MORNING BID – The economic state of things

Aug 1, 2014 13:19 UTC

The jobs report takes a bit of heat off of Thursday’s selloff, which was predicated in part on some nonsense out of Europe and more importantly some kind of growing consensus that the economy is getting hot enough that it might force the Federal Reserve to start raising rates a bit earlier than expected, given a sharp and unexpected rise in the employment cost index on Thursday. And while it’s fair to suggest the stock market has gotten a bit ahead of itself when the Fed is rapidly moving toward the end of its stimulus policies, it’s also possible that stocks have gotten ahead of themselves for a far more prosaic reason – the economy isn’t strong enough to support the kind of valuations we’re seeing in equities right now.

That’s not to say we’ve got bubbles all over the place in stocks – they’re pretty few and far between – but credit standards in various places have loosened, and if the Fed starts raising rates we’re going to see a pretty quick reversal of that before long. There are significant signs of concern emerging in places like the high yield market, which has dropped off sharply in recent days, particularly among the weakest credits, and the housing and auto markets, which are better leading indicators than the jobs data, also suggest that the slack credit standards may end up hitting a wall before long.

Jim Kochan at Wells Fargo Fund Management pointed out that with the U-6 unemployment rate picking up to 12.2 percent this month, it conforms to what Fed Chair Janet Yellen has said in the past – that the “report is consistent with Ms. Yellen’s view that it is too early for the Fed to be contemplating a ‘liftoff’ in the fed funds rate.” That’s caused the expectations for a rate hike – per CME Fed Watch – to back off a bit, with April odds now down to 37 percent (from 43 percent a couple days ago) and June down to 52 percent from 58 percent a couple of days ago.

The U-6 rate ticked up as more people entered the workforce.

The U-6 rate ticked up as more people entered the workforce.

As the labor market improves, there are growing concerns about leading economic areas that point to a slackening in activity and will serve as the real test of the economy’s ability to survive as monetary policy recedes from the picture and interest rates start to rise (even with the Fed still at near-zero and expected not to raise rates until April at least, if not thereafter).

The Detroit team of Bernie Woodall, Ben Klayman and Paul Lienert teamed up for a piece that notes how a minority of groups are seeing real concerns about credit standards being loosened to a point that suggests auto sales demand is being driven by too-easy money. People have long talked about how auto loans tended to be on average about five years – matching approximately a value of a car (to a point) and now the average loan has risen to about 66 months, which means there are plenty more people offering terms to seven or eight years.

Cars are made to last longer than years ago, but it still represents an extension of debt payments over a longer period of time that’s worrisome. Car sales figures are due out later today – July auto sales are expected to show a slight dip to a 16.7 million annualized rate from 17 million in June, and full-year forecasts are set to hit their highest rate since since 2006. Similar action can be seen in the housing market as well, where the four-week moving average of the MBA’s purchase index has been steadily declining for several weeks now. That’s probably to some extent a summer effect but that index now sits far below levels seen in mid-2013 when it rose to a four-year peak.

 

That said, again – it’s a bit early to conclude that the leading areas of the economy have given up the ghost and we’re now headed for an inexorable descent into a recession – housing and auto sales fluctuate quite a bit, and even in expansions sharp declines can be seen. The 12-month moving average of U.S. housing starts are still on an uptrend from a year-over-year basis.

On the other hand, the 12-month average of existing home sales has slipped to 4.908 million. Sales of existing homes have had long periods of stagnation amid economic expansions before – they were weak from mid-1994 to mid-1995 and were slack from mid-1987 to mid-1989 as well. The most recent experience in housing – boom-and-bust – seems overstated of yet. So give it a few months.

MORNING BID – Herbalife and the options market

Jul 28, 2014 15:59 UTC

One of the market’s more well known short bets, Herbalife, reports earnings after the close on Monday. The company is most notable as the target of activist investor Bill Ackman, who has had plenty of choice words for the company and yet has not been able to make good on his short position just yet, despite his fervent belief it is defrauding investors and taking advantage of poor people.

That’s a hefty set of accusations for anyone to deal with, but the stock’s 25 percent one-day surge last week just after Ackman’s presentation turned into a big loser for folks who were betting on big declines by the end of last week.

