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The Other Side: Subprime, Apple


In a cruel riddle for traders and general managers, truly remarkable performers tend to be underestimated.

Note From Prof. Krueger: I wanted to share what may be on the other side of a headline and a stock you have no doubt read and heard of.

Before anyone disagrees with either crazy notion, let me be the first to join you.

That will be the origin of each Other Side column: simply sharing the result of some of my work that began by attacking my own ideas (posing as the other side of each of my trades and structural positions and building its case against me), especially if I can find a mis-priced trade resulting from over-bet assumptions including, at times, my own. Our biggest mistakes can be found in the mirror, not the screens.

Jumping to the top of the "most read" stories of yesterday was S&P watch listing $12 bln in subprime debt. The natural conclusion is yet another tip of the iceberg dead ahead warning, and it may just be, because there are plenty. But my trading diary is quite clear with several bloodstains to remind me that the most dangerous dragons are the ones you do not see.

That's why you never read "tip of the dragon" warnings. Most of these headlines have consistently failed to be put into a broader context that includes the amount wagered against subprime debt, perhaps more than a trillion dollars, which leaves at least one question unanswered- will there be enough meat for the bears to share even if they are right on this bet? That's the thing about odds: picking the winner isn't always the right bet.

I chewed on this topic over the weekend, along with fourteen different meats, at a Churrascaria with a former Friday Night Lights legend down here in Texas (according to those at the table). Again, when you can see a 6 foot 3 inch 350 pound 'berg, you can adjust more easily. The sword-wielding gaucho waiters could see that my buddy might squeeze their all-you-can-eat margins just a bit. So they worked him with relentless attacks of the low-end cuts early in the proceedings, but I smiled, knowing that they would be no match.

I mention this for two reasons. One, I think several casual dining chains' CFOs might look about as nervous as those gauchos while looking at their own margins right about now (they offer no adjustable rate pricing). I have written often about one of my favorite trades- to be long the ingredients, short the cooks. Two, this former left tackle happens to be a professor of economics at Oxford now. I didn't see that coming either, incidentally. We discussed a dragon in the subprime story on our "not as read" list of possible outcomes. Wouldn't it be ironic if, for a trade, the all-knowing credit rating agencies prove to be more at risk as I type this than the average homeowner they only tell us now to worry about? The headline is important, but the dragon may be hiding in the byline. K&C Trading Diary Rule #27 is "There are no ironies."

The iRod

I chose not to join the handicappers trading on the iPhone release. I own Apple (AAPL) and decided to do absolutely nothing. I think the easy, and what may prove correct trade (and my first inclination), would have been to take profits. But I have never looked at Apple the right way, so why start now? I may be the only guy in the world still unsure about how to load an iPod (interns make the device even simpler and more elegant) and I am the same knucklehead that was bullish on Apple at $85 for a reason other than the iPhone when I scribbled here in February about the living room, where I think they can be even more disruptive than the ear.

The only opinion I shared to those who asked ahead of the release was that the "sell on the news" contrarian idea became a little popular for my bones, particularly for a contrarian trade! The analogy I made was to another big ticket item capable of creating the same lines around the corner in New York City and yet later the same evening sparking unparalleled disdain. The 3rd baseman for the home team up there reminds me of this not quite 3rd G phone (it's 2.5, among the early worries).

Incredibly, one of the more vilified athletes is the best in his sport. The second best so far this season, judging by "BOP" (total bases divided by plate appearances) is Barry Bonds, who is inarguably its most vilified. How many knew the other side of that Bonds story this year? I had no idea before looking at the numbers, and would have assumed incorrectly.

I thought the iPhone's fragile glass screen might mirror A-Rod. Its price and impossible expectations would be a perfect target for several rocks thrown their way– and for a trade, those rocks can break you. But over time, in a cruel riddle for traders and general managers, truly remarkable performers tend to be underestimated. Who would have thought in their wildest dreams "at the top" that A-Rod's $250 mln deal could be lived up to? Watch him sign for more (per year) this winter, and inflation is not the reason as contracts have not come close to his ever since. I am not a fan, not even close, but remarkable performance, as it turns out, is capable of surprising to the upside as well. The difference, thankfully for us, is that Arturo Moreno won't be able to use stop loss orders like I can. He owns the Angels. I don't know what phone he'll call A-Rod on or if he'll listen. Just another hunch of what might be around the corner, on the other side.
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Position in AAPL
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