Archive for June, 2007
The Almighty Bill Gross of Pimco has flip flopped on the direction of interest rates for the second time this month.
I can feel Mr. Gross’ pain. At this point predicting the direction of interest rates is like flipping a coin. The global economy is roaring on all engines - a case for higher interest rates. At the same time, we are walking on a subprime, weaker housing, leveraged-consumer mine field. I am so glad that I am not in the interest rates prediction business.
June 27th, 2007
If I’ve learned anything over the years, it’s that people don’t learn. Recently, I talked to my cousin who is an executive with a Russian airline company. In our discussion he mentioned that his company just received semi-unsecured loans (all planes are leased so they are not used as a collateral) from western banks at 10% a year. Though it sounds like a good rate in today’s interest rate environment, it is an airline and it is in Russia.
Why would somebody ever give a loan or buy airline bonds of any country? I can understand buying distressed bonds or maybe a stock as a trade. Not my kind of thing, but I can respect that. But a buyer (an investor) of fully priced (at par or close) airline bonds usually intends to hold them to their maturity, or for a long time. It is well documented that the airline industry as a whole has lost money over its cumulative existence. Thus, uneconomical, low fares that consumers have been enjoying over the years were subsidized by bond and equity investors. This is great for consumers, not so good for providers of capital. I almost want to say “Fly, don’t buy.”
Continue Reading June 22nd, 2007
Fortune’s June 25 issue has come out with the top picks for Growth & Income, Bargain Growth, Small Wonders and Deep Value. The shocking part is that almost every stock in this group (yes, including Deep Value) is trading at, or very close to, an all time high.
If this is not a sign of a market top, I don’t know what is.
June 22nd, 2007
By Vitaliy Katsenelson, CFA
There was an interesting article in the WSJ on Moody’s downgrading 131 bonds backed by a pool of subprime mortgages. As dramatic as it sounds this downgrade only impacted $3 billion worth of bonds, less than 1% of the $400 billion in subprime mortgage issue in 2006.
Though these numbers don’t sound earth shattering, it is becoming painfully apparent that credit rating agencies are extremely reactive, not proactive. This downgrade took place because more data came to the surface (i.e. higher defaults in second mortgages that were lumped together with subprime loans in 2006).
Credit agencies are held to a higher standard than sell side analysts whose recommendations are as useful as last month’s newspaper. Credit agencies have legal access to non-public information and thus one would expect a better, proactive analysis. The problem is that the credit agency’s actions may have dire consequences on corresponding companies and turn into a self fulfilling prophecy (i.e. a downgrade to junk status may shut the company from credit markets and cause a bankruptcy).
Why does this matter? Well, if you think we are in the beginning stages of the subprime default cycle (I believe we are), than you’ll see more and more (reactive) downgrades from Moody’s and the likes. Be skeptical of credit agency ratings, use your own common sense.
June 18th, 2007
By Vitaliy Katsenelson, CFA
The Financial Times reports China’s largest bank, ICBC, announced its intentions to get into the banking business in the US. That move actually makes sense. Politicians already started making waves about China owning a good chunk of the US through its government debt (an idiotic rhetoric, but it is a topic for a different discussion). The Chinese are thinking instead of making loans to the US government and getting paid a barebones rate. Why not help the US consumer to get further into debt and make a juicy profit in the process? Good thinking.
The best part is that politicians will have a hard time blocking the Chinese foray into banking (though they’ll try). If the US blocks the Chinese entry into US banking, China is likely to reciprocate (I would not blame them) and thus American banks’ grandiose ambitions to drown 1.2 billion Chinese in credit card debt will be crashed.
I doubt that you’ll see ICBC branches around the corner anytime soon, but I think the acquisition of a large US bank would make a lot more sense – you get instant scale, American know-how, and you can self finance much higher yielding consumer loans from trade surplus. Call me crazy, but that is what I would do.
June 14th, 2007
by Vitaliy Katsenelson, CFA
The Joseph A. Banks (JOSB) selling machine is kicking on all cylinders - yesterday’s quarterly numbers were proof of that (see article I wrote for Market Watch).
My gripe (and Herb agrees) with the management is that they decided that no Q&A is needed after the quarterly conference call. I completely understand why the company’s management may decide to spend their time on a more productive endeavor than answering sell side analysts’ questions which most of the time have little to do with the company’s long-term future, but zero in on minute, often irrelevant short-term details. That being said, management should have done a better job communicating to the Street the change in Q&A practice.
JOSB’s marketing strategy is the weakest link in its business model. It is extremely short-term oriented and not about long-term brand building. I’d argue that it cheapens its brand. Where Men’s Warehouse’s (MW) “I guarantee it” commercials tell you about product quality and a pleasant shopping experience (long-term brand building strategy), JOSB commercials sound like it’s a cheap car dealership that you’d expect to see in the deep suburbs of nowhere land, with a very annoying voice that tells you something along the lines of, “Only this Tuesday, the whole store is 50% off!” But don’t worry, if you missed this Tuesday special, there are other days of the week; Wednesday, Thursday… you get the point. Yesterday, while reading JOSB’s latest 10Q, I heard the commercial at least three times on CNBC. This short-term driven marketing strategy is responsible for the volatility of same store sales.
June 12th, 2007
By Vitaliy Katsenelson, CFA
Financial Times - May 25, 2007
Wall Street is inherently short-termist. This is not because it is dumb. Quite the contrary, some of the brightest minds in the country labour in the investment industry. But as the mutual fund industry has grown, the desire for short-term gratification has altered the focus, turning an investment business into a marketing one.
There is nothing wrong with marketing; some of my good friends are marketeers. But a good marketeer’s job is to discover what customers want and try to meet that need. Unfortunately, the investing public wants instant gratification. They want to keep up with the (Dow) Joneses, and for their fund to "beat" the other funds and comparable indices on a short-term basis - quarterly and annually. That is not what investing is about; it is about reaching long-term financial goals without taking unnecessary risks.
Continue Reading June 6th, 2007
By Vitaliy Katsenelson, CFA
In this article I made an argument that despite high uncertainty surrounding First Marblehead’s (FMD) business at nine times earnings, it is a very attractive opportunity. Here are some additional points that I omitted in the article:
- A flat yield curve may not flatten FMD’s earnings. I have no idea how long the slope of the yield curve will remain flat, however, historically the yields have not stayed the same for longer than six month. I am aware that history is only there to guide us. Just because they did not stay flat for long it doesn’t mean that they won’t in the future. The flat yield curve in this environment is unlikely to be as negative to FMD as one would think as declining housing prices and increased lending standards by lenders will make it incrementally difficult for home owners to tap into (declining) home equity.
- Cash flows are about to increase substantially as FMD will be receiving a differed (residual) component from the loans it originated years ago.
I have a position in FMD
June 1st, 2007
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