Ackman, from what we’re aware of, has big positions in put options expiring in January – so it’s a long view he’s taken, and if he took it at the right time, it’s not necessarily a loser just yet. (The options rose in value for the first few months of this year, so it’s possible Ackman got out in time – given his presentations, though, he’s clearly got a position somewhere.)

If that’s the case, he’s currently losing money, and today’s earnings report – and subsequent activity – will be another test of his staying power. Now, he’s said he’s prepared to go to the ends of the earth for this short position, but there are limits to everything, and it’s worth looking at just what the bet is like right now.

There are huge, huge amounts of outstanding contracts in various put options expiring in January – about 220,000 contracts across a swathe of nine different strike prices, to say nothing of a bunch of other less popular strikes.

Most of these big positions are currently not profitable, and are actually worth less than what they’ve been worth over the last several months.

If Ackman did his buying in chunks, a good spot to examine is in the $50 put option contracts expiring in January – a bet the stock will fall below $50 by that time. There was a hell of a lot of volume in these options in January 2014 – on January 9, volume in the $50 strike contracts came to 25,000 contracts and on January 10 volume of 20,759 contracts.

On those days, the stock was trading around $81 a share, so if Ackman is behind these purchases, it means he thought that was an opportune time to buy those puts, which cost $7.25 and $7.45 on average that day, according to Thomson Reuters data.

If he doesn’t hold those options anymore, he may have sold them at a profit, but currently those options are a loser, and as long as the stock keeps rising, they will continue to erode in value.

Doing the math, it shakes out like this – at 25,000 contracts at $7.25 each (x 100 because each contract is 100 shares of stock), those would have cost $18.125 million. The other group would cost $15.465 million, for a total cost of about $33.6 million.

Right now, those options would be worth about $18.9 million, so that’s a 40 percent loss, and that’s just for the $50 strike, never mind all of the other strikes. This of course may not be his position, but whomever took these positions, be it one person or several, is not in a happy place.

What matters is this: Since the first day the $50 strikes expiring in January 2015 started trading (back in Oct 2013), this strike has never been worth less than it is now.

If he’s holding the options now that he bought at just about any time between Oct ’13 and now, he’s losing money. Of course, given these are options, he’s easily able to keep rolling down and buying another money and selling these, but eventually, if the stock doesn’t do what he wants, he’ll be losing a ton of money. He’s got a lot of money, but how much pain can he endure? That’s a real question.

MORNING BID – Waiting on volatility

Jul 24, 2014 12:36 UTC

The day brings another run of earnings reports in what’s overall been a steady and admittedly staid earnings season – many of the high-fliers that investors counted on for volatile trading post-earnings haven’t delivered on that promise, an angle we’ll be exploring in more detail later in the day. Facebook went out with results that weren’t terrible or even all that amazing and shares meandered their way to a 2 percent gain in post-close trading Wednesday (it has since risen and is up 8 percent in premarket action Thursday, so that one has at least panned out for some). Shares of Gilead Sciences bucked the trend among more volatile biotechnology shares and really didn’t do all that much at all.

The big-cap stocks have been similarly unexciting, and the equity market gets a ton of them before and after on Thursday, including heavy equipment giant Caterpillar, the two car companies (Ford and General Motors). There’s also Post-It maker 3M, online retailer Amazon, payment processor Visa – another good consumer spending barometer, and the likes of PulteGroup and DR Horton, a pair of larger homebuilder stocks.

Headed into Wednesday evening’s results, the year-over-year earnings growth was 5.4 percent, or 7.1 percent when removing Citigroup, which had some seriously weird charges this quarter. That still makes things good for a high beat rate of 68.5 percent thus far, and overall companies are surprising by 2.4 percent per Thomson data (again, include Citi, and it’s a -0.2 percent result). So the overall foundation of earnings has generally been strong with few real surprises, helping keep a bit of a lid on volatility in general.

Looking at the names on the docket for today, there are a few that stand out in terms of bettors hoping for wild swings one way or another. Pandora Media looks like a candidate for some volatility, with options types banking on a 9.7 percent move in shares one way or another through Friday, while expectations for Amazon are for a more subdued 6 percent move. That’s relatively quiet for names of that type though Amazon has become something akin to the “old tech” names, with reduced volatility and high share repurchases than anything else.

