October Performance - up 2.8%

Performance Overview
In October my IRA account balance increased 2.8%, which is after all expenses and fees. The SP 500 increased 3.7%. Given the substantial cash position of 62% at the beginning of the month, I am pleased with the return.

During the month I entered multiple positions, reducing the percentage of cash in the account to 21%. Domestic equities account for 27%, international equities 23%, commodities 15%, and inverse bond 14%. Within the equity positions, industrial materials is the largest position followed by hardware. This weighting, coupled with the commodities positions, highlights my opinion that deeper in the economy's supply chain, where I believe inflation is building, is a better place to position investments.

The largest drivers of growth in the account came from Huntsman (ticker: HUN), ETF Palladium (ticker: PALL) and RF Micro Devices (ticker: RFMD), up 19.8%, 14.4% and 12.8%, respectively. The reason for the increases, in my view, include a weaker dollar driving commodity prices, ability of Huntsman to hold onto price increases amongst strengthening demand, and improving execution by RF Micro Devices' management coupled with strong secular demand in wireless.

The worst performances came from Duoyuan (ticker: DGW), VIX (ticker: VXX), and Teradyne (ticker: TER). I sold both VXX and TER for losses of 18.3% and 5.4% during the month. Volatility was relatively mute during most of the month and the VXX constantly bleeds value, placing a ticking clock on my position. For TER the December guidance was much lower than I had expected so I decided to move to the sidelines until the stock has settled. DGW was down 9.3% from when I bought it. At this point I plan to hold on to it but will be watching future losses closely.

Poor execution happened on the second purchase of American Axle Mfting (ticker: AXL) as I bought on the open at $10.10 only to see the stock fall to $9.22 at the end of the day. The company announced the September quarter that beat estimates and raising full year revenue growth. I missed that the full year growth combined with results of the third quarter implied a management's guidance for the mid-point of December revenue was below the street consensus. After re-evaluating the position and listening to the conference call, I believe the fundamental trends remain quite healthy and believe the take-away from the sell-off is the market's unwillingness to overlook marginal issues around this stock. It also may suggest that the market remains skeptical about the economic outlook next year. 

Summary
The following is a summary of my positions and their performance during October and relative to their cost.

		29-Oct		Change		Cost/	Sale/
Name	Ticker	% Portfolio		October		30-Sep	29-Oct
HUNTSMAN CORP	HUN	4.6%		19.8%		$11.56	$13.85
GT SOLAR INTL INC COM	SOLR	4.1%		(1.7)%		$8.37	$8.23
FREEPORT MCMORAN COPPER	FCX	3.9%		(5.0)%		$99.84	$94.80
AMERICAN AXLE MFTING HOLDING	AXL	3.8%		(6.5)%		$9.87	$9.22
JEFFERIES GROUP INC NEW	JEF	2.9%		5.5%		$22.69	$23.93
LYONDELLBASELL INDUSTRIES	LYB	2.2%		(4.1)%		$28.00	$26.86
RF MICRO DEVICES INC	RFMD	2.1%		12.8%		$6.46	$7.29
KULICKE & SOFFA INDS INC	KLIC	2.1%		5.4%		$5.90	$6.22
PERKINELMER INC	PKI	1.9%		1.9%		$23.02	$23.45
CA INC COM	CA	1.9%		1.1%		$22.94	$23.20
DUOYUAN GLOBAL WATER INC	DGW	1.6%		(9.3)%		$13.79	$12.51
MULTI SECTOR COMMODITY	DBA	9.8%		8.1%		$27.48	$29.70
ETFS PALLADIUM TR SH BEN INT	PALL	5.3%		14.4%		$56.38	$64.48
ULTRASHRT LEH BROS 20+ YR TRE	TBT	14.1%		8.8%		$31.25	$33.99
MATTHEWS CHINA FUND	MCHFX	10.2%		2.2%		$29.37	$30.02
ISHARES INC MCSI CHILE	ECH	4.7%		2.6%		$73.91	$75.84
ISHARES INC MSCI HONG KONG	EWH	4.7%		(0.6)%		$18.85	$18.73
TERADYNE INC	TER	Sold 10/28		(5.4)%		$11.64	$11.01
Barclays Bank 500 VIX	VXX	Sold 10/13		(18.3)%		$17.29	$14.13

American Axle & Manufacturing Holding (Ticker: AXL)

Increased position from 2% to 4% in American Axle & Manufacturing Holding (Ticker: AXL) at $10.10.

