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.

We’re going to end this one at a dozen, cousin.  Leaving aside a few new and oddball names, by Tuesday of next week virtually everyone will have reported.  So, after I get back from Bermuda, I will finish this series up.

Bermuda?  Business only.  Going to hit about a dozen companies in two days with one of my favorite P&C analysts, Harry Fong of Calyon.  I hope there are a decent number of insurance only buy-side analysts along for the ride.  They make grilling the management teams so much fun.

As an aside, the last time I was in Bermuda was after Wilma.  I was traveling with Bill Wilt of Morgan Stanley (another good analyst).  Because of a glitch, only seven buy-side analysts analysts were on the trip, but four were “insurance only.”  Between us and Bill, we got a lot done.  The meetings were free-form, with a lot of good give and take.

But the night before the meetings started, I had just gotten to my hotel, and I was hungry.  The hotel bar was the only thing open, so I went down with my computer to get a burger or something.  While sitting there, waiting for my food to come, I work on a RealMoney article.  A fellow that I have never met walks up to me and says, “You’re David Merkel; what are you doing here?”  I am floored; I ask him how he knew me, and he said that I wrote for RealMoney.  Amazing what that little picture will do.

He explains to me that he is there for the Bermuda tour.  I tell him that I am glad he is there for the Morgan Stanley tour.  He looks at me puzzled and says he is there for the Lehman tour.  The Lehman tour is well planned… too well planned.  24 analysts in all.  Whereas we got the give and take, they got the canned presentations.  Oh well.

Wait, this was supposed to be about earnings.  We have only two companies.  AIG beat by a healthy amount on both the top and bottom lines.  Whether out of hedge fund mischief, MR Greenberg selling out of spite, or that the buy-side had gotten ahead of the sell side because of prior good earnings this quarter, AIG stock traded down in the after hours.  Hallmark Financial Services, primarily a personal lines insurer, met estimates.  Nothing amazing one way or another.

1) In Grad School, one of my Ph. D. fields was econometrics. In general, I agree with this piece by Jeff Miller on the payroll survey, but I have a few things to add. My main problem with the birth-death model is that they use an ARIMA model. We only use ARIMA models when we don’t have sufficient cofactors to try to explain something structurally. At best, an ARIMA model is the reduced form solution to the broader structural model for which we do not have data. Second, I would simply add that the true error bonds on the month-to-month change are large, and I would advise everyone to look at year-over-year changes to get a better sense of the trend in the economy. As Morganstern showed over fifty years ago, economic data has so much noise that noise swamps signal until you look at year-to-year changes.
2) From the ever excellent Daniel Gross at the NYT, comes his piece questioning how important the US is the US to the global economy at present. I have written about the same thing over at RealMoney. With the US accounting for a shrinking fraction of global trade, it is hard to see how the role of the US is not diminishing here. We need to get used to the idea that we are “first among equals,” and make our policy requests as a part of coalition building among the nations that trade.
3) In general, I like John Hussman; I have learned a lot from him. We even live in the same city. That said, his commentary on share buybacks needs some clarification. Once a buyback is completed, the economics of the buyback are reflected in the diluted EPS. One should not count it as a dividend; the increment to book value reflects the change in value. But after the announcement, but prior to the buyback itself, investors analyze whether a management team is credible on the announcement. Does management follow though? Can the balance sheet handle it? Credible management teams can make the stock price rise with the mere mention of a buyback.

4) Calling John Henry and his modern counterparts: can traders be replaced by computer algorithms? Average traders, yes. The best traders, no. Good trading relies on a variety of factors that are difficult to turn into math. I learned that as a corporate bond manager/trader. Sensing when the speculative nature of the market is turning is touchy. There are many aspects of that that I think would be difficult to teach to a machine. It’s one thing for a computer to beat us at chess, which is a relatively simple game, but when will one beat us consistently at poker?

I have more, but I will publish now, and bring the rest back tonight.

With a few exceptions (young company, etc.) late reporters tend not to do as well versus expectations as earlier reporters do.  Well, in issue 10 of this this series, it feels like the cat dragged in many of these reports.


Alas, but a company that has given me a hard time many times over.  Scottish Re missed earnings badly.  Oh, they’re solvent now, just ask Cerberus or Mass Mutual, or the banks that are extending finance to them.  Will they be able to write significant new business at present?  Not likely for a while.  Will they make money in 2007?  That is anyone’s guess.

Primary Casualty

ProAssurance beat (the only one today) and AmComp missed.  In general, medmal did well this quarter, so good for PRA, which had flat premiums.  AmComp, if anything wrote less business, which might be conservative, but hurt current earnings.  That hasn’t been a recipe for stock price outperformance.