MORNING BID – The consumer outlook, out of earnings

Jul 23, 2014 12:44 UTC

The next several hours will bring a handful of important consumer names that may give investors some idea of the progress the consumer economy is making. This only works as a barometer to some degree. Sales at S&P 500 companies far outpace the growth of the overall economy, which in part explains why the market itself is doing as well as it is (we’re in the 1980s now on the S&P, so crank up the Def Leppard) and the rest of the economy is lagging behind.

And mass market consumer-facing names like McDonald’s and Coca-Cola disappointed investors with their results on Tuesday, so it will be interesting to see whether others, like Whirlpool – which has tended to buck the general trend – will fare a bit better with their results. (Whirlpool, for its part, cut its outlook amid weak results, but North American sales were up 4 percent excluding currency effects, so score that one on the positive side of the ledger.)

Another consumer name that would lend some credence to the idea that Container Store and Lumber Liquidators put forth – that the U.S. economy remains in a funk – would be Ethan Allen Interiors. The furniture retailer actually comes in as undervalued, per StarMine expectations for growth in the coming decade, and it, too, has managed to steadily increase profit margins.

The company’s valuations compare favorably with those of its competitors: A lower forward price-to-earnings ratio than the likes of Haverty Furniture, Laz-E-Boy, and Leggett & Platt – and while it’s not the biggest of bellwethers (it’s a $659 million company, putting it in the S&P small caps), it has a certain cachet that puts it squarely in the mass market luxury area.

Again, it’s not a perfect barometer, but if it’s doing well along with the cable companies, media names that supply premium content, it points to higher-end retailer outperformance (though nobody has told Harley-Davidson or Michael Kors, both high-end companies that have struggled). If it sinks, it validates the “we’re in a funk” thesis.

The S&P’s global luxury retail index has posted annualized returns of about 25.5 percent in the last five years, outdoing the overall retail index (averaging 25.1 percent annualized in the last five years) and the consumer staples stocks (+16.7 percent).

The auto companies come a day later – Ford and General Motors – but the two U.S. automaking giants are buried under a lot of issues involving recalls, particularly GM.

Notably June auto sales came in at their best levels in about eight years, with GM showing a 1 percent increase in sales while Ford sales were down 5 percent for the month, though still ahead of forecasts.
Either way, the overall level of sales suggested some strength in the second quarter, with the primary questions being how much those companies will be hit by further recall-linked issues.

MORNING BID – The quiet days for Apple

Jul 22, 2014 12:59 UTC

Apple’s been the two-ton behemoth of the stock market for so long that it is going to be surprising, in a way, to see that the company isn’t really pulling its weight anymore when it comes to its percentage of S&P 500 earnings. This sort of thing can be a bit silly, but Howard Silverblatt, the index guru over at S&P Dow Jones, points out that Apple right now is about 3.2 percent of the total market value of the S&P while at the same time accounting for an expected 2.8 percent of earnings in the S&P – the first time since 2008 that Apple hasn’t delivered a percentage of S&P earnings equivalent to its market value.

In the past few years, Apple has tended to carry much of the S&P on its back, such as in the fourth quarter of 2011 and first quarter of 2012, when it accounted for 6 percent and 5.2 percent of the index’s earnings – compared with accounting for about 4.4 percent of the market’s value at that time. In the last quarter of 2012 the stock was 6.3 percent of the market’s earnings and was less than 4 percent of its market value.

Of course you wouldn’t expect that to be the case now – the second and third quarters are the relative dead period when it comes to Apple, given people are generally waiting for the next round of Apple innovations at the end of the year, be it a new phone or what-have-you.

This time through won’t be all that different – with the only real issue being just how solid the growth is for the quarter and whether the stock begins one of its patented run-up-to-the-new-phone rallies that we’ve seen in past years that lasts through the end of the calendar year. Notably, Samsung’s Galaxy S5 came out and face-planted, and that’s either the result of just being a lousy product or competition from China, so it’ll be interesting to see whether upstarts out of China are starting to take share from everybody, or if the Samsung problems auger in general for better things for Apple, as tech editor Eddie Chan points out.

In the last five years, the period beginning July 1 has been the most fruitful for holders of Apple shares, with an average price gain of about 22.5 percent, compared with the relatively unexciting 11 percent gains seen in the first half of the last five years (for Apple, that is, for many companies, 11 percent is fantastic).