AXL reported revenue and EPS of $618 million and $0.52 that beat street expectations of $559 million and $0.38. Management provided full year revenue growth of expectation of 45-50%, up from 40-45% offered three months ago. However, given the strong third quarter results this guidance implies revenue in the fourth quarter between $507-583 million versus consensus of $559 million. This suggests analysts will modestly drop their revenue estimates for the fourth quarter (reason for stock weakness today), although 2011 revenue likely remains stable. Management said on the conference call that they do not foresee any changes in the cost structure that will pressure margins in 2011, allaying some of my concern about the impact of higher commodity prices. They expect EBITDA margins likely at the higher end of the their long-term range of 11-15%

Assuming the consensus 2010 full year revenue estimate remains around $2.2 billion (low end of 45-50% growth range), a modest 10% increase in top line (below the minimum run-rate in order for management to double revenue by 2013) moves the consensus 2011 revenue estimate to $2.4 billion (from $2.3 billion). A conservative 14% EBITDA margin in 2011 (given management's expectation of few changes in the cost structure to reduce margins for 15% 2010 levels) produces around $340 million. The current market price of $9.30 implies an enterprise value of $1.46 billion and produces an EV-to-2011 EBITDA estimate of 4x.

New to my thinking since yesterday: Higher than expected sales, a growing tailwind from GM marketing spending and recovering orders for vehicles, and a stable cost structure suggest the company could provide above average EPS growth for the 2-3 years. My biggest worry is an economic slowdown, which I continue to believe is remote in the next few quarters.

American Axle & Manufacturing Holding (Ticker: AXL)

Bought ~2% position in American Axle & Manufacturing Holding, ticker AXL, at $9.63.

Bought AXL for reasons including: largest customer (General Motors - 78% in 2009) planning significant advertising campaign to boost growth into its IPO, management expects to double sales by 2013, investing in high growth markets like South America and Asia, $1 billion of backlog, expanding into passenger cars (historically focused on trucks), increasingly diversifying its revenue from primarily General Motors, financial leverage has improved with no major debt maturing until 2013 and thus financially more stable, AXL trading around 7x C2011 EPS estimates.

Worries include cost pressures from rising commodity costs, competitive pressures within GM, GM costs cutting affecting company, management execution into new markets, union pressures once profits improve, and an economic slowdown.

Teradyne, Inc. (Ticker: TER)

Sold ~2% position in Teradyne, Inc. (Ticker TER) at $11.01 for a realized loss of 5.4%.

Quarter was fine but the outlook for the December quarter was more bearish than I had anticipated:

"Guidance for the fourth quarter of 2010 is revenue of $300 million to $325 million, with non-GAAP net income per diluted share of $0.21 to $0.28 and GAAP net income per diluted share of $0.14 to $0.20." The consensus revenue and non-GAAP EPS estimates were $447 million and $0.59.


I expect to continue to watch on the stock, see where it settles, and potentially re-enter a position once I have a better insight into the likely 2011 trends. I expect the street and market to become overly bearish on the stock, which should provide an attractive entry point should the outlook for 2011 brighten.

The December outlook by Teradyne does give me some pause about my ~2% position in KLIC since they have similar customer bases.

RF Micro Devices (Ticker: RFMD)

RF Micro Devices (Ticker RFMD), a 2% holding, reported September financial results after the close yesterday. The company beat top and bottom line, and provided guidance for the December quarter above street expectations.

The key comment in the conference call, in my opinion, was said by the CEO:
"In fiscal 2011, we continue to anticipate annual revenue growth supporting record operating income and double-digit growth in earnings per share. In fiscal 2012, which begins in April, we forecast sequential growth will accelerate, driving expanding margins and continued improvement in earnings and cash flow."

Translation - Improving ROIC (the primary driver of stock performance, in my view) + Growth.

