Martin Sumichrast |My Top 7 Predictions for 2013

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Last year I predicted: 1. Housing would recover in 2012. I was right and housing starts jumped by 21% from 708,000 in November 2011 to 861,000 in November 2012. 2. I predicted interest rates on the 30-year would increase 20% … Continue reading

Martin Sumichrast |If The Presidential Debate Were A Football Game,It Ended 62-24, Romney In A Blowout

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As a lover of College Football, I have to say, watching last nights Presidential Debate was like watching Nebraska Beat Florida in the 1995 Fiesta Bowl. At halftime, Nebraska so dominated the game with a 35-10 lead, that Florida looked … Continue reading

The Information Aggregator Investors Don’t Know (But Its Customers Love)

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Derycz Scientific (DYSC) is a California-based technology company that has quietly aggregated more scientific content than the largest libraries in the world. The Company has received numerous high profile awards for its products, and its CEO, Peter Derycz, is obsessed … Continue reading

Martin Sumichrast | Elimination of Fannie Mae (and Freddie Mac) Is A Terrible Idea

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According to CNN,  the Obama administration will issue a proposal later this week recommending the gradual elimination of government-sponsored mortgage backers Fannie Mae and Freddie Mac, a White House official said Wednesday. CNN reports that the highly-anticipated “white paper,” which … Continue reading

Excellent Update on Shengkai Innovations (NASDAQ:VALV)

Dear Reader–

As you know, earlier this year I published my StreetTV interview where I discussed my thoughts on Shengkai Innovations (NASDAQ:VALV). I recently read a series of articles published on seekingalpha.com by Zach Mansell, where I thought Zach did an excellent job updating us on Shengkai Innovations.  If you didn’t catch them, here are the links for you to read:

Shengkai Innovations: Undervalued with Great Performance

Shengkai Innovations: Stock Offerings and a Bad Case of Confirmation Bias

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Man Is Not Free Unless Government Is Limited

I was recently reminded of President Ronald Reagan’s 1989 Oval Office farewell address. I have attached below a video link where you can watch it:

No matter your political affiliation, everyone should listen to this 20-minute speech. Here are some key excerpts that ring ever louder today:

On foreign policy:

  • “trust but verify”
  • “play, but cut the cards”

On the role of government:

  • “We the people are the driver, government is the car, we tell government where to go and, what route and how fast”
  • “man is not free, unless government is limited”
  • “as government expands, liberty contracts”

On regrets while in office:

  • “The Deficit”

On teaching of history to our children:

  • “teach history by not what is in fashion, but what is important”

At the end of his address, Reagan also said that although during his eight years in office, America regained its sense of patriotism, he warned of the potential of the “erosion of the American spirit.” He urged Americans to remember the sacrifices that past generations had made by continuing civic rituals.

I coach Pop Warner Junior Pee Wee football. Before every game, we stop and listen to “The Star Spangled Banner.” I watch these 9 and 10 year-old boys take their helmets off, face the flag and put their hand over their heart.  It is important…it is America. I really hope that someday, some activist judge does not take that away.

My parents came to this country in 1955, as penniless refugees fleeing communist Eastern Europe. They never took for granted their right to vote. They never failed to vote. They always said, “If you don’t vote, then don’t complain.” Exercise your civic duty and go vote… it’s important!

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Sumichrast Stock Slayer Portfolio Update

In my February 1, 2010, Street.com article, I talked about eight stocks. Some have done better and some worse, AFTER doing a lot better. My mantra, “Buy and Hold is a thing of the past,” could not have been more evident, as some of my picks ran up, only to come careening back down. So from now on, I will be including Good-till-cancelled (GTC) sell price limit orders on all stock picks. With that, here is my update:

Pulte Homes (PHM) — This major homebuilder was $10.20 in February. I told you to sell it down to $10. I predicted you could buy it back cheaper in the near future. It did spike up in the summer to $13.45, but has since retreated. It is for sale today at around $8.00. I am tempted to jump back in, but for now, hold it if you still own it. If you do not own it, put in a buy limit order around $7.50. Either way, put in a GTC sell ticket at $13.

Huaneng Power (HNP) — This Chinese energy company was making my China picks look bad. I first recommend it at $29.34, then it promptly sank to $22.14. I told you not to panic and to stick with it. The China market is staging a comeback and so is HNP. It is now at $25.21. Hold on and you will make money. Put in a GTC sell order at $36.70. If you don’t own it, buy some under $25.