The stock has been basically flat since the beginning of this month, but it’s early in the “best six months” period for the iPad giant, so we’ll see where it goes from here. Starmine still puts the stock as undervalued, saying it should trade around $104 a share rather than the $94 where it stands now. The forward P/E ratio of about 13.7 is far short of its 10-year historic mean of about 20.7, and the stock’s price has traded around or below its book value for most of the last four years now. We’ll be looking a bit more as well at the idea that there are fund managers that are shunning shares in a way that they hadn’t in the past – not seeing the kind of value that they feel has been offered in other years, perhaps in part as the expected growth rate for the company slows with all of the additional competition.

MORNING BID – Closet cases

Jul 10, 2014 12:57 UTC

Usually when retailers warn of earnings weakness – particularly if they’re saying the entire economy is in a funk – there are two possible explanations:

1: They’re right, and the real economy is truly suffering, or
2: It’s all their own fault.

That the likes of Lumber Liquidators and Container Store Group should warn of comings earnings shortfalls and weak results in the next few quarters – pegging to a consumer that didn’t rebound after the weak weather-hammered first quarter – would seem to fall into the former category, at least at first glance. After all, Container Store, despite stocking its shelves with all sorts of bric-a-brac designed to keep other bric-a-brac, has built its reputation on its Elfa closetizing system that to the normal person is a weird Rube Goldberg contraption but yet stores all 300 of your pairs of shoes, et cetera. And Lumber Liquidators is pretty binary – they sell discounted hardwood flooring. And so with both citing weak conditions that persisted past the weather-related mishegoss that dominated the first quarter of 2014, that’s at least enough to raise some eyebrows.

Both companies deal with the kinds of purchases that speak to substantial renovation and therefore depend specifically on the housing market, which of course weakened in the first half of the year and hasn’t rebounded to levels seen last year. Existing-home sales are still about 5 percent below the level reached a year ago, according to the latest from the National Association of Realtors, even though the May figures did represent an increase from April, suggesting a bit of increased momentum. But if the first-quarter housing weakness then gives way to an ongoing lag in the kind of spending that had people expecting a rebound in the second quarter, well, all the optimism about earnings that’s been baked into stock prices in recent days will surely unravel.

Of course, it’s plenty possible that the companies are screwing things up on their own. Container Store only went public for the first time last year, and after a brief rally that brought shares to a 52-week high of $47 around the end of 2013, it’s been a dog since, losing 43 percent of its value in short order. More than 10 percent of the shares are being shorted right now, and StarMine shows a whole load of worrying metrics with the company – it ranks worse than 90 percent of U.S. names in terms of its price-to-earnings ratio, and also sports a high price-to-book and price-to-cash flow level right now.

Lumber Liquidators doesn’t look much better in this regard. About 13 percent of shares are being borrowed for short bets, and it ranks in the lowest quartile in terms of relative value, given it’s very high price-to-book ratio and price-to-cash flow ratio, which again, just suggests investors are valuing the company’s assets pretty highly given the weak earnings expectations and ongoing reductions in its outlook. The stock is down nearly 32 percent year-to-date, and that doesn’t even include what is likely to be another selloff on Thursday, as it was down about 20 percent in overnight action.

The day’s earnings do not include too many names that can be seen as corollaries for these retailers; Kaufman & Broad, a homebuilder, is about the closest. Interestingly, in late May, Home Depot did reaffirm its earnings outlook for the year and raised its per-share earnings outlook in part due to improved expectations for sales growth. HD has a way of crowding out others – but another such update of that kind might settle just whether there’s a bigger storm coming in retail, or if it’s just warping the hardwood floors.

MORNING BID – Crypto-sale of the Century

Jul 1, 2014 13:38 UTC

Details on the sale of about 30,000 bitcoin have been spare, but what can be inferred by reading through the lines is that the sale of about $18 million went a lot better than many expected – particularly those who expected to get the coins on the cheap somehow. The prevailing market rate at the end of Monday was about $639, according to Coindesk, currently the leader in the pricing world, and the chatter trickling out was that the unsuccessful bidders – including hedge fund Pantera and SecondMarket’s Barry Silber, who put together a consortium of more than 40 bidders – aimed too low in one of those “Price is Right” moves but without the warmth of Bob Barker to confront you when you lose on these things.

