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Archive for May 11th, 2007

One Dozen More Compelling Articles Around the Web

Friday, May 11th, 2007

1)  Picking up where I left off last night, I have a trio of items from Random Roger.  Is M&A Bullish or Bearish?  Great question.  Here’s my answer: at the beginning of an M&A wave, M&A is unambiguously bullish as investors seize on cheap valuations that have gone unnoticed.  Typically they pay cash, because the investors are very certain about the value obtained.

From the middle to the end of the M&A wave, the action is bullish in the short run, and bearish in the intermediate term.  The cash component of deals declines; investors want to do the deals, but increasingly don’t want to part with cash, because they don’t want to be so leveraged.

My advice: watch two things. One, the cash component of deals, and two, the reaction of the market as deals are announced.  Here’s a quick test: good deals increase the overall market cap of the acquirer and target as a whole.  Bad deals decrease that sum.  Generally, deal quality by that measure declines over the course of an M&A wave.

2) Ah, the virtues of moderation, given that market timing is so difficult. This is why I developed my eight rules, because they force risk control upon me, making me buy low and sell high, no matter how painful it seems.  It forces me to buy when things are down, and sell when things are running up.  Buy burned out industries.  Reshape to eliminate names tht are now overvalued.  These rules cut against the grain of investors, because we like to buy when comapnies are successful, and sell when the are failures.  There is more money to be made the other way, most of the time.

3) From Roger’s catch-all post, I would only want to note one lesser noticed aspect of exchange traded notes.  They carry the credit risk of the issuing institution.  As an example, my balanced mandates hold a note that pays off of the weighted average performance of four Asian currencies.  In the unlikely event that Citigroup goes under, my balanced mandates will stand in line with the other unsecured debtholders of Citigroup to receive payment.

4) Bespoke Investment Group notices a negative correlation between good economic reports and stock price performance.  This should not be a surprise.  Good economic news pushes up both earnings and bond yields, with the percentage effect usually greater on bond yields, making new commitments to bonds relatively more attractive, compared to stocks.

5) From a Dash of Insight, I want to offer my own take on Avoiding the Time Frame Mistake.  When I take on a position, I have to place the idea in one of three buckets: momentum (speculation), valuation, or secular theme.  What I am writing here is more general than my eight rules.  When I was a bond manager, I was more flexible with trading, but any position I brought on had to conform to one of the three buckets.  I would buy bonds of the brokers when I had excess cash, and I felt the speculative fervor was shifting bullish.  If it worked, I would ride them in the short run; if not, I would kick them out for a loss.

Then there were bonds that I owned because they were undervalued.  I would buy more if they went down, until I got to a maximum position.  If I still wanted more, I would do swaps to increase spread duration.  But when the valuations reached their targets, I would sell.

With bonds, secular themes don’t apply so well, unless you’re in the mid-80s, and you think that rates are going down over the next decade or two.  If so, you buy the longest noncallable bonds, add keep buying every dip, until rates reach your expected nadir.  Secular themes work better with equities, where the upside is not as limited.  My current favorite theme is buying the stock of companies that benefit from the development of the developing world.  That said, most of those names are too pricey for me now, so I wait for a pullback that may never come.

6) I’ve offered my own ideas of what Buffett might buy, but I think this article gets it wrong.  We should be thinking not of large public businesses, but large private businesses, like Cargill and Koch Industries.  Even if a public business were willing to sell itself cheap enough to Buffett, Buffett doesn’t want the bidding war that will erupt from others that want to buy it more dearly.  Private businesses can avoid that fracas.

7) And now, a trio on accounting.  First, complaints have arisen over the discussion draft that would allow companies to use IFRS in place of GAAP.  Good.  Let’s be men here; one standard or the other, but don’t allow choice.  We have enough work to do analyzing companies without having to work with two accounting standards.

8) SFAS 159?  You heard it at this blog first, but now others are noticing how much creative flexibility it offers managements in manipulating asset values to achieve their accounting goals.  My opinion, this financial accounting standard will be scrapped or severely modified before long.

9) Ah, SFAS 133. When I was an investment actuary, I marveled that hedges had to be virtually perfect to get hedge treatment.  Perfect?  Perfect hedges rarely exist, and if they do, they are more expensive than imperfect ones.  Well, no telling where this one will go, but FASB is reviewing the intensely complex SFAS 133 with an eye to simplifying it.  This could make SFAS 133 more useful to all involved… on the other hand, given their recent track record, they could allow more discretion a la SFAS 159, which would be worse for accounting statement users, unless disclosure was extensive. Even then, it might be a lot more work.

10) ECRI indicates better growth and lower inflation coming soon.  I’ll go for the first; I’m not so sure about the second, with inflation rising globally.

11) What nation has more per capita housing debt then the US?  Britain. (And its almost all floating rate…)  With economics, it is hard to amaze me, but this Wall Street Journal article managed to do so.  Though lending institutions bear some blame for sloppy underwriting, it amazes me that marginal borrowers that are less than responsible can think that they can own a home, or that people who have been less than provident in saving, think that they can rescue their retirement position by borrowing a lot of money to buy a number of properties in order to rent them out.  In desperate times, desperate people do desperate things, but most fail; few succeed.  We have more of that to see on this side of the Atlantic.

12) I am not a fan of what I view as naive comparisons to other markets and time periods.  There has to be some significant similarity in the underlying economics to make me buy the analogy.  Thus, I’m not crazy about this comparison of the current US market to the Nikkei in the late 80s.  Japan was a much more closed economy, and monetary policy was far more loose than ours is today.  I can even argue that the US is presently relatively conservative in its monetary policy versus the rest of the developed world.  So it goes.


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.

Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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