, is nothing to count on.
ICE management recently acknowledged that they may begin a more rigorous share buyback program, as the market has not yielded any more prime deals.
But, as rumor would have it, the London Metals Exchange is being courted by a possible suitor. It is not wise to believe every rumor that you hear, but if this is true, I think this would be a great complement to ICE. LME still conducts much ots trading by the open-outcry system, complete with a trading pit and floor traders. Such a system is unnecessarily costly to operate. As ICE demonstrated with its 2001 takeover of the International Petroleum Exchange, conversion from the open-outcry system to an all electronic system can save money and widen margins for the exchange while lowering spreads and reducing transaction costs for market participants. If the rumors are true, and if ICE can get its hands on LME, it could hold a great potential upside.

As far as exchanges go, my favorites are still the two competitors*, CME and ICE. Recent declines in CME have offered tremendous value in that stock as well. But ICE remains the stock with the largest potential upside, and management that is focused on continual growth.

I currently own shares of CME, but would like to purchase shares of ICE soon, definitely before ICE reports on November 2.

(1)http://www.bloomberg.com/news/2011-02-24/ice-to-publish-serial-numbers-for-unusable-emission-credits-1-.html

(2)https://www.theice.com/publicdocs/ice_trust/ICE_CDS_Buyside_Clearing_Overview.pdf

(3) ICE’s latest 10-Q http://www.sec.gov/Archives/edgar/data/1174746/000119312511207376/d10q.htm

* I am currently investigating the Singapore Exchange (SGX). The net profit margins for this exchange are VERY wide, and the exchange looks attractive, as Singapore is rapidly becoming a trading hub. As it is a foreign stock, I would have to purchase over the counter, which makes me a little more cautious.