A few months ago BullBearTrader highlighted a U.S. News and World Report interview with Jon Auerback, in which he discussed potential new BRIC-type countries (see the original article, or initial post). In the article Auerback mentions Nigeria, Zimbabwe, and Kenya as potential regional opportunities. Other analysts and investors have also begun to talk about Africa as being one of the next regions for achieving above average growth and investment opportunities, even given some of the political, economic, and inflationary risks that still exists.

To take advantage of current and future redistribution of capital into Africa, Van Eck Global is offering a new frontier market exchange traded fund called the Market Vectors Africa Index ETF (AFK). For more information, see the IndexUniverse article, or read the prospectus. The AFK is not the first vehicle to begin tracking the performance of companies domiciled or operating in Africa. In a recent post we discussed the newly offered PowerShares MENA Frontier Countries Portfolio (PMNA). The PMNA tracks the Nasdaq OMX Middle East North Africa Index, which includes the countries of Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Nigeria, Oman, Qatar, and the United Arab Emirates.

The AFK is unique in that it follows the Dow Jones Africa Titans 50 Index, covering 50 stocks from 11 different African markets, including Nigeria (32.5% weight total, 25.2% onshore, 7.3% offshore), South Africa (26.2% total, 24.7% onshore, 1.5% offshore), Egypt (13.1%), Morocco (11.4%), Equatorial Guinea (6.2% offshore), Zambia (3.4% offshore), Angola (2% offshore), Mali (1.7% offshore), DR Congo (1.5% offshore), Kenya (1.2%), and Ghana (0.7% offshore).

A few points are worth noting about the index. For one, not all of the companies in the index are domiciled in Africa but are nonetheless included since they derive a majority of their revenues from African markets - thus the classification of "offshore." Also, the index is not constructed totally of frontier markets. Both South Africa and Egypt are typically classified as emerging (see previous post for a discussion of the distinction between emerging and frontier markets). This classification is important given that the emerging markets represent nearly 40% of the index. This actually gives the index both the higher growth and return potential of the higher-risk frontier markets, but also some of the liquidity of slightly less risky investable emerging markets.

The index is market cap weighted and sets maximum holdings at 25% for countries and 8% for any individual companies. Of interest is that Nigeria is already overweight at 32.5% total weight, with 25.2% onshore. It is not clear if the offshore percentages are included in the 25% country limits. Banks currently make up 33.7% of the index, with basic resources at 18.2%, oil and natural gas at 13.5%, telecommunications at 10.2%, and technology at 7.3%. As for components, the fund states that it "..will normally invest at least 80% of its total assets in securities that comprise the Africa Titans 50 Index." Companies must have market capitalizations greater than $200 million. The fund's prospectus also mentions that it may utilize derivatives. The expense ratio for the fund is 1.2%, which can be waived down to a net expense ratio of 0.83%, but is still expensive compared to some of its peers.

While not a pure frontier market ETF (there currently are none), the index does give concentrated exposure to the African region, allowing investors to follow their belief that growth in Africa may be the next big thing. Given capital flows into Africa, and the benefits of higher commodity prices for some of natural resource rich countries in the region, a small exposure to Africa within your portfolio may be worth considering.

The SEC is looking to expand investigations into the spread of false rumors that may affect the financial system. Articles at Reuters and Bloomberg mention the recent slide in Freddie Mac and Fannie Mae, as well as Lehman Brothers, for the increased SEC attention. No word in either article whether a member of Congress will be investigated after the recent collapse of IndyMac, although an LA Times article does mentioned that some federal regulators are looking into the issue.

This all comes just as the International Herald Tribune is reporting how banking analysts are predicting that as many as 150 of the 7,500 banks nationwide (mainly small and mid-size) could fail over the next 12 to 18 months. Others disagree and state that while there will be liquidity issues, many lenders are likely to first either shut branches or seek mergers with stronger banks. The article also notes that the nation's banks are in less danger now than in the late 1980s and early 1990s when over 1,000 institutions failed during the savings-and-loan crisis. Unfortunately, even with less bank failures, the $125 billion government bailout that resulted at the time may seem like a good deal if things were to get as messy this time around. Hopefully we can avoid reaching the same levels, but some analysts are not optimistic.

Some perspective is in order. In 1994, the FDIC listed 575 banks that it considered to be troubled, while earlier this year only around 90 banks were listed - but the list is probably growing. Yet given recently developments, more failures are likely beyond the six already reported given that bank failures are a lagging indicator. Of interest is that IndyMac was not on the troubled bank list earlier this year, highlighting the fluidity of the problem. Also, of the $53 billion the FDIC has to reimburse consumers of failed banks, IndyMac is estimated to need between $4-8 billion, putting more pressure on existing banks, and possibly forcing the government to get more involved as it has recently with Freddie and Fannie.