Reasons for likely improving ROIC:
(1) Focusing on areas of leadership and RF components and compound semiconductors.
(2) Fundamentally altered the capital intensity of the business through IP, intellectual property, and technology leadership. Can now drive significantly higher revenue with less capital investment. (Capacity utilization is roughly 75%)
(3) Improved execution

The drivers of the accelerating growth include:
(1) Strength of new product launches
(2) Customer diversification efforts (Nokia down to ~39% of revenue)
(3) Long-term secular growth trends in our end markets

Bottom Line - This outlook should set-up the stock for a sustained run because the stock is trading under 10x the consensus estimate for C2011 non-GAPP EPS.


Transcript from call.

Everyone should do their own research on an investment idea before buying/ selling.

Teradyne Inc. (Ticker: TER)

Bought 2% position in Teradyne Inc., ticker TER, at $11.64.

Bought Teradyne for similar reasons as Kulicke & Soffa (Ticker: KLIC). Specifically, I bought TER due to a bearish street outlook on company after KLIC comments in early October (lower EPS estimate in 2011 relative to 2010 of $2.39 vs. $1.87), majority of revenue outside the U.S., should benefit from investing by semiconductor companies in new facilities and updated technologies, low valuation of 6x C2011 EPS consensus estimate, and healthy balance sheet with about $0.5 billion net cash.

Note: The company actively hedges currency risk and thus the impact of the weaker dollar is likely limited to improvements in the company's price competitiveness, as opposed to gains on reported financial information.

Teradyne announces its quarter after the close tomorrow. The consensus revenue and EPS estimates for the September quarter are $507 million and $0.79. The consensus estimates for the December quarter are $451 million and $0.59.

Teradyne is a supplier of automatic test equipment. The Company designs, develops, manufactures and sells automatic test systems and solutions used to test complex electronics in the consumer electronics, automotive, computing, telecommunications, and aerospace and defense industries. The Company’s automatic test equipment products and services include semiconductor test (Semiconductor Test) systems and military/aerospace test (Mil/Aero) test instrumentation and systems, hard disk drive test (HDD) systems, circuit-board test and inspection (Commercial Board Test) systems and automotive diagnostic and test (Diagnostic Solutions) systems, collectively these products represent Systems Test Group.

A Couple Positions Placed on Emerging Turnarounds

Bought ~2% position in Computer Associates, ticker CA, at $22.94.

Bought CA primarily for the changes made in the business over the past year, which includes new management and acquisitions in the cloud computing sector. Generally, this is how I like to invest by identifying companies making good investments in their business that should lead to improving returns. Stock trades around 11x 2011 non-GAAP EPS consensus estimate, slightly lower than IBM and Oracle. While the company is by no means a pure play cloud computing company (legacy mainframe business provides stable and substantial amount of cash flow), and it has significant hurdles to migrate its business in this direction, more cloud-oriented software companies like Salesforce.com (Ticker: CRM), Amazon.com (Ticker: AMZN), and Concur (Ticker: CNQR) trade north of 40x 2011 EPs estimates. So I realize it has been "dead money" for years, but I expect the business to gradually look better over the next few years, offering accelerating EPS growth and possible multiple expansion.


Bought ~2% position in A shares of LyondellBasell, ticker LYB, at $28.00.

Complex business analyze due to its breadth, recent emergence from bankruptcy court and recent listing on the NYSE. However, it boils down to this: the company has pricing power, should benefit from a weakening dollar (although difficult to pin-down due to hedging activity), and it fits in my macro strategy of investing deep in the supply chain where inflation is most likely to emerge first. As time rolls forward the business trends should become clearer and analysts should pick up coverage, providing greater clarity for investors.

The stock trades at an EV /TTM Sales of about 0.7x, comparable to other chemical companies like DOW, GRA, and ASH.

LyondellBasell plans to release the results for the September quarter before the market open on Friday October 29.

LyondellBasell participates in the entire petrochemical value chain, from refining to specialized petrochemical product end uses. They are the largest producer of polypropylene and polypropylene compounds; a leading producer of propylene oxide, polyethylene, ethylene and propylene; a global leader in polyolefins technology; and a producer of refined products, including biofuels. Additionally, LyondellBasell is a leading provider of technology licenses and a supplier of catalysts for polyolefin production. To learn more about their business please look through recent presentations.

