Drought in Higher Rates May Be Over
The drought in higher interest rates may be nearing an end? Ever since the global financial crisis accelerated into full force in the fall of 2008, there were a constant flow of coordinated interest rate cuts triggered around the world with the aim of stimulating global GDP (Gross Domestic Product) and improving credit flow through the clogged financial pipes. Central banks across the world cut key benchmark interest rate levels and the impact of these reductions has a direct influence on what consumers pay for their financial products and services. More recently, we have begun to see the reversal of previous cuts with rate hikes witnessed in several international markets. Last week we saw Norway become the first western European country to raise rates, following an earlier October rate lift by Australia and another by Israel in August. For some countries, the sentiment has switched from global collapse fears to a stabilization posture coupled with future inflation concerns. In the U.S., the data has been more mixed (read article here) and the Federal Reserve has been clear on its intention to keep short-term rates at abnormally low levels for an extended period of time. That stance would likely change with evidence of inflationary pressures or improved job market conditions.
What Does This Mean for Consumers?
Prior to the financial crisis, credit availability flourished at affordably low rates. Now, with signs of a potential global recovery matched with regulatory overhauls, consumers may be impacted in several financial areas:
1) Credit Card Rates: Beyond regulatory changes in Washington (read more), the interest rate charged on unpaid credit card balances may be on the rise. When the Federal Reserve inevitably raises the targeted Federal Funds Rate (the interest rate for loans made between banks) from the current target rate range of 0.00% and 0.25%, this action will likely have direct upward pressure on consumer credit card rates. The associated increase in key benchmark rates such as the Prime Rate (the rate charged to a bank’s most creditworthy customers) and LIBOR (London Interbank Offer Rate) would result in higher monthly interest payments for consumers.
2) Other Consumer Loans: Many of the same forces impacting credit card rates will also impact other consumer loans, like home mortgages and auto loans. Pull out your loan documents – if you have floating or variable rate loans then you may be exposed to future hikes in interest rates.
3) Business Loans / Lines of Credit: Business owners -not just consumers – can also be impacted by rising rates. When the cost of funding goes up (.i.e., interest rates), the banks look to pass on those higher costs to the customer so the account profitability can be maintained.
4) Dollar & Import Prices: To the extent subsequent United States rate hikes lag other countries around the world, our dollar runs the risk of depreciating more in value (currency investors, all else equal, prefer currencies earning higher interest rates). A weaker dollar translates into foreign goods and services costing more. If international central banks continue to raise rates faster than the U.S., then imported good inflation could become a larger reality.
5) Hit to Bond Prices: Higher interest rates can also result in a negative hit to your bond portfolio. Higher duration bonds, those typically with longer maturities and lower relative coupon payments, are the most vulnerable to a rise in interest rates. Consider shortening the duration of your portfolio and even contemplate floating rate bonds.
Interest rates are the cost for borrowed money and even with the recent increase in consumers’ savings rate, consumers generally are still saddled with a lot of debt. Do yourself a favor and review any of your credit card agreements, loan documents, and bond portfolio so you will be prepared for any future interest rate increases. Shopping around for better rates and/or consolidating high interest rate debt into cheaper alternatives are good strategies as we face the inevitable end in the drought of higher global interest rates.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Style Drift: Hail Mary Investing
The mutual fund investing game is extraordinarily competitive. According to The Financial Times, there were 69,032 global mutual funds at the end of 2008. With the extreme competitiveness comes lucrative compensation structures if you can win (outperform) – I should know since I was a fund manager for many years. However, the compensation incentive structures can create style drift and conflicts of interest. You can think of style drift as the risky “Hail Mary” pass in football – you are a hero if the play (style drift) works, but a goat if it fails. When managers typically drift from the investment fund objective and investment strategy, typically they do not get fired if they outperform, but the manager is in hot water if drifting results in underperformance. Occasionally a fund can be a victim of its own success. A successful small-cap fund can have positions that appreciate so much the fund eventually becomes defined as a mid-cap fund – nice problem to have.