Not unexpectedly, short sellers are jumping into the waters as various regional banks, such as BankUnited Financial Corporation (BKUNA), now trading under a dollar, and the Downey Financial Corporation (DSL), trading between $1-2 after reaching a 52 week high of $65.67, have been highlighted as having potential problems. In order to spot banks in danger, two popular ratios are used. First, when you divide non-performing assets by all outstanding loans, you find that a ratio over 5% signals danger (see CNBC article). Using this ratio you find that other banks, in addition to BankUnited and Downey (BankUnited's ratio is 5.36%, while Downey is at 13.86%) are suspect, including Corus Bankshares (CORS) at a 13.18% ratio, Doral Financial (DRL) at 12.82%, and FirstFed Financial (FED) at 6.73%. A second commonly used ratio that compares non-performing assets divided by reserves plus common equity causes Washington Mutual (WM), with a ratio of 40.6%, to also become suspect. Any value around 40% is thought to be in the danger zone.

As expected after the news leaked out Friday morning, the WSJ is reporting Sunday evening that Anheuser-Busch has agreed to be acquired by InBev for $70 per share, or nearly $52 billion. Hopefully you had less connection than myself and made an options purchase. Even with the tenuous credit and equity markets, I am sure there are some investment bankers happy to make the deal happen. Given the lack of stock activity in BUD over the last six years, I suspect shareholders will also have no problem approving the deal. (I guess now I am glad that BUD sold the Cardinals a few years back. At least St. Louis still has baseball).

A few years ago it seemed that all we heard about from stock market pundits were the exchanges and how they were literally printing presses for money. They were the gate keepers at the toll booths of trading, taking a small cut every time a trade matched. As trading volume increased, and platforms became more efficient, the ability to generate steady and growing profits seem limitless. And then of course, the market sold off, trading patterns and hot products changed, and the stock prices of the exchanges corrected.

As the charts of the Nasdaq OMX (NDAQ) and NYSE Euronext (NYX) show (Source: StockCharts.com), it has been a difficult two months for the stocks of the exchanges. The drop in prices has been severe enough that many of the stock pickers that seemed to continuously pump the exchanges, even through the current downturn, have recently found themselves throwing up their hands and admitting defeat.

This week Barron's has an article that is taking a different approach, laying out an argument why one exchange in particular, the Nasdaq OMX, may be a good buy. With estimates of $2.50 a share in earnings (a little on the high side from consensus estimates), a 25 multiple would value the company at $62.50 a share. Why use a 25 multiple? Both Visa and MasterCard tend to be given 25 multiples, and when you get right down to it, Nasdaq OMX is a transaction processor without credit risk, similar to Visa and Mastercard. Beyond financial estimates, another reason for considering Nasdaq OMX involves the benefits they are seeing from their recent acquisitions which have helped to diversify their businesses, as well as provide a global presence. Revenue is nicely spread out between global issues (20%), market data (19%), derivatives (17%), U.S. equities (15%), Nordic equities - OMX merger (9%), market tech (8%), and other (12%).

It really is astounding to think that only 15% of Nasdaq OMX revenues now comes from U.S. equity trading. If you believe that global markets will continue to boom due to the increased levels of global capitalism and subsequent flows of capital worldwide, then Nasdaq OMX may be well positioned to take advantage of this growth. In addition to global growth, Nasdaq OMX is also increasing their exposure to the higher margin derivative business, now at 17% of revenues, and expected to increase.

While the story is intriguing, buying Nasdaq OMX at this point in time may require a little leap of short-term faith, given that you picking a bottom in the stock after the recent correction, even though the Barron's article should provide some near-term support and buying pressure. Nonetheless, at $23.70, the stock is obviously well off its recent highs, and unlikely to hit its 2003-2005 lows under $10 per share given the current diversified revenue stream (unless the current market meltdown continues and spreads - not totally out of the question). While the stock could be poised for a rebound, and again will most likely get some type of Barron's bounce or support, it may be safer to wait for additional market clarity. This is not to say that the stock will not rally from here, it very well may (I have been burnt betting with and against the Barron's rush before), but it needs to remembered that the stock has been a "good buy" all the way down from $50. It may be worth a few points to wait for a retest of the support that was recently broken to see if stock can hold up without the Barron's bounce. While the Barron's article may provide the catalyst needed to push the stock price back through previous support (now resistance), whether or not it holds will depend on more than another trader or article discussing how the stock continues to be a good buy.