Duoyuan Global Water Inc. (Ticker: DGW)

Bought a 2% position in Duoyuan Global Water, ticker DGW, at $13.79.

This purchase is primarily a value play with strong support against the stock moving lower due to both its balance sheet and cash flow trends. Yet, the company should benefit from healthy secular growth trends within the water industry and a rising yuan.

Reasons for buying:
(1) $209 million of net cash on balance sheet, relative to a market cap of about $340 million.
(2) Guided sequential revenue growth in 3Q of 10%, or almost 30% y/y, in constant currency.
(3) Consistently CFO and FCF positive, reporting $18.6 million of FCF in 2009 (~13% unlevered FCF yield).
(4) Management appears active in pulling in new technologies to address China's water issues, improving competitiveness of the company within China.
(5) Benefit from a rise in the Yuan relative to the dollars for reporting purposes.
(6) Company positioned in the attractive clean water niche in China.


Duoyuan Global Water Inc. is a China-based domestic water treatment equipment supplier. Duoyuan's product offerings address several steps in the water treatment process, such as filtration, water softening, water-sediment separation, aeration, disinfection and reverse osmosis. Duoyuan offers a comprehensive set of complementary products across three product categories: water conservation, including circulating water treatment; water purification; and water reuse treatment, including wastewater treatment. The Company has a local distribution network, which provides proximity to end-user customers and responsiveness to local market demand.

PerkinElmer Inc. (Ticker PKI)

Bought a 2% position in PerkinElmer (ticker PKI) at $23.02.

Good day to buy given the pullback in the markets and PerkinElmer passed a couple screens for me, including:
(1) Majority of sales come from outside the U.S. (around 60% last quarter)
(2) Healthy secular trends in healthcare spending (especially China) and environmental spending (especially China).
(3) Momentum in the business, highlighted by mid-teen top-line growth.
(4) Active restructuring as management exits less attractive businesses and acquires businesses with greater potential.
(5) Decent return characteristics of the business, illustrated by 10% ROI and 13% ROE last Q.
(6) Attractive valuataion of 14.5x C11 EPS estimates, which show close to 20% EPS growth next year.
(7) Potential share repurchases since management has 8 million shares available under a 10 million share buyback program.

For a more complete understanding of the business at the outlook, readers can look through the following recent presentation by management.

Recent News Articles Reinforce Themes

A couple articles that reinforce my theories around sagflation.

(1) Prices Squeeze Main Street in the WSJ today offers a proof point of the argument I made about a likely shake-out in consumer focused companies.

(2) Although the editorial has some unnecessary political undertones, How the Fed is Holding Back Recovery offers a similar position to my posting Is the Fed Driving us into an Age of Sagflation?

(3) My positions in the Chilean economy through ECH and copper prices through FCX should benefit from the growing demand for batteries, which require copper, as highlighted in the article High Battery Cost Curbs Electric Cars.

Each of these points build confidence in my macro thesis over the next one to two quarters. They also suggest that investors should position themselves deeper in the supply chain in companies with greater pricing power. This pricing power is relatively easy to determine at the moment since companies are trying to raise prices. If they have successfully passed prices along, then it is likely the the competitive pressures and customer negotiating power is not too great.

Freeport McMoran Copper & Gold Inc. (Ticker: FCX)

Bought a 4% position in Freeport McMoran Copper & Gold Inc. (Ticker: FCX) at $99.84.

Freeport McMoran is the largest publicly traded copper company in the world. It also mines gold and molybdenum, which is used in steel production. The position expects to take advantage of increasing copper prices, driven by rising demand in developing countries and the high-tech industry. The company should also benefit from the strong price increases in gold and the demand for steel production in developing countries. As highlighted in the company's 10Q compared to spot prices, there should be upside to the company's outlook of $5 billion in operating cash. This suggests higher earnings in 2011 and the company raising the dividend at year end, should commodity prices remain strong.