Drifting Issues
Why would a fund drift? Take for example the outperformance of the growth strategy in 2009 versus the value strategy. The Russell 1000 Growth index rose about +28% through October 23rd (excluding dividends) relative to the Russell 1000 Value index which increased +14%. The same goes with the emerging markets with some markets like Brazil and Russia having climbed over +100% this year. Because of the wide divergence in performance, value managers and domestic equity managers could be incented to drift into these outperforming areas. In some instances, managers can possibly earn multiples of their salary as bonuses, if they outperform their peers and benchmarks.
The non-compliance aspect to stated strategies is most damaging for institutional clients (you can think of pensions, endowments, 401ks, etc.). Investment industry consultants specifically hire fund managers to stay within the boundaries of a style box. This way, not only can consultants judge the performance of multitudes of managers on an apples-to-apples basis, but this structure also allows the client or plan participant to make confident asset allocation decisions without fears of combining overlapping strategies.
For most individual investors however, a properly diversified asset allocation across various styles, geographies, sizes, and asset classes is not a top priority (even though it should be). Rather, absolute performance is the number one focus and Morningstar ratings drive a lot of the decision making process.
What is Growth and Value?
Unfortunately the style drift game is very subjective. Growth and value can be viewed as two sides of the same coin, whereby value investing can simply be viewed as purchasing growth for a discount. Or as Warren Buffet says, “Growth and value investing are joined at the hip.” The distinction becomes even tougher because stocks will often cycle in and out of style labels (value and growth). During periods of outperformance a stock may get categorized as growth, whereas in periods of underperformance the stock may change its stripes to value. Unfortunately, there are multiple third party data source providers that define these factors differently. The subjective nature of these style categorizations also can provide cover to managers, depending on how specific the investment strategy is laid out in the prospectus.
What Investors Can Do?
1) Read Prospectus: Read the fund objective and investment strategy in the prospectus obtained via mailed hardcopy or digital version on the website.
2) Review Fund Holdings: Compare the objective and strategy with the fund holdings. Not only look at the style profile, but also evaluate size, geography, asset classes and industry concentrations. Morningstar.com can be a great tool for you to conduct your fund research.
3) Determine Benchmark: Find the appropriate benchmark for the fund and compare fund performance to the index. If the fund is consistently underperforming (outperforming) on days the benchmark is outperforming (underperforming), then this dynamic could be indicating a performance yellow flag.
4) Rebalance: By periodically reviewing your fund exposures and potential style drift, rebalancing can bring your asset allocation back into equilibrium.
5) Seek Advice: If you are still confused, call the fund company or contact a financial advisor to clarify whether style drift is occurring in your fund(s) (read article on finding advisor).
Style drift can potentially create big problems in your portfolio. Misaligned incentives and conflicts of interest may lead to unwanted and hidden risk factors in your portfolio. Do yourself a favor and make sure the quarterback of your funds is not throwing “Hail Mary” passes – you deserve a higher probability of success in your investments.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Wade W. Slome, CFA, CFP is a contributing writer for Morningstar.com. Please read disclosure language on IC “Contact” page.
Meat & Potatoes Investing with Joel Greenblatt
Joel Greenblatt has a long resume. Besides being the founder and managing partner of Gotham Capital, Mr. Greenblatt is the author of The Little Book That Beats the Market and an adjunct Professor at Columbia Business School. Now he is adding “Quant-fund Manager” to his work history. In his recent CNBC interview (below), Greenblatt discusses the real-world portfolio implementation of his “Magic Formula” on www.FormulaInvesting.com, a new venture he has undertaken.
The Magic Formula as it turns out is not all that magical, but rather very simple. The formula is based on two straightforward meat and potato factors gathered from Standard & Poor’s data: 1) the trailing Price/Earnings ratio on a stock (value factor); and 2) the Return on Capital ratio of a stock using historical earnings. The portfolio management strategy is fairly basic as well. Twenty to thirty securities are selected from the model, with the ability of the investor to customize if they so choose, and the portfolios are rebalanced on an annual basis making sure any relevant tax-loss selling occurs before the end of the calendar year.
Based on the back-tests, the model portfolio was up +291% over the last 10 years versus down -2% for the S&P 500 index. For 2008, however, the performance of the Magic Formula was not too enchanting – down about -36% versus -37% for the S&P 500 index, according to Greenblatt.