If you have not already had a chance to check out the Pickens Plan, have a look. It is worth the time to visit the site and watch the short video (linked below). Regardless of your impression of T. Boone Pickens, his past politics, or any skepticism you may have about motivation, it is worth your time to begin thinking about the energy issue, and this is a good place to start. There is actually a little there for just about everyone, including natural gas producers, hybrid, electric, and alternative fuel automobile makers, solar, wind farmers, and electricity producers. Both green and conventional cleaner burning sources are considered. Even crude oil will still have a presence as we make changes in how energy is used over the next few decades. I applaud Mr. Pickens for at least coming up with a plan for people to begin discussing and debating. As Pickens states, we need to settle on something and start marching in the same direction. Time is no longer on our side.

Zubin Jelveh provides an interesting chart (reproduced below) over at the Odd Numbers blog at Portfolio.com. In the article, Jelveh discusses how the S&P 500 (which is officially in -20% correction bear market territory) has been in a bear market six times since 1950. The chart shows the number of days it took to hit the bear market, how long from bear market start to market low, and low long before it made its way back to the previous peak. Overall declines are also included.

Source: Portfolio.com (Odd Numbers blog - Zubin Jelveh)
From the chart, Jelveh identifies that there are two kinds of bear markets: Short (1961, 1966, 1968, and 1987) and Long (1973, 2000). If you take the averages, the current bear market will probably hit the low next summer, but not reach the peak again until 2011-2012. If that was not enough to depress you, it could get worse. Given that this bear market has the makings and headwinds of the longer version, this could be a difficult number of years. Hopefully in 10 years we will not be talking again about the "lost decade".

There is an interesting article over at the Capital Spectator blog concerning rising market volatility, and what it means for predicting the market bottom. The recent bear market in volatility ended at the end of 2006, beginning of 2007. See the chart below:

Source: The Capital Spectator blog

As mention in the post, falling volatility is a byproduct of rising prices, while rising volatility is often an indication of falling prices. While not perfect, it may be useful as another indicator in our toolbox, and another reason to assume that the bottom has not yet been made.

You can check out a new article called "Chesapeake Peak? - Not Likely" over at the greenfaucet.com site. I will be contributing some exclusive posts to greenfaucet from time to time, in addition to this blog. Check it out. There are some great contributors, articles, and resources.

Tomoko Yamazaki discusses in a Bloomberg article how current market dynamics have created four new power brokers: Asian governments, oil exporters, hedge funds, and private equity groups. The four had a combined $11.5 trillion in funds at the end of 2007, and increased assets by 22% last year. As an illustration of their influence, Asian governments and oil-rich nations invested $59 billion in western financial institutions over the last 15 months. As for the numbers, Asian governments, including sovereign wealth funds, increased to $4.6 trillion over the last decade, oil exporter assets increased to $4.6 trillion by the end of 2007, private equity assets reach $900 billion globally, and hedge funds grew assets under management to $1.9 trillion in 2007.

While each new power broker has provided much needed capital and liquidity to the markets, there are also some potential problems listed. Most notably is how increased liquidity may spur asset price inflation, sovereign wealth funds might use their capital for political means, there is the potential for leverage abuses in the private equity arena, and hedge funds could exacerbate, or even start a financial destabilization given the herd mentality to invest in similar hot sectors, as well as utilize similar trading strategies. While it is mentioned by the author that the rise of the new power brokers could pose risks, it appears that all potential problems have either occurred at one time or another fairly recently, and/or are beginning to show their ugly side once again. Of course, capital and liquidity needs to come from somewhere, and the Federal Reserve and the government can only do so much. So while the trend is intact, we should continue to expect each power broker to have some influence on capital allocation going forward.

As discussed in a recent article in Financial Week, Ernst & Young found that businesses sold by private equity firms last year had more growth in profits, and subsequent value than comparable public companies. The enterprise value of companies previously owned by private equity firms increased 24% in 2007, compared to half that amount for public companies previously listed. In fact, the enterprise value grew by a rate of 32% per year when private. Nonetheless, given the recent downturn in the markets, and the poor environment for IPOs, it is expected that many private equity firms will need to hold on to some companies longer than expected, and may subsequently see slower growth and lower returns when exiting through sale or initial public offerings. Of interest to me was the quote: “The myth of private equity as financial engineers who cut costs to make their money is false.” Actually, this may not be a total myth, but simply not all of the story. Cutting cost is one part of adding value, and apparently, many private equity firms have figured out a way to increase the value of the businesses they own through cost cutting and other means, while also selling them at the most opportunistic times. Timing may be as important as cost cutting and financial engineering.