"Based on projected consolidated sales volumes for 2010 and assuming average prices of $3.00 per pound of copper, $1,200 per ounce of gold and $14 per pound of molybdenum for the remainder of 2010, our consolidated operating cash flows for the year 2010 are expected to exceed $5 billion (up 14% y/y), net of an estimated $0.2 billion for working capital requirements. The impact of price changes on operating cash flows in 2010 would approximate $150 million for each $0.10 per pound change in the average price of copper, $30 million for each $50 per ounce change in the average price of gold and $25 million for each $2 per pound change in the average price of molybdenum."
  - FCX most recent 10Q

Copper prices have been increasing and currently sit at around $3.80 per pound.
Gold prices have also increased dramatically throughout the year and sit at around $1,377 per ounce.
Molybdenum's outlook remains robust and the price is around $15 per pound.

Trading at 11x 2011 EPS estimate of $9.04 (16% growth over 2011 estimate) with a dividend yield slightly greater than 1%.

Fed May Keep Foot on Accelerator into 2011

"Now, the Fed is saying: We stopped prematurely."
  - David Wessel, WSJ 10/14/2110, "For Fed, Goosing Markets Is a Risk Worth Taking"

"Mr. Bernanke felt that Japan's central bank needed to make a commitment to get inflation higher and keep policy accommodative until it increased. Among his proposals was a suggestion that the bank publicly adopt an inflation target of 3% to 4%."
  - Jon Hilsenrath, WSJ, 10/12/2010, "Fed Chief Gets Set to Apply Lessons of Japan's History"

"China’s stockpile of currency reserves, already the world’s biggest, increased by $194 billion from July to September, the most ever in a three-month period, to reach $2.65 trillion."
  - BusinessWorld, 10/13/2010, "China’s foreign reserves soar to $194B in Q3"

"The central bank doesn’t want to see excessive liquidity and is seeking to send a slightly tighter signal to the market"
  - Chen Qi, a Shanghai-based fixed-income analyst at UBS Securities Co., 10/11/2010

Tension continues to build in the world economy. The Fed appears intent on an expansionary monetary policy to fend off deflation and boost the U.S. economy. In China the policy makers continue to intervene in exchange markets to avoid a rapid rise in the yuan, which would hurt their export-based economy. As a result, the Chinese are buying dollars in their reserves, issuing yuan, and tightening their monetary policy to avoid inflation. So you have the Fed pushing on the accelerator and the Chinese pushing on the brakes. How this tension eventually unwinds will likely have a strong influence on my investment decisions in 2011.

My assumptions are the following:
(1) The Fed likely keeps flooding the markets with U.S. dollars into next year, in my view. This boosts the equity markets and eventually swings treasury yields higher (conflicting forces between Fed buying of treasuries versus improving outlook and rising inflation potential). I believe it is in Bernanke's nature to keep his foot on the gas long enough to see a material appreciation in the equity markets and decline in the dollar.
(2) There is increasing pressure on China to loosen the yuan relative to the dollar. I think this becomes a self-fulfilling prophecy as increasing "hot money" flows to China in anticipation of the yuan's appreciation, making intervention in the exchange markets more and more costly to the Chinese.
(3) There may be a dramatic swing in measures of inflation in the U.S. during 2011 as the dollar falls, monetary policy remains expansionary, and the Chinese slow down dollar purchases. This likely drives up treasury yields, further erodes the dollar after a period of conflicting signals, and forces the Fed to react in a tightening manner.


So my game plan remains unchanged for now, but 2011 could become a macro minefield as real economic activity remains muted and prices become more unstable, as our walk into a gloom of sagflation takes another step forward.

Barclays Bank PLC IPath S&P 500 VIX Short-Term Futures (Ticker: VXX)

Sold my 4% position in VXX at $14.13 for a realized loss of 21%.

Sold because the outlook for stocks continues to improve. The position was meant to capitalize on a pull-back in the market in October, which I have less confidence in now. Also, structurally the ETF is simply horrible and consistently bleeds value, so I wanted to avoid long-term exposure.

Kulicke and Soffa Industries, Inc. (Ticker: KLIC)

Entered into a 2% position of Kulicke and Soffa Industries, Inc. (Ticker: KLIC) at $5.90.