With that in mind the speculation on just where the auction ended up can run wild – did it go for $650? $700 for the lot? Perhaps; those commenting on twitter and to Reuters in a story from Gertrude Chavez and Nate Raymond on Monday were suggesting that there were plenty of newer bidders in the process, firms that have been just getting going in the bitcoin world and probably wouldn’t mind to get their hands on a large stake even at a somewhat elevated price.

Either way, it points to the possibility of more sales from the U.S. Marshals, who are still hanging onto another 144,000 bitcoin that it obtained off a hard drive from Ross Ulbricht, who is accused of running the Silk Road online drug ring, which was shut down last year. (Keep in mind of course the Marshals Service hasn’t released any results.)

Whatever its inauspicious beginnings, that the USMS was able to stage such a successful sale of the crypto-currency means the product has been given real legitimacy as it sold with substantial demand, and leads to more sales later. So there’s only so many times one can say this is fake before one has to think somewhat differently.

BANNER YEAR
Bitcoin is down about 16 percent on the year, so it’s been a loser in a year where almost everything else has gone well in the first half. In a somewhat uncommon fashion, both stocks and bonds, along with gold and oil, are all higher on the year. YTD asset performance

That’s a surprise in both the equity and debt markets, where higher interest rates were supposed to sap investor enthusiasm for bonds and reduce the attractiveness of stocks as well. But markets are funny and instead the second half begins with the S&P not far from a record and bond prices surging (high yield bonds, notably, were at their tightest rates against U.S. Treasuries in 2007). We’ll be looking at this a bit later, but suffice to say some people in the credit world are starting to get somewhat nervous about this, believing that the rally has come far enough.

With that there’s some adjustment going on among big credit managers who see the opportunities in riskier credit waning. Fund flows remain strong, though, so what’s a person to do? Either way, the excesses that many discuss when it comes to credit don’t seem to quite be there yet – but they are starting to move closer. The Fed remains very much in the game, but there are plenty of strategists who believe it won’t be more than a few months before they start to pull back, which means a rough ride for almost everyone else.

MORNING BID – To my brother Russell…

Jun 27, 2014 14:35 UTC

The index business is a big business, so it’s not for nothing that the London Stock Exchange agreed on Thursday to buy Frank Russell Co and its Russell Indexes.

Those indexes are benchmarked to more than $5 trillion in index funds and puts the LSE in the third position behind S&P Dow Jones and MSCI in the ETF world as well, a lucrative business that involves using their well-known indexes like the Russell 2000 and its “value” and “growth” versions into a multitude of funds.

The iShares Russell 2000 ETF is generally in the top five in terms of daily trading volume among ETFs, and the Direxion triple-short Russell ETF hovers around the top 10; several other leveraged ETFs linked to the small-cap index are big ones too, and we haven’t even gotten to all of the regular funds that index to the Russell.

With that in mind the market awaits the big rebalancing of Russell Indexes which will cross at the end of the day in a massive trade (Credit Suisse estimates about $42 billion in trading on the “cross,” that is, the moment when everything rebalances all at once in an event that sometimes seems like it should be a Y2K-style debacle, only it isn’t).

Of course, big index desks have been preparing for this for months, with some of the preliminary trading to position for companies they expect to see a bigger weighting even starting as early as January. Credit Suisse notes that some index trading desks likely make most of their profit-and-loss for the year as a result of this trade.

That said, this year’s notable additions to the Russell 1000 index are a bit underwhelming: Tyco has come back to the fold not long after being banished due to domicile concerns, while Ally Financial and CBS Outdoor Americas are also among those coming into the index.

The Tyco addition will produce a trade of about $648.3 million, the largest of the day, and significant buying will also be notable in Twitter and Facebook – $495.6 million and $452.8 million, respectively, ranking them fourth and fifth.

Those two stocks are seeing their share in the Russell 1000 increase as well – explaining the adjustment there.
Some of the trading, meanwhile, will relate specifically to shifts in a stock’s growth/value profile, such as American Airlines, expected to see an index trade worth about $558.7 million, second only to Tyco – the result of it being classified as 100 percent growth, rather than the 58/42 split from last year, according to Credit Suisse.