IndexUniverse is reporting the offering of a new frontier markets ETF on the Nasdaq: the PowerShares MENA Frontier Countries Portfolio (PMNA). The PMNA will track the Nasdaq OMX Middle East North Africa Index, which includes the countries of Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Nigeria, Oman, Qatar, and the United Arab Emirates. Claymore recently offered the Claymore/BNY Mellon Frontier Markets ETF (FRN) on the Amex, which is more global given that in also includes countries in Asia, Europe, and Latin America, along with the Middle East and Africa. As a result of its focus, the PMNA is a little more concentrated in oil-rich countries. In a recent post we discussed the new Gulf States index launched by S&P, called the GCC 40, covering 40 stocks from the Gulf Cooperation Council. Of interest is that this index covers some of the same region as as the PMNA, but is focused more on financial companies, and less on crude oil and industrial companies.

The PMNA ETF may be of interest to those investors looking to participate in the growth of the oil-rich gulf states that are themselves in the process of reinvesting capital. Furthermore, some analysts have recently discussed how Africa could be one of the next regions for growth. If this is the case, then Northern Africa would be a good place to start investment in this continent.

Also, for those who are interested, there is a distinction between emerging and frontier markets. The term emerging market was first introduced by the World Bank and is often used to describe a country with an economy that is in the process of rapid industrialization, and one that usually finds itself between developing and developed status. The term frontier market is often used to describe equity markets of smaller and less accessible countries of the developing world, yet still investable. Frontier markets are essentially "pre-emerging" markets that are expected to be classified as emerging markets once capital and liquidity increase. Frontier markets could have a high level of development, but still be too small to be considered emerging (for instance, the Baltic States, such as Estonia and Lithuania). They could also be countries where investment restrictions have started to loosen, allowing companies to be investable (such as countries in the Gulf States), or be countries with lower levels of development than similar regional emerging markets (such as Vietnam and Pakistan). As to be expected, frontier markets in general may offer higher return and longer-term growth, but will also carry more risk.

As recently reported at Bloomberg, hedge funds have produced their worst first-half performance since 1990, when the firm Hedge Fund Research began tracking returns of the hedge fund industry. Hedge funds are down collectively 0.75% year to date. Lower equity returns, the impact of volatility, and the inability to borrow cheaply due to the credit crunch all appear to be affecting performance.

The impact of less leverage has been discussed for a while now, and the fallout of lower equity returns is evident to all investors. What has not been discussed as much is how increased volatility is apparently affecting some funds. This is ironic given that many funds and traders thrive on volatility, or at least need some type of market movement. Now, many managers are finding that they cannot cope with the changing nature of the markets.

As a result of the poor performance of the market, and in particular hedge funds that are often expected to protect against losses, investors appear less willing to stick around for the long-haul, and instead are looking for more immediate returns. Given the current challenges for hedge fund managers, large established funds with both proven strategies and proven managers are doing well. On the other hand, small funds are seeing lower returns, redemptions, and in some cases are closing up shop (see previous post).

In addition to hedge fund veterans, such as John Paulson and Philip Falcone, whose funds have returned 26% and 42% year to date, respectively, some quantitative funds using computer modeling for investment decision making are also up this year. New funds, with managers spinning off from existing larger, more credible funds are also seeing inflows of capital as investors look for managers and strategies that generate confidence and offer more reliability. No doubt struggling funds will continue to look for ways to generate alpha and keep nervous investors, and their capital, from heading for the exits. The trend of hedge funds scooping up talent, just as Wall Street is cutting back on salaries and bonuses, is likely to continue (see previous post).

As recently reported at IndexUniverse.com, Standard & Poor's launched the S&P GCC 40, covering 40 stocks from the Gulf Cooperation Council markets, a trade bloc formed by the Persian Gulf states of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. The narrow-based index will contain large and liquid stocks that are participating in the current growth in the Persian Gulf. Of note is how Saudi Arabia, a largest market of the six, is excluded since it is not considered investable, or accessible to foreign investors. Stocks included in the index must have a market caps of $400 million or more and average daily volume over three months of at least $1 million. Three countries have the lion's share of the weighting, with the UAE at nearly 35% weighting, Kuwait at around 30%, and Qatar will a little over 29%. Financial companies also hold over 60% of the index weighting. Not surprisingly, the index was up 10.82% from January-May of this year, along with being up 39.22% for the last 12 months.