As with any back-test, or model, I am very skeptical about the output and inferences that can be drawn. Here are a few reasons why:
1) Past ≠Future: Just because this strategy worked in the past doesn’t mean it will work in the future. Greenblatt admits that the strategy can underperform for long periods of time.
2) Limited Data: Ten years is an extremely limited period of time to base a robust strategy on – much more data should be used.
3) Cost Estimates: Following a potentially very illiquid, out of favor value strategy with possibly large sums of money can cause past results to look quite different. Factors such as trading costs and impact costs can be underappreciated in computer based back-tests.
4) Data Mining: With any model, problems can arise when reams of data are sliced and diced for the sole purpose of creating a positive outcome. Often, there are no cause and effect between a variable and future returns, yet practitioners will jump to that conclusion because the factors fit the data.
To learn more about shortcomings in quantitative models, I suggest you learn more about butter production in Bangladesh (read article here). I will eagerly watch how Mr. Greenblatt’s “Magic Formula” works from a distance. In the mean time, I’m hungry. I think I’ll keep it simple…a steak and baked potato.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
The Halloween Indicator Buried at Cemetery in 2009
Boo!
Statisticians, economists, speculators, and superstitious investors have been known to get spooked by scary patterns. Tomorrow marks the end of the menacing six month period of supposed underperformance that starts in May and ends on Halloween. The so-called “Halloween Indicator” has popularized the expression of “sell in May and walk away.” The indicator obviously has not followed the alleged tendency in 2009, as there has been more “treat” than “trick” for investors over the last six months. The S&P has rallied about +22% (excluding dividends) with only one day left in the trading period. Numerous academics have studied the phenomenon and not surprisingly there is some debate regarding the validity of various studies (see past study) – differing opinions have risen to the surface, depending on the number of years compiled in the data.
Here is what Mark Hulbert at MarketWatch had to say on the subject:
“Over the Dow’s history up until the last 12 months, there were no fewer than 17 occasions (15% of the years) in which both the winter months turned in a net loss for the stock market and the summer months produced a gain. There furthermore were 45 years (41% of the time) in which the stock market during the summer period did better than it did over the winter months that immediately preceded it. So the stock market’s performance over the last 12 months is hardly exceptional. It would take a lot more than the recent seasonal missteps to convince a statistician that this long-term pattern has stopped working for good. “
Other calendar effects besides the Halloween Indicator include, the January Effect, Monday Effect, and Presidential Cycle. Even though some pundits point to evidence supporting calendar effects, in many cases the data is proved to be statistically insignificant.
With Halloween just around the corner, here’s Sidoxia Capital Management wishing you a larger bag of treats rather than tricks in your quest in following calendar effects.
Wall Street Halloween Costume Ideas:
Short of ideas for Halloween costumes this year? No need to fear. Here are a few bloodcurdling Wall Street costume ideas with the help of Joshua Brown at The Reformed Broker and our friends at Forbes:
Top Ten Scariest Wall Street Halloween Costumes
Halloween Index:
For those that would rather get there treats from the stock market rather than a candy bowl, perhaps you may find a sweet idea from Stockerblog’s Halloween Stock Index.
Have a happy and safe Halloween!
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct positions in any of the Halloween Stock Index companies with the exception of long positions in WMT for some Sidoxia accounts. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page
Clashing Views with Dr. Roubini
The say keep your friends close, and your enemies even closer. Nouriel Roubini, professor of economics and international business at the NYU Stern School of Business, is not an enemy, but I think his fluctuating views (see previous story) and Armageddon expectations are off base. Perma-bears like Roubini and Peter Schiff (view article) have gloated and danced in the media limelight due to their early but eventually right calls. Over the last seven months or so, their forecasts on the U.S. economy and markets have been off the mark. With that said, even those with competing views at times can find common ground. For Nouriel and I, we currently share similar beliefs on gold (see my article on gold).