MORNING BID – Climbing the Wall

Jun 26, 2014 12:56 UTC

Eventually, lack of volatility, rock-bottom rates and this accommodating monetary policy will realize the build-up of excesses that causes some kind of market crack that devastates people – particularly in areas where many do not expect it. But it won’t be today, and investors should continue to ride that so-called Wall of Worry through the 2,000 mark on the S&P 500 before long.

Goldman Sachs strategists note in a piece overnight that volatility is likely to remain lower for longer, but the slowness of the economic expansion and the additional regulations as a result of the financial market crisis of 2008 mean that the buildup of those speculative excesses is happening at a much slower rate. That’s not to say they aren’t out there – Brian Reynolds of Rosenblatt Securities is adamant that we are now in a “runaway bull market,” which of course usually ends in tears for someone, but again, not today.

But back to Goldman: their head of credit strategy, Charlie Himmelberg, notes that bank regulation and other issues have reduced that so-called accelerator, where activity in the economy amplifies risk-taking in credit markets and use of leverage, and vice versa. So that’s adding some drag to the system, which can be seen through, well, the fact that the economy plods along – contracting by a ridiculous 2.9 percent in the first quarter – without any real sign of taking off. Again, there’s merit to this in that it means a recession is far off because we’re so far only about midway through the business cycle, at best.

The emerging signs of additional spending on capex are there, and investors, per Bank of America/Merrill Lynch, are practically begging for more capex – the long-term spending that follows lots of buyback and dividend activity and then after the M&A activity that we’ve seen a lot of in 2014. The company’s global fund manager survey currently shows a net 60% plus that want more capex — and the last 12 months capex growth rate is up to 5.6 percent from 2.2 percent in the previous quarter, so investors are getting what they want.

What that portends, though, is an eventual shift in volatility. That hasn’t happened yet, and some measures, like Credit Suisse’s measure of fear, where they look at the cost of put options versus call options, show a lot of fear – but that’s because the price of calls has collapsed, meaning investors just don’t see a reason to bet on higher markets. They’re not really increasing bets on lower markets – so that’s the ultimate signal of boredom. Which is a merit of sorts.

MORNING BID – Speculating on a Hypothesis

Jun 23, 2014 13:18 UTC

A few thoughts as the market heads into a relatively quiet week featuring mostly Federal Reserve speakers and a few other random events that aren’t likely to knock the market to its knees:

  • Bear markets don’t just start “because,” as Dan Greenhaus of BTIG puts it. Usually there are a few factors, but most often it’s some combination of speculative excess, tightening rates, and a reduction in that bit of froth in an area that’s crucial to the bull market or economic expansion in question. When technology investing money dried up and the companies that sold shares to the public foundering on a lack of earnings, the tech bubble was unwound pretty quickly. The financial crisis came about as banks became unable to handle the volume of debt that had been sold and as the Fed raised rates, sapping demand in the “greater fool” housing market, and as the banks ate themselves under synthetic products that weren’t anything underlying. So with that in mind, what’s the speculative excess now? Probably the overall thing is ultimate low rates, because when that does go, the market is going to view growth differently.
  • The expectation for higher rates is a primary underpinning for overall investor nervousness. If rates are higher, the expansion is threatened, and inflation becomes an issue. It’s not that those conditions exist now, but the prevailing view for rising rates explains in many ways why this bull market is as loathed as it is. People remain wary of making bets in this market, even if retail investors would have been handsomely rewarded by getting in at any morn, so that’s point in favor of them rather than against.
  • Higher rates often do end up killing a lot of bull markets – and economic expansions – so the inflation figures and the Fed members’ beliefs related to the threat of rising prices are all important, and we’ll attempt to make sure of the chatter coming from the likes of Charles Plosser, Jeff Lacker and John Williams. So that’s the second team when it comes to Fed speakers (Bill Dudley also speaks, but the Puerto Rican economy is the topic) in terms of influence, but still, those views remain important.
  • Complacency isn’t a “thing.” As Luciana Lopez and Jennifer Ablan wrote about late last week, the VIX being low isn’t a workable assessment of the concerns thousands of investors have about the equity market and economy, particularly when the VIX really only reflects expectations for volatility in the coming couple of weeks and not in any long-term kind of way. So yes, the VIX around 10 doesn’t make a lot of sense until you remember it’s been about 45 cays where the index hasn’t even hit a 1 percent change – so realized volatility has been in the 4 percent range.
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