The index may prove to be popular as investors look for ways to diversity their international exposure away from the BRIC countries, while also participating in the growth spurred by higher crude oil prices, available capital, and increased investment in the region. Furthermore, crude oil and industrial companies do not dominate the index, allowing investors to limit their exposure to this volatile commodity directly, yet still benefit from its recent increases.

The WSJ is reporting on a survey of 96,000 investors, brokers, and analysts conducted by the CFA Institute. The survey found that many of its members want a new regulatory body to oversee rating firms, along with a different set of ratings for structured products, such as for mortgage-backed securities and CDOs. Amazing, the CFA survey found that 11% of the 1,940 respondents globally said they had seen a ratings firm change a rating as a result of pressure or influence from an outside party, such as a bond underwriter.

Around 47% of respondents said regulators should force ratings firms to use different symbols for structured-finance products that differ from ordinary corporate debt, while 42% said they should not. Even with current problems, the number voting for change is significant, given that changing from the AAA scale would be costly and may initially add even more confusion at a time when the credit market is already in a tenuous state. The article mentions how "The SEC proposed a new rule in June that would give ratings firms the choice between using new symbols for structured products or publishing more research about the products' risks. "Given the level of confusion, we felt there should be a more overt requirement" to use different symbols, said Mr. Schacht." I guess we don't need more information about the risk, just a different symbol system. I find it interesting how we cannot have both. I realize that is not exactly what is being said, but it is telling nonetheless. While ranking from 1-10, or something similar would be clearer when distinguishing the move from say, A to Baa, does it really help one understand the risk any better?

There is an interesting article from Bloomberg that discusses how TIPS (Treasury Inflation Protected Securities) are not living up to their goal of protecting against inflation. The principal for TIPS increase with increases in the CPI, yet many bond holders do not feel that the CPI is properly tracking inflation, in particular the large price increases in gasoline and soft commodities, such as corn. Even as prices have increased over the last 18 months, yields on TIPS relative to Treasuries have essentially stayed the same.

As an alternative, some investors are using swaptions, which when purchased give the buyer the right to purchase a swap. Swaptions are essentially options on interest-rate swaps. Inflation swaps allow one party to pay a fixed rate in exchange for the inflation rate. Lately, swaptions have been better at gaining value when the expectations of future inflation increase, even if the CPI is not keeping up. As an example, in April and May one-year inflation swaptions returned about 0.3%, compared with a 2% loss by TIPS of all maturities. Nonetheless, even while reacting to inflation better, some investors still prefer TIPS since they are backed by the government, unlike derivatives that depend on the credit quality of the issuing firm.

As a former Missouri native growing up in the suburbs of the St. Louis area, I had come to think of Anheuser-Busch and the Clydesdale's as part of my identity, even before I was old enough to drink. Along with McDonnell-Douglas (now gone and replaced by Boeing), AB was part of the fabric of St. Louis. Just about every person you knew either worked for Mac or AB, or at least had a family member or friend who did. When McDonnell-Douglas was finally taken over by Boeing, it felt like the city was losing its security blanket, even though most of the employees and operations stayed. Now that Anheuser-Busch may fall victim to a takeover attempt by InBev, it feels more like potentially losing a friend.

Of course, this friend was the one that hung out with the cool kids, and only the best cliques. To get a job at Busch, well, you seem to have to know someone, someone deep in the clique. Yet, we all tried. I mean how great would it be to work for a beer company, especially one as dominate as AB? As they say, people drink in good times and bad, so job security was a given. Plus, they owned (or did own) the baseball Cardinals, another St. Louis tradition. And of course, they made really cool commercials. All was good.

But then the city got punched in the gut with news that InBev was making a play for Bud. InBev? Who the heck is InBev? Coors, sure. We have all heard of Coors, but they were no threat. Miller? Sure. They were big competitors, but let's be real. We did not really worry about Miller. The great taste - less filling commercials were amusing, but again, not to worry. We had Bud Light. And then a little thing happened while everyone slept. Smaller beer companies started becoming larger ones, and before you knew it, once mighty AB was a target. Instead of being the one acquiring, AB became the acquired - maybe.

So there it is. As AB's stock languished in the high $40's and low $50's, InBev offered $65 a share ($46.4 billion total), and mouths in St. Louis and across the country collectively gaped open. As expected, Bud rejected the offer, and went on the offensive. As a starting point, the company began running countless commercials of the CEO August Busch IV talking about company heritage. Notably, the commercials also included other spots with father and former CEO August Busch III, who did not always agree with his son's stewardship. InBev quickly replied by running an advertisement discussing what it would not change, including the headquarters in St. Louis, the U.S. breweries, Grant's Farm, and of course, the Clydesdale's. In addition to commercials, AB has begun crafting a $1 billion cost cutting plan that they hope will bring value back to the shares. In other words, we don't need your $65 a share bid. We can do it ourselves.

