Archive | April, 2011

Greeks now undertaking a criminal investigation of London trader

24 Apr Guardian has reported that a London Citigroup trader is going to face a criminal investigation by the Greek authorities and Interpol for sending out the below email. If there is evidence to suggest that the trader has been acting on inside information then please progress, but the email reads:

“MKT NOISE Over the last 20min, there seems to be some increased noise over Gr debt restructuring as early as this Easter weekend. Spreads are moving wider now with 2y spread +100 from +35 at midday, while Gr banks are at -4%, -6% vs +2% in the morning.

The last few days the talks over Gr restructuring/rescheduling have intensified, despite the ongoing denials by Gr and foreign officials.

If a credit event takes place it is crucial to see what the terms would be as a haircut would have a much different outcome vs an extension of maturities.”

To most apt investors the email is purely a well summarised indictment of the current Greek bond market situation tied within the political complex. The note also briefly states the market reaction towards the Greek banking sector. The mentioning of widening Greek CDS spreads would have completed the rout. On the basis of the three paragraphs the email contains nothing contentious, it is alarmingly difficult to see where the problem lies. While this is undoubtedly going to cause additional strain for the Greek government, hiding or criminally prosecuting individuals who are merely highlighting facts is unwise. It was laughable hearing that the Greeks were seeking additional war reparations from Germany to soften their debt burdens, but this is now comical. Greece has become a circus and their politicians have routinely been  shown to be liars and grossly ignorant of their financial difficulties; history has also been a testament to that.


Delving into the Financial Crisis Inquiry Commission’s interviews

24 Apr

If you have not already listened to or read some of the transcripts of the Financial Crisis Inquiry Commission’s analysis into what caused the mortgage mess, take a look. Clearly some of the interviews provide a lot more utility and value than others; there are some participants that have nothing to lose and want to contribute to the exchange like the guys formerly at Deutsche Bank, Greg Lippmann and Eugene Xu. Michael Burry – have a read of The Big Short (by Michael Lewis) for further details regarding him also contributes to the inquiry. These are individuals who made a lot of money by being on the right side of the trade so their insights are imperative. Others such as Blankfein are playing a game, mixing some truths among many lies; all the investment banks were leveraged with toxic junk to the stratosphere; Blankfein has to pretend like they didn’t know as well; well they didn’t for a long period of time, but they realised just before the rest of the herd did, and were able to short change clients like the Abacus deal totally oblitering any fiduciary responsibilities they were supposed to have.

It’s an interesting collection of interviews; it is easy to comment now with such hindsight but those who were able to profit from the mess with such accuracy have every right to re-tell these generational events; to discuss cause and effect. While it has taken 18 months to culminate these findings, a few of these guys could have saved the Commission a lot of time reading ‘Learn Derivatives in 24 Hours Guaranteed!’, ‘Trading for Dummies’ etc., without having to persist with spending so much money and energy in generating findings whose future value is unlikely to be exercised. The inquiry was essentially an event in blame transfer; to ensure regulators and the government at large were not to be held accountable for their complete absence of oversight and inaction; and to mitigate any negativity they received by offsetting that with a greater public frustration at Wall Street; directly at the major firms that underpin this community. What I find most striking is the lack of prosecutions, or, at least, trials of those individuals who committed fraud; it is peculiar that Chris Dodd and Barney Frank, two of the individuals that orchestrated the crisis by proselytising the GSEs, and their federally mandated guarantees of toxic trash are now framing the new legislative works; are things upside-down or is it just me?

Why short term fixes in the mortgage market are going to cause long term structural issues

23 Apr

The US mortgage market is unique; the peculiar composition and dominance of government sponsored entities guaranteeing mortgage debt destabilises the price matching function of the free market. The GSE’s do not allocate capital effectively; securitisation masks risks instead of decreasing them.  Markets traditionally are a meeting place between buyers and sellers where supply and demand match to establish price. Sometimes this process is compromised where monopolies or price fixing exists, but generally the system functions well and roots out inefficiencies. It allocates capital to the most efficient and effective operators. Furthermore, even bankruptcy is a healthy process; it re-allocates capital to the more efficient providers and exits those companies who cannot create a return on capital employed.

The US mortgage market is characterised by heavy government policy, involvement and interference. Almost 90% of mortgages are federally guaranteed by GSEs. This transfers the risks from the lender to the government.  Why should the government be the orchestrator of the mortgage market? Why should gains for the banks be privatised and the losses are socialised? There are many countries where home rentals are in the majority; home ownership shouldn’t be a mantra that the government prosletysizes; it is job of the individual who should consider whether they can afford to and whether this is in their best interests; where the government is involved this causes unnecessary distortions at a magnitude which is going to be catastrophic, and has already been.  A federal guarantee also encourages relaxed lending standards or the complete absence of them; the government is not qualified to make an assessment of individual creditworthiness, the government itself is insolvent.  The government should not be dictating to individuals that they should make it their lifetime objective to purchase a home; again it is for individuals and their families to make that decision and direction. What the government should be advising is that individuals should spend and save prudently even if that means renting. It is absolutely due to the government abuse and behaviour in the mortgage market that had encouraged rampant speculation in the largest domestic sector.