I enter into this position with my eyes open, drawn to the potential upside but wary of the risks. Only one analyst has a Buy on it, with Jefferies downgrading it after management's December outlook. That said, I generally like contrarian positions.

Reasons for Buying: Low single digit P/E, potential upside to estimates, growing net cash position, significant operating and EPS leverage, attractive secular trends to drive business, and my expectation of improving economic conditions.

Risks: Volatile orders, high fixed costs, new CEO, warned last week of weaker December revenue.

Recent Weaker Management Outlook Gives Pause. Management provided revenue guidance of around $255-260 million for the September quarter, and also lowered expectations for the December quarter on October 7. Not surprisingly this announcement caused weakness in the stock. The announcement coincided with a change in CEO as the previous CEO retired after over 30 years in the position. My take is the lowered expectations for December are a combination of requested delays in delivery dates by customers during August and September, and the new CEO "lowering the bar" to ease his first quarter at the helm. Intel (Ticker: INTC), one of the companies larger customers, had warned in August of weaker PC demand. Yesterday, Intel reported healthy earnings, provided a more bullish outlook for the industry, and maintained full year capital spending expectations of $5.2 billion, +/- $200 million.

Valuation is hard to ignore. The current FY 2011 (FYE Sept) EPS consensus is $1.58, down from the FY 2010 consensus estimate of $2.09. The low estimates for 2010 and 2011 are $1.93 and $1.05, respectively. I find these estimates fairly conservative given my expectation of healthy real economic growth in developing countries, strengthening nominal economic growth in developed growth over the next 6-12 months, and potential secular drivers. Using the low-end 2011 estimate the stock is trading at under 6x, despite improving returns, healthy balance sheet with net cash, and potential upside to estimates. If my thesis is even partially correct the company should produce growing earnings next year, implying EPS over $2.00 next year. If EPS grows next year the P/E multiple should expand, especially if returns continue to improve and remain at the high-end of the industry.

Secular Trends Healthy, albeit Order Volume Volatile. The semiconductor industry likely continues to convert to greater use of copper in circuits, requiring new machinery that K&S provides. K&S's largest customer, ASE Global (Ticker: ASX), is building a large new manufacturing facility that is expected to open later in 2011, likely producing large orders for K&S. Amkor Technology (Ticker: AMKR), the company's second largest customer, is also expanding its manufacturing capacity due to healthy growth trends. The company has entered the LED market, which is expected to produce a CAGR of 30% over the next few years.

Weakening dollar offers mixed dynamics. Company has been re-locating assets to Asia, from Israel and Switzerland, in order to reflect demand trends and lower costs of labor. Majority of business transacted in U.S. dollars, and therefore a decline in the dollar can help boost sales. However, sourcing of commodities and supplies in dollars can produce weaker margins when the dollar weakens. Therefore, currency fluctuations are somewhat mixed.

Top 10 customers in F09:

1.	Advanced Semiconductor Engineering (>10% revenue)

2.

Amkor Technology Inc. (>10% revenue)

3.

Siliconware Precision Industries, Ltd.

4.

Texas Instruments, Inc.

5.

First Technology China, Ltd.

6.

Techno Alpha Co.

7.

ST Microelectronics

8.

Samsung

9.

Micron Technology Incorporated

10.

Intel Corporation

Sagflation Theme - Riding Upward Price Instability through the Spring

My Sagflation thesis remains intact as I continue to allocate capital in my retirement account. Here is a quick update on my outlook as it relates to previous comments:

"The U.S. economy has likely entered a period of "Sagflation," defined as sagging economic activity combined with greater price instability."
           - Stock Ideas to Money - Is the Fed Driving Us Into an Age of Sagflation? August 27


(1) Positions deep in the supply chain, especially commodities, likely perform the best. Commodity prices have been rising, as discussed on the cover of today's WSJ and in previous articles. Increasing speculative activity likely continue to drive prices higher into 2011, in my view. Central banks have been aggressively expanding the money supply around the world. However, as I argued last week, the expansion of money and weakening dollar likely pushes up commodities and costs to consumer-related businesses in 2011 and therefore acting more like a tax on many domestic companies. I expect to continue to hold significant positions in commodities, like DBA and PALL.