The cost cutting plan will include cutting 10% of the workforce over two years through attrition, cuts in benefits, price hikes for its top beer brands, and the repurchase of $7 billion in shares. This is all good, unless of course you are a big beer drinker, or an employee seeing your benefits reduced. Yet, while possibility too little, too late, does this really help AB? If InBev does acquire AB, wouldn't you expect InBev to do exactly the same thing? It would seem that such a move by AB does not really strengthen their case with existing shareholders, as far as maintaining control, but actually makes it more likely that InBev will proceed with their takeover attempt. AB may be doing nothing more than speeding up the process for InBev, both from a cost-cutting perspective, and also from a takeover perspective. AB may simply be forcing their hand, causing them to raise their bid, or go hostile, beyond just threats to remove the board.

While seemingly late, and possibly counterproductive to halting a deal, AB may have no other choice than pursue the approach it is taking. AB currently does not have a poison pill in place, but does have the means of adopting one. Nonetheless, given their recent talk of increasing shareholder value internally, it is difficult to see them putting one in place. The other much talked about option of buying out the remaining half of Mexican brewer Groupo Modelo also seems unlikely given that all six families that control the remaining 50% would have to sign off on the deal.

If the deal does go through, it is unclear at what price. Some analysts are predicting that InBev may have to go as high as $73 per share to close the deal, while others are predicting that even if the InBev offer goes as high as $80 a share, AB would still say no. Of course, if $73 per share could make the deal happen, there is no guarantee that InBev could come up with the financing. InBev has written to AB stating that it has the necessary financing in place for the $65 per share deal, yet if the deal goes higher, or becomes hostile, it is unclear if banks will want to step out on a limb in the current credit environment. InBev also recently announced that it plans a stock sale to fund the AB bid (see Jackson Business Journal article), but did not disclose how much capital they hope to raise, causing some concern regarding their ability to obtain enough money from the credit markets to get the deal done.

So what is an investor or trader to do? If the deal does get done, it is likely to be at a higher price, possibility in the $70s. Given the closing price of $61.67 on July 3rd, that gives around a 5.4% return for a price of $65, a 13.5% return for a offer of $70 a share, and a return of 21.6% for a deal going out at $75 per share. If InBev were to pull a Microsoft and simply walk away instead of going hostile, the price will surely fall back near the before-take-over value (near $48 per share), representing around a 22.2% decrease in price, unless of course you assume that investors believe the internal turn-around story advertised by AB and reward the company with a higher valuation. Given how Yahoo! fell, even with the Google news, this is unlikely. Yet, if investors do believe the story, the downside of taking a position may not be as painful. Nonetheless, any position now, given either optimistic or pessimistic scenarios, should produce a roughly one-to-one risk-reward relationship.

For those who trade options, buying calls may be a safer, and a potentially more profitable move. Currently, the December $60 calls are going for about $5, essentially eliminating gain at a $65 per share takeover, but allowing you to double your money if the offer rises to $70 per share. Of course, traders will need faith that the offer will be increased. If expecting a $70 per share price, another investment might be the December $65 strike calls, which are going for about $2. At $70 you are getting over $5 for your $2 investment, and of course limiting your downside. To help pay your premium, traders could also sell December $50 strike puts, currently going for about $1.30, or December $45 strike puts, going for about $0.70, depending on whether you believe the turn-around story by AB, and how much you think the price might fall if the deal does not go through. September calls are a little cheaper, and give a slightly better reward if you think any deal will either be done or fall apart quickly. But this is only one trade, and probably not the best. Things may change tomorrow. There are countless possibilities.

As for me, I will probably have a hard time pulling the trigger. No only is the risk-reward outside my comfort zone, with too many possibilities, there is also added danger since this would be an emotional trade. As any trader knows, once emotions sets into your trading, you are dead. Furthermore, I would probably be rooting against myself. It would kind of like be betting on the Tigers over my beloved Cardinals in the 2006 World Series, simply because all year the Tigers appeared to be the better team. What is the point? I both lose and win no matter what happens. It's a wash. I guess I could buy some puts, but again, I would be trading with emotion, and not my head.