General Electric (GE) — This was one of my very first picks two years ago when it was at $11.62. In February, it hit $16.40. I told you to hold it. I ran up to $19.70, before pulling all the way back to $14.26. It is now at $16.28. I predict we will see $20 by next spring. Do not put a GTC on this one as it will be a long time hold.

Bank of America (BAC) — I picked it at $16.50 and it plunged to $12.63 by February. It has had a wild ride ever since. It ran up to $19.36 over the summer, but now, with the mortgage mess, it is back under its February price level at $11.98. I hate to drop back and punt, so for now, I say hold on for another 6 months and let’s see what happens. Put in a GTC sell at $20, in case we get a run.

JP Morgan (JPM) — I picked this stock at $38.50 in February. I was right and it ran straight up to $48.20. Now it is back down to $37.80. Hold on to it, though, because it will be back over $45 by next spring, or maybe sooner. If it gets any lower, it may be time to buy some more. Like GE, no GTC orders. I love Jamie Dimon and if anyone can maneuver a bank through these muddy waters, it is him.

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Don’t Let The Facts Stand In The Way of a Good Story: How Storytelling Has Become Journalism

The joke when I was in college was “don’t let the facts stand in the way of a good story.”  Back then, the facts behind the far-fetched stories of late night were always stretched to sound better or more dramatic so that the story lived in infamy. Twenty five years later, my buddies and I still enjoy those stories.

Today’s “journalism” seems to have taken a page straight from the old college mantra. How many times have we seen articles that paste semi-facts with generalizations and guilty-by-associations that tarnish reputations with the singular goal to profit from the damage these kinds of stories can generate. None do this better than the short newsletters and blog posts.

As my readers know, I have been an investor in the Chinese economy, via reverse mergers of Chinese companies in the US capital markets. I see the potential coming from China and it is unstoppable. If you don’t have some allocation in this market, you should. As with any new and explosive space, there is always a period of overcrowding, followed by a period of failures that come from Darwin’s Law that only the strong survive. Some failures are natural (ie. bad business plan, executions, etc) and some outright fraud. It’s unfortunate, but not unique to the China stocks. But what it does do is provide an excellent bully pulpit for those betting against the China space.  And those that are well versed at this game are in high gear exploiting this part of the story.

You can always tell the negative news is coming by following the short interest. If it’s on the rise, get in the bunker, you are about to be shelled by short seller reports. I read with interest on Monday, August 30, the Barron’s article , “Beware This Chinese Export,” critical of the overall performance of China based reverse mergers. Versed as I am in this space, I couldn’t believe that the numbers where as bad as the writers had suggested. Like many, I was too busy to fact-check the data from the Barron’s report. Last week, Rames El Desouki, a writer for the blog site, Seeking Alpha, countered the Barron’s report with data he researched. I don’t normally re-post someone else’s article, but in this case I think it warrants the attention. Please read it below, I think you will find it informative.

I have also included a table of open short interest at the end of every quarter this year (September is not out, so I used the most current data which is August 30th) as reported by NASDAQ on the 10 stocks covered in the Barron’s article. Judge the results for yourself.

Short_Interest_Fig1

“The Myth of Underperforming Chinese Reverse Mergers”
by Rames El-Desouki

Two weeks ago, Barron’s printed a feature article titled “Beware This Chinese Export“, written by Bill Alpert and Leslie P. Norton. It was labeled as a “study” and subtitled “Chinese Reverse-Merger Stocks Lag Key Indexes.” The tone of the article was very negative about anything related to U.S.-listed Chinese stocks that went public via reverse mergers. It basically warned investors not to touch any of those, closing with this caveat:

The reverse-merger industry gathers in Hawaii this week at a Roth conference—a venue equally favored by China stock touts and by the sector’s short sellers. The rest of us should probably stay home.

Barron’s explicitly mentioned nine Chinese stocks in their article and I have added a tenth name here (China Agritech – CAGC – which was downgraded last week on concerns over an auditor that the company dropped 2 1/2 years ago), just to get to an even number. As you can see, this group of Chinese reverse merger stocks has clearly underperformed the key indexes since the Barron’s article was published. In the last two weeks both the Shanghai Composite Index (SSE, +2.0%) and the S&P 500 (SPX, +4.2%) posted gains, while this group retreated on average by a significant 8.56%. It can’t be denied that Barron’s had some influence in this.

Now back to the key argument of Alpert and Norton, that Chinese reverse merger stocks lag “key indexes.” I will use the Shanghai Composite as the most watched index in mainland China, and the S&P 500 Index for the U.S. as “key indexes” for this article. But let’s also add the Halter USX China Index (HXC), as Barron’s refers to this index as their “key index.”