(2) Likely stock market inflation, especially overseas, driven by aggressive monetary policies around the world, increasing investor appetite for risk as money growth loosens economic activity, and early 2011 over-reaction by investors who see growing momentum in the market. While earnings likely generally improve over the next couple quarter, I expect to see the market multiples expand as money flow shifts more into equities and away from debt. I expect to focus on companies with pricing power, like Huntsman (Ticker: HUN), companies in industries with healthy secular trends, like GT Solar (ticker SOLR), and U.S. companies with exports accounting for a large percentage of sales, like RF Micro Devices (ticker, RFMD). All these positions are also deep in the supply chain.

(3) Decreases in debt prices, driven initially by money shifting to equity as investors' economic outlooks brighten, and later this year by the on-going large treasury issues by the government. I expect treasury prices to continue to slide as inflationary pressure increasingly works its way into the economy. The other side of the argument, at least in the short-term, is that treasury prices continue to rally due to QE2 and a few unusual market dynamics associated with foreign purchases. This outlook is captured in my TBT position, which has performed poorly to date.

(4) Weak real economic performance within the U.S., which may appear like it is improving over the next year as inflation returns to more normal levels. The weak economic performance is the "sag" portion of sagflation. Therefore I expect to have small exposure to the U.S. consumer, in general, with greater emphasis on relatively stronger economies in Asia and South America. My positions in ECH, EWH, and MCHFX are expected to take advantage of this outlook.

I expect price instability to produce a U.S. stock market rally into Spring 2011 at which time valuations become stretched, Fed reins in expansionary monetary policies, real economic growth signals remain weak, and potentially increasing protectionism by countries. This tide likely lifts all boats for a period but also creates shorting opportunities as consumer companies are separated into winners and losers.

RF Micro Devices (Ticker: RFMD)

Bought a 2% position in RF Micro Devices, ticker RFMD, at $6.46.

Reason for Buying: Attractive segment with healthy secular tailwinds of increasing wireless usage, U.S. company with 85% of sales outside the country (benefits from weakening dollar), increasing market share in Asia, accelerating revenue growth, healthy ROIC of 13% last quarter (likely strengthens going forward), EPS recovering with growing trend of upside surprises, conservative FY12 (FYE March) EPS growth rate of just over 10%, P/E of under 10x on F12 EPS estimate.

RF Micro Devices designs and manufactures high-performance radio frequency (RF) components and compound semiconductors technologies. The company’s products enable worldwide mobility, provide enhanced connectivity and support advanced functionality in the cellular handset, wireless infrastructure, wireless local area network (WLAN or WiFi), cable television (CATV)/broadband and aerospace and defense markets.

Largest customer is Nokia, representing 44% in the June quarter. RFMD has been losing market share within Nokia, which has been widely talked about in the industry and market during 2010 and likely one of the main reasons the stock performed poorly until recently.

Large majority of revenue, as determined by "bill to" address, is outside the U.S., approximately 85% in F10. The company has been gaining market share in Asia as management has actively worked to diversify its customer base and replace Nokia's business. Revenue increased 29% last quarter, highlighting success in this strategy. China represented 37% of F10 revenue, followed by 14% in India. The majority of international sales are denominated in U.S. dollars, which become more price competitive when the dollar weakens.

Recent announcements of expansions to product lines. Completed restructuring in 2009 to improve operating efficiency. Repurchased 2012 convertible debt in July to reduce outstanding debt balance by $90 million, lowering interest expense and potential dilution should stock rise above $8, the initial conversion price.

Company has exceeded the EPS estimate for the last four quarters by $0.01 to $0.05. EPS estimate for F11 (FYE March) is $0.60 from Factset and $0.64 for FirstCall, and for F12 is $0.67 for Factset. P/E for F12 is therefore under 10x with potential upside to earning.

IShares Inc MSCI Hong Kong Index FD (Tick: EWH)

Purchased a 5% share in IShares Inc MSCI Hong Kong Index FD (Tick: EWH) at $18.85.