It is worth noting that I have closely followed and commented on the Microsoft-Yahoo! talks for the last six months, arguing that Jerry Yang should just look out for shareholder interest and get the deal done. Now as I find myself hoping AB can stay a St. Louis tradition, calls of hypocrisy are understandable. Yet, this one is slightly different, at least to me - AB has leading brands in its markets, and seems to have some idea how to create shareholder value. But, their are similarities too. Without a deal, shareholders will certainly have to wait and hope that management can delivery the same value for them, something that I am still not convinced Yahoo! could do by themselves. I believe that AB can. If they don't, AB has no one to blame but themselves. In general, the founders or the family members of founders will need to realize that they are vulnerable. This is not just their company, it is the shareholder's company. If they cannot bring value, then the shareholders will find someone who can. If you sit on your hands long enough, competitors and/or shareholders may take your company away from you. Just ask Steve Jobs. He ended-up getting control of his company back. AB may not be as fortunate.

Are you interested in generating returns that consistently on-average beat the S&P 500, have a low correlation with other assets, and have low volatility of returns? Looking to get into the commodity markets, but worried that crude oil, natural gas, coal, and the soft food commodities have gotten ahead of themselves? No need to worry. We have the prefect investment for you - wood. No kidding, wood. And when I say investment, I mean investment. Waiting around for trees to grow is not for active day traders.

As reported by IndexUniverse, it turns out that timber investments have outperformed stocks, bonds, and commodities over the long run. In fact, the NCREIF Timberland Index, which is the standard benchmark for this asset class, increased 18.4% last year, versus a 5.5% rise for the S&P 500. Over time, the Timberland Index has beat all the major asset classes, except small-cap stocks. From 1992-2006, returns for timber were 12.2%. During the same time, large cap stocks returned 10.6%, small cap stocks returned 15.4%, international equities returned 8.2%, and corporate bonds returned 8.0%. When you consider volatility using the Sharpe Ratio, timber has the highest risk-adjusted returns, even beating small cap stocks (the Sharpe ratio for small cap stock was 0.63%, while reaching 0.84% for timber). Since 1987, the timber index has had only one down year in 2001 (-5.25%). During the same time frame, the S&P 500 has been down four times (as low as -22.10%).

Timber as an asset class also has a very low correlation to other asset classes given that its primary driver (biological growth) is not as affected by sub-prime woes, dot-com meltdowns, or the next Enron. The trees just keep growing. Also, with timber there is always the threat of physical damage (who among us has not seen a California wildfire on TV recently). Yet for a diversified portfolio, physical losses usually only decrease returns by 0.1% annually, on average.

What are the downsides? First, timber has been attracting more attention lately, so some investors have been paying up for assets. There is a lot of institutional and private money chasing a limited number of trees, at least those open to harvest and investment. Some investors are now even looking overseas. As with any investment, overpaying can certainly lower returns. Second, trees are not liquid investments given that much of their return requires patience. When you look at the profits from trees, about 61% comes from biological growth, with 33% from the price of timber, and 6% from land appreciation. Selling at the right time, and waiting for the trees to get big enough to command top dollar, are key. Patience truly is a virtue for timber investors.

So where to invest? George Nichols, who authored the original IndexUniverse article, does a great job outlining the pros and cons of current "timber" investments in an article located here. I put quotes around the word timber because, as Nichols points out, many proclaimed timber investments are not what they seem. Two popular timber ETFs are the Claymore/Clear Global Timber Index ETF (CUT) and the iShares S&P Global Timber & Forestry Index Fund ETF (WOOD). If anything, they have easy to remember tickers. The problem with these ETFs is that they do not provide investors with direct access to the timber asset class - which has all the return, correlation, and volatility benefits mentioned earlier. Each is broadly focused on forestry/paper stocks, such as International Paper (IP). Instead of investing in an asset class, investors end up investing in a sector, one of which ironically may suffer with higher raw material timber costs. According to Nichols, WOOD appears to be a little better than CUT for correlation to timber, primarily due to its REIT exposure (more below). Nonetheless, it is also still not perfect, or really that good as a timber pure-play.

An alternative to ETFs are timber REITs. Nichols mentions three in his article: Plum Creek Timber (PCL), Rayonier (RYN), and Potlatch (PCH). Plum Creek has 8 million acres of forests, making it the country's largest non-government owner of timberland. Unfortunately, like the ETFs, the REITs are also not pure-play timber companies since each has manufacturing operations, giving significant exposure to sawmills and paper mills. Of the three mentioned, Plum Creek Timber has the highest timber exposure (71%), yet still suffers a low correlation to timber. Nonetheless, it is expected that correlations will increase in the future as firms continue to divest manufacturing assets, giving the funds a higher pure-play timber focus. Potlatch recently announced that it was spinning-off its pulp-based businesses.