Here’s what Professor Roubini has to say:
“ I don’t believe in gold. Gold can go up for only two reasons. [One is] inflation, and we are in a world where there are massive amounts of deflation because of a glut of capacity, and demand is weak, and there’s slack in the labor markets with unemployment peeking above 10 percent in all the advanced economies. So there’s no inflation, and there’s not going to be for the time being.The only other case in which gold can go higher with deflation is if you have Armageddon, if you have another depression. But we’ve avoided that tail risk as well. So all the gold bugs who say gold is going to go to $1,500, $2,000, they’re just speaking nonsense. Without inflation, or without a depression, there’s nowhere for gold to go. Yeah, it can go above $1,000, but it can’t move up 20-30 percent unless we end up in a world of inflation or another depression. I don’t see either of those being likely for the time being. Maybe three or four years from now, yes. But not anytime soon.”
My thoughts on oil are less bearish, but nonetheless more cautious given the massive price bounce to around $80 per barrel. Could I see prices coming down to $50 like Roubini feels is appropriate? Certainly. With the $100+ per barrel swing we saw last year, I cannot discount completely the possibility of that scenario. However, unlike gold, oil has a much stronger utility value, and based on the slow adoption of more expensive alternative energies, this commodity will be in strong demand for many years to come. The pace of global economic recovery, especially in countries like China, India, and Brazil provide an underlying demand for the petroleum product. In order to understand the underlying bid for this economic lubricant, all one has to do is look at the appetite of emerging economies like China when it comes to this black gold (see my article on China).
And where does Roubini think markets go from here?
“If the recovery of the economy is going to be anemic, sub-par, below-trend and U-shaped, there is going to be a correction. And therefore my view is to stay away from risky assets. Stay in liquid assets. I don’t know when the correction is going to occur, it could be a while longer, but eventually it will be a pretty ugly correction, across many different asset classes.”
Perhaps Roubini’s “double dip” fears will eventually come true – and he leaves himself plenty of room with vague loose language – however, I follow the philosophy of Peter Lynch: ‘‘If you spend more than 14 minutes a year worrying about the market, you’ve wasted 12 minutes.” Great companies don’t disappear in challenging markets – they become cheaper – and new innovative companies emerge to replace the old guard.
As much as I would like to be right all the time, that’s not the case. In order to learn from past mistakes and continually improve my process, it’s important to get the views of others…even from those with clashing perspectives.
Read IndexUniverse.com Interview with Nouriel Roubini Here
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct long or short positions in gold positions, however accounts do have long exposure to certain energy stocks and ETFs. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Economic Indicators Like Kissing Your Sister
The economy is on the mend, but we are obviously not out of the woods. Leverage and asset inflation through the housing bubble were major causes of the financial crisis of 2008-09. Now some of the major indicators are turning upwards with GDP expected to rise around +3% in Q3 this year and we are seeing housing units up, housing prices up, and housing inventories down (charts below). Although some of these numbers may create some warm and fuzzy sensations, abnormally high unemployment rates, massive budget deficits, and stuttering consumer confidence make this rebound feel more like kissing your sister.
There are, however, other signs of economic strength. For example, credit appears to be healing as well. Moodys predicts global speculative debt default rates will peak in Q4 this year at 12.5% – lower than the 18% Moodys predicted earlier this year in January. The CEO Confidence Board index, which typically leads profit growth by two quarters, jumped to a five year high in the 3rd quarter. The recovery is not limited to our domestic economy either – the International Monetary Fund (IMF) recently raised its global growth forecasts in 2010 from +2.5% to +3.1%.
Housing Sales Up, Inventories Down (Source: National Association of Realtors)
How sustainable is the recovery? Bears like Nouriel Roubini still think we are likely heading into a double-dip recession, perhaps by mid-2010, once the temporary home purchase credits expire and the stimulus funds run out. A collapse in the dollar due to exploding debt and rising deficits is feared to cause a spiraling in debt costs – another factor that could cause a relapse into recession. Unemployment remains at an abnormally 26 year high at 9.8% (September) and any self-maintaining recovery will require an improvement from this deteriorating trend. Before consumers freely open their wallets and purses, consumer confidence could use a boost in light of the recent -10% month-to-month drop in October.