A quick look at the Halter FAQ shows that “for a company to be included in The Halter USX China Index, it must be listed on the NYSE or Nasdaq and have an average market capitalization of at least $50 million for the preceding 40 trading days,” and if we look at the list of current components, we find out that China Agritech (CAGC), China Integrated Energy (CBEH), China Green Agriculture (CGA), China Natural Gas (CHNG), Deer Consumer Products (DEER), AgFeed Industries (FEED), Gulf Resources (GFRE), Orient Paper (ONP), RINO International (RINO) and also SkyPeople Fruit Juice (SPU) are in fact current components of this index.

Those 10 stocks haven’t always been eligible for the Halter Index, though. They usually started out on the OTC/BB a short while after their reverse merger deal, stayed there for a for a few months or even years, did a reverse split and uplisted to Nasdaq or a NYSE exchange shortly after. All 10 names have matured from their rather obscure post-RM stage on the bulletin board. They have successfully listed their stock on a senior U.S. exchange now, which is the final goal of basically all reverse merger deals.

Now Barron’s claims that reverse-merger stocks have drastically underperformed the key indexes:

Most reverse-merger stocks have proven to be a poor way to ride China’s boom. Today, the market cap of these stocks has shrunk to $20 billion, a 60% drop.

The authors have also determined that:

The median return among the 30 CCG reverse-merger clients with at least three years of trading history underperformed the Halter index by a whopping 70%, since their mergers.

So Alpert and Norton use stocks with “at least three years of trading history” and measure their performance “since their mergers.” I believe that using both those terms is deliberately misleading; it doesn’t prove anything and doesn’t show the actual performance of those stocks.

First of all, there aren’t that many reverse-merger stocks with a trading history of three years or more. If we go back those three years we get to the peak of the stock market bubble in mainland China. The Shanghai Composite climbed 124% from January to October 2007, reached 6124 points on October 16, and dropped 56.5% to reach the current level of 2663 points. Yes, the average return of a domestically listed Chinese blue chip is a negative 50% for this 3-years period.

However, it is not just pure coincidence that the number of reverse mergers exploded at the peak of China’s stock market bubble. Five of the ten stocks in our group exercised their reverse merger between October 2007 and February 2008:

Short_Interest_Fig3

Now what we can’t do is evaluate the overall performance of a stock using the date of the reverse merger or the first quoted price as the starting point. The first quote price is meaningless if there is no active trade in the stock. It can take many months until a reverse-merger stock is actively traded; until then there is virtually no one outside of the deal participants or shell share owners involved. The quoted price on the OTC/BB does in no way reflect what the market is willing to pay for the stock; it very often is nothing else than a painted quote on a single trade of 100 shares with many days of no volume at all in between.

A good example is North China Horticulture (IDCX), which completed their reverse merger on July 16 of this year. The first quoted price since the merger was $4.50 and the stock is quoted between $5.00 and $7.00 since. However, there have been only four days with actual volume since July 16, and none of those days saw more than 1000 shares changing owners.

The current quote of $5.00 for IDCX is completely meaningless as it would imply a P/E-ratio of 43 based on the last two reported quarters. We don’t know when the stock will actively start trading, but I would expect the price per share to settle at a level of around $0.50 – or about one tenth of the current quote – which would imply a reasonable P/E-ratio of 4-5.

If Alpert and Norton use the term “since their mergers” for measuring performance, it is misleading investors, and they know it. A responsible approach to evaluate total performance would be to use the opening price of the first day when a reverse-merger stock traded more than 10,000 shares – or even better, the average price of the first five sessions a stock was actively traded.

Short_Interest_Fig4

Investors who purchased our group of 10 stocks during the first week of active trading, would have been sitting on an average return of 145.00% on August 27 this year, the day before the Barron’s article was published.

Short_Interest_Fig5

Investors who purchased our group of 10 stocks two years ago – at the close of September 10, 2008 – would have a gain of 176.69% today. That compares to a 23.83% gain for the Shanghai Composite (SSE), a 9.94% loss for the S&P 500 (SPX) and a 13.68% gain for the Halter Index (HXC).

Short_Interest_Fig6

Investors who purchased our group of 10 stocks 18 months ago – at the close of March 10, 2009 – would have a gain of 378.54% today. That compares to a 23.38% gain for the Shanghai Composite (SSE), a 54.19% gain for the S&P 500 (SPX) and a 84.21% gain for the Halter Index (HXC).

Short_Interest_Fig7

Investors who purchased our group of 10 stocks one year ago – at the close of September 10, 2009 – would have a gain of 3.46% today. That compares to a 8.95% loss for the Shanghai Composite (SSE), a 6.26% gain for the S&P 500 (SPX) and a 4.28% gain for the Halter Index (HXC).