A home primarily is a place to reside in, it should not be leveraged as an object of speculation.  Now I don’t want to repeat the causes of the crisis and this is no attempt to do so, I am just noting that after a crisis that pinpointed exactly what the major problems are,  Fannie and Freddie Mac, nothing meaningful has changed with these GSEs.  The government needs to move out the way and let the market operate to re-establish the true price-finding mechanism of the free market; governments need to be apt to ensure lending standards are being enforced and that they are not artificial; bank writedowns should be encouraged and the interpretation of regulation should not be freely adjustable; this allows financial institutions to value their assets purely as they see fit rather than marking to market.   Deposits should be enforced and short term flipping should be taxed to discourage speculation. There is no need for the government to be so deeply mashed within the mortgage market; it is incredible that rates are approx 5% with implicit government guarantees; rates are being artificially subdued with government intervention; the upcoming rate hikes are going to penetrate the mortgage and wider markets; debt matters and we have 5000 years of recorded history to prove that.

Cognitive dissonance and the impact it has on investing

21 Apr

You know when you invest in a stock and then you try to seek out every reason to validate your investment thesis i.e. ‘this stock is cheap, look how much cash they have on their balance sheet, its year-on-year growth momentum will ensure the company grows into its earnings multiple’ etc; and you phase out almost all negative information about the stock (which may just be the plain reality), well scientists (well not the ones in white lab coats!), have a term for this collective pattern of behaviours, ‘cognitive dissonance’.

A large part of investing is about psychology and sentiment and what drives human behaviour. Cognitive dissonance is perhaps one of the most significant psychological theories with a direct transmission mechanism into investing.  Investors purchase stocks long or short because they hold a certain set of beliefs about that stock, even short term investors.  Now if markets are efficient information is already in the market and prices should adjust accordingly. Now, unless everyone is trading on inside information they
are taking positions based on their interpretation of market information. It is precisely this fact which essentially makes markets.

Cognitive dissonance almost explains why investors typically nurse significant losses on stocks and don’t always sell them even when they have ample opportunities to exit positions incurring only marginal losses.  When bad news occurs, damaging fundamentals, the idea of buying into weakness or lowering your average purchase price reinforces this cognitive dissonance behaviour. Instead we should be reconsidering the position itself.

A good example of effectively managing cognitive dissonance behaviour was Whitney Tilson’s  Netflix short. Clearly on a financial metric basis the company is overvalued and faces a number of headwinds going forwards. In addition, negative news or general downward market momentum is likely to result in Netflix experiencing deeper stock price losses due to the significant appreciation which has already been achieved to date. However, the company is the premier franchise in online video; international expansion also offers the opportunity to further consolidate their dominant positioning. It would also cost competitors billions to create a bold infrastructure to compete.

Netflix also has first mover advantages and although content costs are high and are expected to increase this is somewhat offset by subscriber growth, and the potential to leverage subscriber price increases. Also any upward guidance is likely to propel the stock artificially higher due to the existing high short interest.

Whitney covered his short and this prevented potential further losses of approx 50%+. He appreciated that his position was not as originally perceived; but there are shorts who have been in Netflix since $70 and the stock has had a parabolic move since then. It is this behaviour of ignoring company and market fundamentals that reflects exactly what cognitive dissonance is. So the next time you see a psychology or social studies book, don’t throw it by the way-side, as it may just contain that small nugget of wisdom hidden behind all that bravado.

Why Bank of America (BAC) should drop the Merrill Lynch name tag

17 Apr

Merrill Lynch was one of the worst Wall Street firms in history. Period. They leveraged their balance sheet into the stratosphere in toxic illiquid assets whose value could not be measured. Stan O’Neil, the former CEO, lacked the knowledge and cross-product experience to take the healm at ML. Merrill Lynch were one the key players in the sub prime market and racked up losses in excess of $7 billion dollars, which are frankly conservative estimates.  O’Neal’s remuneration was $48 million in 2006 and $46 million in 2007 and his eventual exit package was approx $160 million. I don’t believe any of O’Neil’s adventures into the sub prime area had any fraudulent undertones; it is more an issue of competence and plain ignorance.

Bank of America’s biggest division is the Global Consumer and Small Business Banking (GC&SBB) unit which is the largest by revenue. The company is headquarted in Charlotte, North Carolina and expanded out of California across the US. While I don’t prefer any financials or insurance stocks, and would not advocate being invested in either, the situation here is trying to make the best out of horrible circumstances. Clearly, financials can rise from here but this article is purely focused on semantics in terms of corporate identity. Bank of America is perceived as a consumer and small business franchise, conservative and cautious compared to the pure play investment banking franchises. Merrill Lynch is a story of a battered franchise bailed out by Bank of America in an over-priced premature takeover.  These two organisations as entities do not mesh well.  Negative connotations are already being transmitted to the core Bank of America franchise.