American Capital Access and Primus Guaranty both missed.  In general, I feel there is little franchise value to these companies that deal in credit default swaps and suchlike.  Much of the reason for the miss is rising credit spreads through the quarter.  That very well may revert over the next quarter.

Personal Lines

Bristol West misses badly, with the loss ratio up.  Since Zurich sees enough value to buy this company out, I only wish them well.  They will need all the good wishes that they can get.  National Atlantic, a company that my employer has a large investment in, met estimates today, but had better revenues than expected.  More of the business mix moves to homeowners and small business commercial, and away from auto.  How many insurance companies do you know that have growing revenues, trade at a single digit forward earnings multiple, and trade below book (and book is conservative)?  Don’t think too hard here, there aren’t many.

Earnings season is drawing to a close.  There are a few more companies to go, and I will bring them to you over the next few days.

Full Disclosure: very long NAHC

Earnings season finally slows down.  Here’s some commentary on what companies reported on Tuesday.


Protective Life beats and raises.  Last quarter, many parties got hung up on an accounting adjustment, and drove the stock down.  This quarter there is no adjustment, but instead an improvement in margins, so PL guides up.  Conseco misses; the clean-up of their administration systems persists, though these adjustments should be over with the second quarter report.  The old LTC block is still an albatross.  The sale of the annuity lines to Swiss Re with an expanded buyback may provide some price support tomorrow, but perhaps at a lower level.

Universal American misses, but the stock goes up because of the purchase of a private Pharmacy Benefits Manager, MemberHealth.  It certainly seems like they got a favorable p;rice, but they had to issue a lot of stock to make the deal work.

The Bermudans

Allied World beats handily.  The price action tomorrow may be muted by their conservatism in not writing so much premium in the first quarter.


Marsh Mac misses on higher revenues overall. I don’t think they have worked out how to replace lost contingent fee income from their brokerage businesses.

Primary Casualty

HCC beats on higher revenues; all segments show some improvement   The big news is that they see opportunities to grow profitably at present.  Wonderful news if true.

Now to bed; I am  beat.

Full disclosure: long AWH CNO

Before I start, some additional commentary on M&A items. It was interesting to see Liberty Mutual buy Ohio Casualty for several reasons:

  • At the premium that they paid, there were better things to buy. I don’t find a 6% return on capital to be that attractive, and I don’t see a lot of synergies.
  • It implies that there is not that much for sale among stock P&C companies.
  • Primary Casualty companies buying Bermuda reinsurers makes a lot of sense (like AGII/PXT). This isn’t as cogent.
  • It lowers my previously high opinion of Liberty Mutual.

On another note, I found the announcement from KMG America to be lightweight. After the stock fell so hard, I had a look at it, and concluded that the purchase GAAP accounting adjustments stripped profits out of the old stable blocks of business to hide losses in the LTC block. Now, that’s just a guess on my part. I could be dead wrong. That said, I would not be surprised to see that KBW finds only limited opportunities for capital enhancement.

On to earnings:


KMG America missed, taking a number of charges, and hiring an investment banker. The stock went up. FBL Financial beat by a small amount.


Investors Title beat earnings. In a very mixed quarter for title earnings, the smallest of the five did well.


Mercury General and Safety Insurance both beat earnings. Mercury expanded their writings and Safety contracted them slightly. Safety had the bigger beat, though.

Primary Casualty

NYMAGIC, Amerisafe, and Ameritrust all beat earnings, with growing revenues. Ameritrust Financial deserves special mention because it came public recently through unusual means; they listed the stock on NASDAQ, and allowed the private equity holders to go “free to trade.” I can think of another example of that, Quanta Holdings, but AFSI lookws more stable than Quanta.


Berkshire Hathaway meets earnings, but what can I say? Earnings aren’t very relevant to the way the marginal investor views Berky. The insurance pricing cycle does mean something here, and Buffett was honest enough to inform investors that insurance earnings will likely not be as good next year.

The Bermudans

Max Capital Group beat earnings but on lower written premiums. It will be interesting to see how it fares tomorrow.

Full Disclosure: Long SAFT

Here’s my take on a large part of what is going on it the markets now.

  1. Bond market implied volatility is low. Tony Crescenzi comments about that on the Treasury market, but it is also true of the agency and swap markets. Less true of corporates, because rumored LBOs are making market players jumpy, but spreads are still pretty tight. People are too complacent…
  2. What did well in the first four quarters of this year? Borrowing from Merrill Lynch, in terms of sectors, it would be utilities and materials, follow by healthcare and energy. In terms of quality, low quality continues to win, which is a function of tight credit spreads. Growth strategies are working — low PEG ratios, small caps, and high ROE are doing well so far in 2007.
  3. China may take the global economy over the edge. Between tightening interest rates and raising deposit requirements, they are moving to slow their economy. One thing that fights against them is the currency; much stimulus comes from keeping the yuan low.
  4. One factor that helps to keep oil prices high is the inefficiency of the average state-owned oil company. Venezuela, Iran, and Indonesia are great examples of the damage that can be done by negligent government-sponsored companies tha don’t reinvest enough in their businesses.
  5. Fascinating to see copper and gold up, Baltic freight up and timber prices down. US housing is damaging timber, but demand outside of the US is driving the rest at the margin.
  6. Even more amazing is the foreign buying of Treasuries, which proceeds unabated to recycle the shrinking current account deficit.