So what to do? Nichols believes that in theory timber is an attractive asset class that should be considered as part of a portfolio. Unfortunately, in practice, getting some timber in your portfolio is more easily said than done. Of the group, PCL is the most attractive, even if not a perfect proxy for timber. Waiting for more divestment of manufacturing operations from each of the REITs may be necessary to fully see the benefits that timber investment offers. Who ever thought wood could be this profitable, and for that matter, so difficult to buy?

(Note: For those interested in more details beyond this summary, please refer to both articles written by Nichols. Each is well written and researched, providing both the pros and cons to timber investment, along with data to support his conclusions.)

Recently, there have been some interesting financial products being released and/or discussed (see previous posts, here and here). Now IndexUniverse.com is discussing the development of a no-load, open-ended mutual fund that is based on hedge fund replication techniques. The fund offered by IndexIQ, called the IQ Alpha Hedge Strategy Fund, replicates hedge funds returns by purchasing various combinations of individual securities and ETFs, ETNs, and ETVs. The fund does not come cheap since investors in the replication fund will need to pay both the management fees from the replication fund, along with the operating expenses of the underlying securities and exchanged traded products that are used for replication. As of June 4, 2008, the index was comprised of 13 ETFs, ETNs, and ETVs representing exchanged-listed securities, fixed income, currencies, commodities, and real estate assets. This will bring the total expenses of the fund to 1.64% for investor class shares, slightly below the 2% expense ratios often required by traditional hedge funds. The advantage is that unlike traditional hedge funds, replication strategies can save the investors the 20% fee on profits that is also typical for hedge funds.

The IQ Alpha Hedge Index uses algorithms to create six strategies that seek to replicate the risk-adjusted returns of six different hedge fund indexes, including Long/Short Equity (currently -16.67%), Equity Market Neutral (13.33%), Fixed Income Arbitrage (3.33%), Global Macro (33.33%), Emerging Markets (33.33%), and Event Driven (33.33%). Then, optimization techniques and leverage are used to generated alpha by adjusting the weights among these six hedge fund strategies. In addition to adjusting for return, adjustments are also made to provide lower volatility relative to the S&P 500, with a correlation to the S&P 500 that is similar to the correlation between typical hedge funds and the index. The fund, which has been offered for only a short time, currently has an alpha of 7.72%, beta of 0.48%, and correlation of 0.58 versus the S&P 500. More details about the fund can be found in their fund summary sheet. It is also worth mentioning that a number of researchers, investors, and hedge fund managers do not necessarily believe that replication funds are as fantastic as often advertised. A somewhat dated, albeit still interesting and different perspective can be found in a post at the Hedge Fund blog.

There is an article at Spiegel Online that discusses an interesting turn of events in the Persian Gulf, and another consequence of high crude oil prices. Oil rich countries are turning to coal to fuel existing and new coal-fired electricity power plants. Why would oil rich countries do this? Simple economics. Coal is currently cheaper per BTU, making it more cost effective for oil producing countries to export their crude oil, rather than use it for domestic electricity generation. As mentioned in the article, the cost of producing a megawatt hour of electricity using coal is only about 42% of the cost of producing electricity using natural gas, and only about 22% of the cost of using crude oil, based on current prices. Of course, coal is also currently more polluting than natural gas, and even crude oil. Even when using a modern anthracite-fired power plant, emission from coal are 750 grams of CO2 per kilowatt hour of electricity produced. This CO2 level is 100% more than a gas-fired power plant, and nearly 50% more than an oil-fired power plant. Yet, while affecting air quality, many of the Gulf States are classified as developing countries, meaning that they have no obligation to reduce their CO2 emissions under the Kyoto Protocol. Coal stocks took a beating yesterday, but if crude oil and natural gas prices continue to rise, more countries, especially those outside the Kyoto Protocol, will no doubt continue to increase their use of coal.

As reported at the People's Daily in China, futures trading volume is up 148% in the first half of 2008 as trading in farm products rose. Volume was up 36% at the Shanghai Futures Exchange, where gold, copper, and zinc trade. At the Zhengzhou Commodity Exchange, where wheat, cotton, and sugar are traded, volume was up 450%. The Dalian Commodity Exchange, which trades corn and soybeans, saw trading volume increase 381%. Compared with other developed world exchanges, the Chinese futures markets are still weaker, but futures trading in pork, steel, crude oil, silver, and lead are expected to be traded on the various Chinese futures exchanges in the near future, and volume in existing products is expected to continue to increase as well.