The Merrill Lynch brand is dead in the dumps. It represents financial terrorism, uncapped leveraging in toxic trash. There is clearly a wide disconnect between the Bank of America and Merrill Lynch franchises. Brian Moynihan is still relatively new in post so he is still able to transition or phase out the Merrill Lynch brand, as clearly the synergies between the brand entities are non-existent.

Established a small short position in Monster Worldwide (MWW)

17 Apr

Established a small short position in Monster Worldwide at 16.7 px at $2.2 bn market cap. The total float is already 13% short so this is no contrarian position. MWW is already down approx 30% YTD 2011 so further upside/downside volatility is to be expected. The current job market in most major economies is anemic. Companies and public sector organisations are still shedding jobs and at a higher pace and are saving costs through natural wastage and re-deploying their existing workforce within their organisations to avoid costly redundancies.  Budgets for HR and recruitment are being cut because the transmission mechanism into earnings performance by non-core functions like HR are weak in a lot of organisations especially public sector. Unemployment in the US is currently 8.8% although most apt investors are well aware that U2 which is a better gauge of unemployment is considerably higher.

It is also not possible to consider unemployment metrics in a homogeneous manner globally. In the US fiscal monetary expansion is occurring with significant momentum; across most of Europe the seeds of fiscal tightening are beginning to sprout. Monster Worldwide’s management are also weak; the purchase of HotJobs from Yahoo for $225 million in cash was poor and a reflection of the Board’s fundamental non-understanding of the core and systematic issues their company now faces. Competition within the sector has also intensified with the rise of Indeed and Simply Hired, who have pioneered the meta-search functionality, which basically amalgamates job postings across hundreds of websites harmonising search across one platform. Indeed is the #1 job site worldwide, with over 40 million unique visitors and 1 billion job searches per month. It has the lead in page views in the US and UK.

The concern on the Street is mainly focused around LinkedIn and the fact that almost half of its revenue originates from job postings and related company advertising. Clearly LinkedIn is positioned around professional networking but the real economic benefits are being leveraged around its job portal functionality and that is the catalyst going forwards. Either way both functions are worrisome for Monster Worldwide. The resignation of their CFO, historic problems with option settlements and financial restatements reminds us that there are still legacy issues with MWW. Ongoing earnings guidance are also sketchy and have been poorly received by the Street. Furthermore, major companies are re-directing larger proportions of their recruitment and advertising expenditures towards the social networking sphere including Facebook, Twitter and LinkedIn.

There is chatter around mergers and acquisitions circling Monster and from a stock performance/valuation perspective now may be an apt time if there is such interest. However, I cannot see the logic or wisdom in such a purchase; the ongoing fundamentals of the company are horrible, they have a poor control over costs and management are not sophisticated enough to direct the company successfully through the numerous headwinds that are likely to impact its performance going forwards. Monster has been obsessed with discounting and short-term promotions to retain and win new business further eroding margins. While I believe longer-term social networking trends are likely to be making major inroads into Monster’s core business the threat from meta-search job websites is the major immediate threat. Recruiters websites are crawled and job posts are aggregated. Recruiters can also feed their job postings directly into Indeed’s index at no cost with a high number of eyeballs. Monster is clearly behind the curve.

Why value investors should appreciate technicals

17 Apr

Value investing is all about searching for financial securities that are at a discount to their core intrinsic value. They also offer a considerable amount of margin of safety to offset any potential downside. We can extend these concepts further but these are some of the primary features. In order to understand stock movements we need to appreciate market composition, cycles within the economy, macro and micro economic issues, fundamental company-specifics and drivers, including near-term catalysts, and general trading behaviour.  As a value investor I don’t pay much attention to short-term technical behaviour such as moving averages, MACD’s, volume and RSI’s. However, it has been estimated that 60% of trading volume is directly attributed to either short-term traders or high frequency algorithms. Therefore, because this group correlates so highly to market performance we need to consider their behaviour and influence.

Short-term technicals overall can generally be viewed as noise rather than having any meaningful value for long-term value investors. The short-term technicals were horrible in March 2009 yet we experienced a generational rally across all stock averages. In terms of technicals I find long term support and resistance indicators as a good barometer for financial instruments. We need to appreciate that there is an underlying fundamental attribute that stock resistance and support levels reflect in terms of market valuation and whether the market is comfortable with that. As always, however, markets are generally inefficient and the market does not always know how to price valuation – the 2000 tech. bubble and the generational March 2009 low highlight this.

To reinforce the point, long-term market behaviour and its directional emphasis is useful and can give clues to future performance. However, viewing technicals in isolation, especially short-term, can be dangerous and is more about speculation and greed rather than investing. It is this type of behaviour and absolute reliance on short-term market performance that almost guarantees continued market volatility and dysfunctional dynamics.

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