Source: Associated Press (AP)
Fewer people are debating the existence of “green shoots,” however now the discussion is turning to sustainability. Time will tell whether those feelings of harmless sibling cheek pecks will lead to the discovery of a new long-lasting romantic relationship with a non-family member.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Compensation: Pitchforks or Penalties
Currently there is witch hunt under way to get rid of excessive compensation levels, especially in the financial and banking industries. Members of Congress and their constituents are looking to reign in the exorbitant paychecks distributed to the fat-cat executives at the likes of Goldman Sachs, Bank of America and the rest of the banking field. According to The Financial Times, Goldman has set aside $16.7 billion so far this year for compensation and benefits and pay is on track to meet or exceed the $661,000 employee average in 2007. The public is effectively calling these executive bankers “cheaters” because they are receiving benefits they don’t deserve. The backlash resembles the finger-pointing we see directed at the wealthy steroid abusers in football or cork-bat swingers in baseball. Americans seem OK with big payouts as long as they are achieved in a fair manner. No one quibbles with the billions made by Bill Gates or Warren Buffett, but when you speak of other wealth cheaters like Jeff Skilling (Enron), Bernie Ebbers (WorldCom), or Dennis Kozlowski (Tyco), then the public cringes. The reaction to corporate crooks is similar to the response provoked by steroid use allegations tied to Major League Baseball players (i.e., Barry Bonds and Roger Clemens).
Less clear are the cases in which cheaters take advantage of a system run by regulators (referees) who are looking the other way or have inadequate rules/procedures in place to monitor the players. Take for example the outrage over $165 million in bonuses paid to the controversial AIG employees of the Financial Products division. Should AIG employees suffer due to lax rules and oversight by regulators? There has been no implication of illegal behavior conducted by AIG, so why should employees be punished via bonus recaptures? The rules in place allowed AIG to issue these lucrative Credit Default Swap (CDS) products (read more about CDS) with inadequate capital requirements and controls, so AIG was not shy in exploiting this lack of oversight. Rule stretchers and breakers are found in all professions. For example, Lester Hayes, famed All-Pro cornerback from the Oakland Raiders, used excessive “Stickum” (hand glue) to give himself an advantage in covering his opponents. If professionals legally operate within the rules provided, then punishments and witch hunts should be ceased.
Regulators, or league officials in sports, need to establish rules and police the players. Retroactively changing the rules after the game is over is not the proper thing to do. What the industry referees need is not pitchforks, but rather some yellow flags and a pair of clear glasses to oversee fair play.
Cash Givers Should Make the Rules
What should regulators and the government do when it comes to compensation? Simply let the “cash givers” make the rules. In the case of companies trading in the global financial markets, the shareholders should drive the rules and regulations of compensation. “Say on pay” seems reasonable to me and has already gained more traction in the U.K. On the other hand, if shareholders don’t want to vote on pay and feel more comfortable in voting for independent board members on a compensation committee, then that’s fine by me as well. If worse comes to worse, shareholders can always sell shares in those companies that they feel institute excessive compensation plans. At the end of the day, investors are primarily looking for companies whose goal it is to maximize earnings and cash flows – if compensation plans in place operate against this goal, then shareholders should have a say.
When it comes to government controlled entities like AIG or Citigroup, the cash givers (i.e., the government) should claim their pound of flesh. For instance, Kenneth Feinberg, the Treasury official in charge of setting compensation at bailed-out companies, decided to cut compensation across the board at American International Group, Citigroup, Bank of America, General Motors, GMAC , Chrysler, and Chrysler Financial for top executives by more than 90% and overall pay by approximately 50%.