As we can see, our group of 10 reverse-merger stocks has not underperformed the “key indexes” in any of the scenarios, quite the opposite actually. However, many of the Chinese RTO stocks have retreated this year, probably in large parts as a result of negative articles like Alpert and Norton’s piece and generally due to concerns over corporate governance, internal controls, earnings quality and management credibility.

This development suggests that many long-term investors who started a position in those reverse-merger stocks have realized profits in the last 12 months and didn’t hold on to their shares no matter what, watching their portfolio drop in value every day. Most responsible long-term investors will have protected their holdings with stop-loss marks or will have reacted on market developments. Just for fun, let’s have a look at what those investors could have earned if they had sold at the 52-week high.

Short_Interest_Fig8

Now what is the bottom line of all this? You should not generalize all Chinese reverse-mergers and throw them all into the same pit. Alpert and Norton followed-up on their article in this weekend’s Barron’s edition with another misleading claim:

[We measured] the investment performance of every identifiable reverse merger company, then showing how investors would have done if they had picked the typical (i.e., median) performer in the group.”

Here is your answer to that: many, if not most reverse mergers fail! Those stocks never make it past their post-merger stage, they never come even close to maturing, to becoming eligible for a senior exchange. And most importantly they never came even close (and probably never will) to catch the attention of a value-oriented investor in Chinese stocks. Those stocks are trading on very low volume on the OTC/BB or Pink Sheets, they are often delinquent in their filings, the price per share is below $1 or even below 1 cent and nothing and absolutely nothing makes them part of the group of serious, profitable Chinese businesses that became public companies via reverse mergers.

No serious investor puts their money in any of the many questionable China-based penny stocks on the OTC/BB or pinks, and most of them went public via reverse mergers. Just like you wouldn’t choose any of the OTC-quoted U.S. penny stocks if you seriously intended to invest in technology or mining and metals. That’s why the Halter Index has eligibility rules, and that’s why investors and research firms do their due diligence, visit the company, talk to customers and competitors and so on…

Look for maturing reverse mergers! They have to be actively traded, should be consistently profitable, and should have a clear path ahead, off the OTC/BB or Pink Sheets onto a senior U.S. exchange. You have to do your own due diligence, there is no way to avoid that for a serious investor in Chinese stocks. If you buy into a newly listed reverse merger stock, you take on many additional risks, including a large number of shares that might flood the market from early investors (hedge funds) who got in at a very low price, or from those parties that managed the reverse merger deal and got a good share of the company in return. Again, as an investor, watch for those RTO stocks that are maturing and have a clear path to Nasdaq or a NYSE exchange.

Alpert and Norton wrote this weekend that “unless one cherry-picks examples, the expected performance of these stocks is lousy.” I have cherry-picked those very stocks Alpert and Norton explicitly mentioned as negative examples in their original article, and those have outperformed the key indexes including the Halter Index in every single reasonable scenario. I have picked those ten stocks despite the fact that they are now far off their highs, having dropped in no small part due to Barron’s and other publications presuming that “China plus Reverse Merger automatically leads to losses.” As any reader or prospective investor can now see, this presumption by the critics is simply not valid.

Disclosure: No positions

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The Ugly Duckling Turns Into A Swan – Wall Street Searches for New Revenue Streams

Why Reverse Mergers Make Sense & What to Look for Before You Leap In…

My First Prospectus – Back in 1992, a document was dropped on my desk. The front page said “Preliminary Prospectus”, “Kaliningrad Fund”. Under the name in big bold letters it read “AN INVESTMENT IN THE SECURITIES OFFERED HEREBY IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK”. As I started to read, every page was worse than the next. 

I wondered what this Company did. It had no revenues, no business and only $10,000 in the bank. I found out that a family friend, the former Secretary of State, General Alexander M. Haig, had been asked to be the Chairman of the Board of this new venture which involved acquiring businesses in the former communist bloc.
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Sort of Sums Things Up, Doesn’t It?

My father always used humor in his many books and speeches. My father-in-law emailed me this little gem and I thought it was too on point to not pass along. I don’t know who wrote it, but if it wasn’t so true, it would be funny.
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A Japanese company (Toyota) and an American company (Ford Motors) decided to have a canoe race on the Missouri River. Both teams practiced long and hard to reach their peak performance before the race.
 
On the big day, the Japanese won by a mile. The Americans, very discouraged and depressed, decided to investigate the reason for the crushing defeat. A management team made up of senior management was formed to investigate and recommend appropriate action.

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