I have more, but I am tired, and will post more on Monday.

It is my goal to make this blog more enjoyable and usable for my readers.  To that end, today I added some code that adds recent comments to the sidebar, and allows users to subscribe to comments on a post if they like.


Future enhancements that are likely coming:

  1. More books and more commentary on my books page, plus links to Amazon (whether I make money off it or not).
  2. Update of the major articles list.
  3. Addition of a polls feature.
  4. And internal enhancements that will enable me to better monitor my site.  Please note, I will never sell the e-mail addresses of those who register on my site.  I live by the words of Jesus Christ, who said, “Do to others as you would have them do to you.”  People hate having their e-mail addresses sold; I hate it when it happens to me.  I won’t do it to my readers.
  5. Some way of tracking my portfolios, apart from what I am doing now at Stockpickr.com, so that I can comment on my performance as needed.


Now, if there are other features you might like to see, let me know, and I will do my best to see if I can provide them.

Things are slowing down, but not much.  Here’s my summary of Thursday’s earnings:


RAM Holdings beats handily, and Assured Guaranty beats.  I used to own RAM Holdings, but I kicked it out because of the negative macro view of the firm that I work for.  Absent the negative macro view, I would have loaded the boat in the twelves and hung on.  I like the management team and the strategy.


Nationawide and Phoenix both beat.  Big beat for Phoenix, and the stock price was up 5%.  Both are heavily levered to equity prices, so the beat should not be so surprising.
Manulife met estimates and the price fell a little.  Manulife is a company where I don’t get the valuation; it seems too high.  As pointed out yesterday, American Equity missed and fell hard today.  UnumProvident rose as it demonstrated its turnaround through beating earnings on Wednesday after the close.


Aon reports and beats on higher revenues.  It seems like the big brokers are beating, while the smaller brokers are missing.  They are different business models.

Primary Commercial

PMA Capital and Tower Group beat, while Specialty Underwriters Alliance missed.  Revenues grew at all of them, and generally continued a 1Q07 theme: so long as earnings are decent enough, the market prefers companies that are growing the top line.


First American misses. They foresee a slowdown in their business and will be looking to reduce expenses.  A writedown here, a writedown there.  FAF is well-managed in my opinion, so if the stock falls tomorrow, it won’t stay there for long.

Personal Lines

Kingsway and Twenty First Century Holdings both miss.  Kingsway is has a high loss ratio from a troublesome acquisition, and the stock goes down 11%.  TCHC cuts earnings giuidance in half because of the onerous nature of Florida personal lines regulation.  The stock falls 45% in the aftermarket on Thursday.  My guess is it finishes up from there, but running a personal lines company with a large Florida exposure is risky; that should not be news to anyone.

The Bermudans

Odyssey Re beats, continuing the pattern of strong earnings on low cats.  They wrote less business, so perhaps gains tomorrow will be muted.  The earnings of Endurance Specialty were pretty good, but their conservatism in new writings was not appreciated by investors, and the stock was down more than 2%.

In summary: Great quarter for primary commercial and the Bermudans.  Good quarter for Life insurance and Financial insurance.  So-so quarter for brokers, personal lines and title.  Poor quarter for mortgage insurers.  Conservatism is not appreciated at present.  Absent catastrophes, I would be inclined to see these trends continue into the next quarter.

Full disclosure: long ENH (take heart, Ken LeStrange!)

Yesterday I swapped my holdings in Patterson-UTI for Noble Corp. I also reduced my holdings in SPX Corp, which has been a great turnaround play for me. I sold 20% of my position, which I do to rebalance to a target weight. This limits my risk, and given that nothing moves up in a straight line, it allows me to add 2-4%/year to my returns. For more information ion this sort of trade, for those that have access to RealMoney, see this article.

As for the swap, have a look at this article from Forbes. I see reason to swap to a cheaper name, when earnings trends are working in favor of deep water drillers. If oil prices rise a great deal, I will be proven wrong here, but at current oil prices, I like the swap.

Full disclosure: long NE SPW

Update: now, what should happen after I sell PTEN but that it puts up decent, but not stupendous numbers, and it goes up 5%. The relative return difference since the swap is -3%. I don’t play for days, so this does not bother me. My methods work on average over the intermediate term. The proper measurement period for this swap is over the next 1-3 years.