Put Away the Pitch Forks
In my view, too much emphasis is being put on executive pay. Capital eventually migrates to the areas where it is treated best, so for companies that are taking on excessive risk and using excessive compensation will find it difficult to raise capital and grow profits, thereby leading to lower share prices – all else equal. Government’s job is to partner with private regulators to foster an environment of transparency and adequate risk controls, so investors and shareholders can allocate their capital to the true innovators and high-profit potential companies. Too big to fail companies, like AIG with hundreds of subsidiaries operating in over 100 countries, should not be able to hide under the veil of complexity. Even in hairy, convoluted multi-nationals like AIG, half a trillion CDS exposure risks need to be adequately monitored and disclosed for investors. That why regulators need to take a page from other perfectly functioning derivatives markets like options and futures and get adequate capital requirements and transparency instituted on exchanges. I’m confident that market officials will penalize the wrongdoers so we can safely put away the pitch forks and pull out more transparent glasses to oversee the industry with.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and its clients do not have a direct position in Goldman Sachs (GS), AIG, Berkshire Hathaway, BRKA/B, Citigroup (C), Enron, General Motors, GMAC , Chrysler, WorldCom, or Tyco International (TYC) shares at the time this article was originally posted. Sidoxia Capital Management and its clients do have a direct position in Bank of America (BAC). No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Insider Trading: Raj Rajaratnam vs. Pete Rose
A recent Wall Street Journal article written by Donald J. Boudreaux, a professor of Economics at George Mason University, makes the case that insider trading is actually healthy for the operations of the financial markets. The arrest of Galleon Group founder and hedge fund manager, Raj Rajaratnam, is a tragedy according to the article’s author. Specifically he says, “Insiders buying and selling stocks based on their knowledge play a critical role in keeping asset prices honest—in keeping prices from lying to the public about corporate realities.”
Oh really? Then I suppose Professor Boudreaux would be fine with all-time leading hitter and former Cincinnati Reds Manager betting on his own baseball team to win or lose.
Another disputed aspect of insider trading by Boudreaux is the inability to monitor the crime. “Insider trading is impossible to police and…parsing the difference between legal and illegal insider trading is futile—and a disservice to all investors.” Maybe heroin and cocaine should be legalized too, since we can’t completely police these crimes either? Seems to me the insider trading laws are pretty clear what insiders can and cannot do with material information. The digital world we live in today only empowers investigators more than ever to discover clear electronic footprint trails connecting trading and banking accounts. Certainly, there will be creative crooks like Bernie Madoff that can slyly succeed for a period of time, but those that grasp too far will eventually get caught.
Professor Boudreaux goes on to describe the scenario of an unscrupulous CEO at a hypothetical company (Acme Inc.) driving a company into bankruptcy. He argues employees, creditors, and investors would be better served by a CEO enriching himself with insider trading in the name of price efficiency. Capital productivity would be enhanced for creditors/investors thanks to information efficiency and employees could manage their job hunting effectively.
Sounds great Don, but in a legal insider trading world, don’t you think inefficient, unscrupulous behavior for siphoning information from executives might lead to distracting and wasteful corporate actions? If I’m an employee at ACME Inc. and I can make more money trading ACME stock, rather than being a productive employee making widgets, then it doesn’t take a genius to figure out where my 40 hour work week concentration will reside. Moreover, how is a sabotaging CEO, who is raking in millions by shorting his company’s stock ,supposed to be a good thing for stakeholders? I strongly disagree. Stakeholders will be jeopardized more by an unfocused, greed-absorbed workforce than by the current enforcement structure, which strives for an even playing field of information.
After forcefully arguing trading on insider information should not be prohibited, the professor hedges his stance by saying there are exceptions: “There are, of course, situations in which it is in the interest of both a company and the public for that company to delay the release of information.” For example, he describes a merger situation where early information leakage could “jeopardize the prospect of achieving greater efficiencies.” If according to Boudreaux, policing of insider information is impossible, then determining what he calls “proprietary” versus “non-proprietary” information is only going to stir up a worse hornet’s nest.
In the end, if price efficiency (see story on market efficiency) and cheaper cost of capital is Professor Boudreaux’s central aim, then perhaps disclosing inside information, rather than selfishly profiting from trading on inside information, is a more suitable approach. For Pete Rose, I recommend sticking to legalized sports betting in Las Vegas as a superior strategy.
Read Full Professor Boudreaux WSJ Article
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Now You See It, Now You Don’t: TARP
Elizabeth Warren, who oversees the TARP (Troubled Asset Relief Program), along with being the Chair on the Congressional Oversight Panel and a professor at the Harvard Law School, goes out on a limb and candidly states, “ We not only don’t know [where the TARP money is], Maria, we’re not ever going to know.”