EWH seeks to provide investment results that correspond generally to the price and yield performance of publicly traded securities in the Hong Kong market, as measured by the MSCI Hong Kong index. The fund normally invests at least 90% of assets in the securities of the underlying index and in ADRs based on the securities in the underlying index. It uses a representative sampling strategy to try to track the index. The index consists of stocks traded primarily on the Stock Exchange of Hong Kong Limited. It is non-diversified. Expense ratio of 0.55%.

Entered this position to increase exposure to China for economic growth potential, and to move more money out of the dollar.

Investment theme can be summed up very simply right now: commodities, U.S. exporters and foreign economies. Eventually I'll drill down into more fundamentals on a company basis, but with the aggressive monetary policies around the world it suggests macro trends continue to drive the bus. The biggest question is when do the wheels on the bus start to fall off?

A couple upcoming books that I believe highlight growing investor sentiment going into 2011:
(1) Inflated: How Money and Debt Built the American Dream
(2) When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany

IShares Inc MCSI Chile Investable Market Index Fund (Ticker: ECH)

Bought a 5% position in IShares Inc MCSI Chile Investable Market Index Fund (Ticker: ECH) at $73.91.

ECH seeks to track the performance of MSCI Chile Investable Market index. The fund invests at least 90% of assets in the securities of the underlying index or in depositary receipts representing securities in the underlying index. The underlying index is a free float-adjusted market capitalization index that is designed to measure broad based equity market performance in Chile. The fund is non-diversified. The net expense ratio is 0.65%.

This investment plays into a couple angles, including expected growing inflationary pressure in commodities, continued economic growth and investment in developing countries like China and India, and the on-going deterioration of the dollar.

Chile's economy is open and largely driven by mining and exports. Specifically, the country is one of the largest suppliers of copper in the world according to the British Geological Survey. Copper mining accounted for about 14% of Chile's GDP in 2009, according to the Central Bank of Chile. Copper prices recently hit a two-year high, which should provide significant economic stimulus to the economy and Chile Peso.

Sagflation to Cause Consumer Company Shakeout?

"The cumulative effect of these management decisions to fund low-level return projects is a glut of assets, highlighted by overcapacity in industries like the restaurant industry."
                                                                  - Liquidity Trap, June 26 posting.

"Everyone is talking about raising prices."
                                                                  - Manny Chirico, CEO of Phillips Van Heusen quoted in WSJ

Industries selling directly to the U.S. consumer are increasingly feeling pinched between rising costs and an inability to raise prices. Companies appear to be reaching a pressure point in which they are willing to risk raising prices, and potential slowing sales, in order to maintain margins. Companies have been trying to maintain net margins through cost rationalizations, including outsourcing, lay-offs, and debt restructuring. Offsetting these efforts are rising commodity prices and an outlook of potentially increasing benefit costs, increasing regulations, and higher taxes. Weak consumer purchasing and a crowded competitive landscape have largely neutered price increases, in fact causing many companies to offer on-going price concessions as highlighted in the September release of NFIB Small Business Economic Trends.

I expect to see stronger companies successfully pass along higher costs and maintain overall returns of the business. Stronger businesses are typically well managed, offer higher value products and services, and are positioned in less competitive niches. Assuming economic activity remains flattish, I expect to see weaker companies without clear advantages falter and retreat. Put another way, segments in which there is over-capacity due to over investment spending likely produce tepid sales and declining margins until the weaker players are shaken out.

This analysis suggests that 2011 could produce a painful shakeout in the consumer segments of the economy. It also suggests that the surviving businesses should benefit in a few years from less competitive pressures, more growth opportunities, and more pricing power once this shakeout has occurred. Thus I believe, in general, consumer companies are poor investments in the near-term but could offer very attractive returns in the mid-to-long term.

How does this outlook weave into my sagflation theme? I continue to believe in this environment inflation starts deeper in the supply chain and eventually moves up. The CPI may not accelerate in 2011, but the PPI likely does, and thus my investments in companies deeper in the supply chain that can pass along price increase, like HUN and SOLR. Additionally, the inflationary pressure is likely not evenly distributed in the economy, instead bubbling up in specific asset classes and generally causing greater price instability.

Proof points for which I will watch to show a shake-out is occurring in consumer companies include rising bankruptcies and acquisition activity. While this cleansing process plays out I plan to generally avoid consumer companies that are primarily focused domestically.