Ms. Warren is quick to blame former Treasury Secretary Henry “Hank” Paulson for not implementing accountability for the TARP funds handed to the large commercial and investment banks (see my earlier TARP article). How do you prove the money handed over to the banks was used for non-lending activities, such as marketing, compensation, television advertising, dividends, acquisitions or other corporate purposes other than lending? The short answer…you can’t! Even if TARP capital tracking was instituted, I think it would have been a fruitless effort since even legitimate use of the TARP funds would only free up additional capital for other suboptimal purposes. If my mom gave me $100 while I was struggling for money in college and told me to use it for food – well I, like a good chunk of students, would have eaten anyways without the handout. The windfall $100 bailout would likely be used for a guys trip to Las Vegas or some Laker basketball tickets. The banks will certainly lend, but not at the same pre-Lehman bankruptcy levels, regardless of whether TARP tracking was instituted or not. Ms. Warren correctly points out that regulators are speaking out of both sides of their mouths. The government wants banks to lend more (which reduces the bank’s capital base) and also raise their sickly reserve levels at the same time.
See TARP commentary on CNBC video interview at minute 2:48
Maria Bartiromo also probes the topic of executive pay compensation given a recent Congressional proposal that TARP recipients cut salaries of the top 25 executives by -90%. Seems like a reasonable request given the circumstances. However, having the government force banks into making bad loans is probably not the right answer. This stance will only force the banks to take higher loan deliquency provisions and recognize more potential writedowns in the future. Eventually the Fed will cut interest rates paid to banks on the reserves held at the central bank, thereby invcentivizing the banks to take advantage of the steeper yield curve and make handsome spreads on loans.
Until then, some of the banks will sit patiently on their TARP capital (not lending) while Ms. Warren and government officials will wonder how the billions of TARP bailouts magically disappeared.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and its clients had a direct position in VFH and BAC shares at the time this article was originally posted. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Misery Loves Company – Ruler Waffling
Besides using a ruler for measuring small distances and rapping disobedient knuckles, the wooden instrument can also be used for extrapolating trends. This ruler is a very convenient tool when rigorous analysis is a second choice.
Misery loves company, so the often maligned pool of inaccurate Wall Street equity analysts are happy to share the limelight with their trend leaning junk bond analyst cousins. As default rate expectations have bounced around like a jack rabbit post the Lehman Brothers bankruptcy, these bond forecasters have been caught flat-footed.
Reuters highlighted the backpedaling of Standard & Poor’s recent forecast changes:
“S&P said it now expects defaults to decline to 6.9 percent a year from now from a September rate of 10.8 percent. On Oct 2, it had said it expected defaults to escalate to 13.9 percent by August 2010.”
For a lazy analyst, extrapolation is a good fall-back strategy. Sticking your neck out by looking out further into the future or grasping the concept of reversion to the mean can be difficult and politically risky from a job retention perspective. It’s much easier to constantly hug current trends because it then becomes virtually impossible to be wrong.
Just as the rating agencies contributed to the subprime and auction rate securities (ARS) debacles by rubber stamping their AAA approvals last year through the financial crisis, so too have we witnessed the failure of bond analysts to properly analyze junk bond default rates.
Hopefully the narrowing of credit spreads is a leading indicator for economic improvement, but regardless the number and amount of high yield deals hitting the market is flowing heavily. The Wall Street Journal recently reported billions of junk bond deals being priced this week and next, including the $500 million Crown Castle International’s 10-year deal; $200 million Mohegan Tribal Gaming’s eight-year bonds; $325 million in Headwaters Inc.’s five-year notes; and over $2.4 billion of bonds from four other borrowers, including Boise Paper Holdings, Reynolds Group, Murray Energy Corp. and Universal City Development.
As larger companies are freely tapping the capital markets for capital, it’s becoming more and more evident that small businesses are having tougher and tougher times accessing credit, thanks in large part to banks hunkering down and reducing lending. Reference the flattening commercial bank credit curve chart provided by the Federal Reserve System:
As we watch the credit flow drama unfold in these uncertain economic times, don’t panic if you wondering what will happen next. Just reach into the desk drawer and pull out the favorite tool of Wall Street equity and junk bond analysts…the righteous ruler.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and its client accounts do have direct positions in HYG shares at the time this article was originally posted. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
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