the Bloomberg snooping scandal

May 20, 2013 By in Current Market Thoughts, Information for investors, Trading Tags: , , , , Leave a comment

About a week ago the New York Post, of all places, broke a story that reporters for Bloomberg News could (and did) access to information about customers’ use of their Bloomberg data terminals–and were using the insights they gleaned to try to generate stories.   In the instance the NYP cited, a Bloomberg reporter was asking Goldman about whether a certain executive was still on the payroll.  It sounds to me that in the course of an unproductive conversation the reporter said he knew something was amiss because the person in question hadn’t been using his Bloomberg terminal for an unusually long time.

Once the story broke, J P Morgan revealed that it had been pressured for information on the fate of the disgraced “London whale” trader by Bloomberg reporters who said the same thing–that they could see changes in his usage of Bloomberg data.

Bloomberg says reporters’ access to customer data has since been turned off.

good news/bad news

The good news, for Bloomberg users, is that the reporters in question made no effort to disguise the fact that they had been analyzing their target’s Bloomberg usage.  This has brought to light fine print in Bloomberg contracts that apparently allow such behavior.  The contracts will doubtless be changed.

Also, the ineptitude of the Bloomberg reporters suggests to me that the practice of mining customer information was not kept quiet for long.  They went directly to the companies; their main tactic seems to have been to beat them over the head with the privileged information they had–ensuring instant publicity.   So the problem has likely been nipped in the bud.

relevance?

Whether and when the London whale lost his job isn’t really a market-moving story.  It would be inconceivable that a trader could rack up monumental losses, hide them while trying to recoup through further trades, and still keep his position once discovered.  And the workout of the mess he made would follow easily predictable steps.  So this was not investment news.

No, this was a general news story.

That’s the interesting part of the tale.  If we figure there are 300,000 Bloomberg terminals in use, at, say, an annual fee of $25,000 each, that would mean they generate $7.5 billion in yearly revenue for Bloomberg LP.

Why in the world would you put that revenue stream at risk by undermining customer confidence in your discretion?   …especially by going after stories that have no direct relevance in helping investment industry customers do their jobs?

My guess is that someone high up in Bloomberg LP has decided that it’s a good idea to try to develop a new source of profits by building a general news capability using the investment researchers already in the company as a base.   I’d also guess that this is a relatively recent development, one that coincides with the fading of Bloomberg Radio as a source of investment information.

Peter Lynch of Fidelity called it “diworsification” (a term I hate), when a company strayed from what it was successful at to enter an allied field.  Often, the diversification make the company worse, not better.  We may be seeing an instance of it here, particularly if worries about being spied on cause customers to start looking for alternatives to important Bloomberg services.

the US Census Bureau on immigration (and GDP growth)

May 17, 2013 By in Basic Concepts, Current Market Thoughts, economics, Portfolio management, Strategy Tags: , , , , , , , , Leave a comment

gauging GDP growth potential

Over the years, I’ve found that there’s a very simple and effective rule for quickly gauging a country’s GDP growth potential.  Here it is:

Output can rise in one of two ways:

–either more people are at work, or

–workers are more productive.

My first boss in the financial markets was as close to a nineteenth-century capitalist as I’ve ever encountered.  He maintained that increasing productivity is solely a function of employees spending more time at their desks.  Although this suited his penny-pinching mentality, it’s not true.  Productivity gains come primarily from the employer investing in better equipment, and from better worker education/technical training.

If we pluck a number out of the air and say that a country can achieve a constant 1% increase in worker productivity per year (I’m not trying to be precise; I want to get a simple picture that gets the general idea.  Also, a 1% annual gain is a pretty good number), then a country’s ability to grow economically becomes a direct function of one thing   …the expansion of its population.

the Census Bureau Annual Population Projections

That’s what makes the Census Bureau’s latest population assessment so interesting.

Two days ago the Bureau, an arm of the Commerce Department, issued its 2012 Annual Population Projections.  It says that in the US, net births/deaths are currently adding about 0.75% annually to the population.  By 2030, that figure will drop to 0.50%.  By 2050, it will shrink to about 0.35%.

Two reasons the figure is so low:  as people become more prosperous, they tend to have fewer children, and people are living longer.

projecting US GDP

So, what’s the trend growth rate of GDP in the US, according to my simple rule?   …2%- per year, or about what we have now.

how to make growth higher

Can we make the economic picture brighter?

Yes, in two ways–both of which, unfortunately, are questions of policy coming out of Washington.

–We can allow foreigners to come to the US to work, either permanently or by increasing the number of work visas awarded to highly skilled foreigners who want employment in the US for a period of time.

Republicans oppose the first,  Democrats the second (for reasons that escape me).

–We can attract productivity-enhancing capital investment to the US.  This is primarily a function of tax policy, which neither party in Washington appears to want to change.

We can also make out schools better.

implications

This isn’t really new news, but thinking about long-term GDP growth suggests, to me, two investment conclusions:

–investors anticipating a rapid expansion of GDP from the current level are likely to be disappointed (look for that in Asia, or from exposure through US-based multinationals), and

–superior earnings growth–and stock performance–will come from companies that have unique products or services that are in high demand.  In other words, the environment favors growth stock techniques rather than value.

(Note:  I realize that it’s not really the population that counts.  It’s the workforce.  But looking at the workforce introduces complications that I don’t think change the overall picture, but which can easily obscure it.  Stuff like:  the influence of the Baby Boom, the decline in female participation, long-term unemployed…)

 

 

 

I’ve been VERY wrong about the Japanese stock market

May 16, 2013 By in Asian economic development, economics, Japanese development, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , , Leave a comment

The Liberal Democratic Party retook control of the national government in Japan late last year on a platform of massive monetary stimulation aimed at shocking the economy out of its quarter-century of torpor.

Most economic effects have been as expected.  The ¥ has lost about a quarter of its value.  This has given export-oriented industries a big boost.  The price of imports has risen by enough, however, that the overall effect of devaluation on Japan has been slightly negative so far.  The trade balance will doubtless improve as Japanese citizens adjust to the tremendous drop in their standard of living that the devaluation has brought about.

Where I’ve been wrong has been in handicapping the behavior of the Japanese stock market.  In the only other recent episode of a big fall in the ¥, the Topix index (Tokyo large caps, the index professional investors use) rose as the currency declined, but only by enough to keep a dollar-oriented investor from losing money.  Yes, export-oriented stocks did better than Topix, but the overall index was unchanged in dollar terms.  I thought something similar would happen again.

Not this time, though.

Since the Abe administration took office and made it clear it would carry out its campaign promise, the Topix is up by 66% in local currency terms, meaning a dollar-oriented investor in the index has made a 25% gain.  Buyers of down-and-out consumer electronics firms like Sony have made twice that.  The long-Topix, short-¥ trade has made a killing.

As I see it, the rise in the Topix has been driven by foreigners.  Locals–never, in my experience, the canniest of investors–have  been mostly using the opportunity offered by devaluation to declare victory in their foreign investing forays and are bringing money home to put into things like real estate.

Press reports indicate new investors in Japanese stocks, including high-profile Western hedge funds, believe very strongly that the change in money policy also heralds a new era of openness to structural economic reform by Tokyo, and that foreigners will be allowed to play a significant role in the latter process.

My view, based on almost 30 years of watching Japan, is that Tokyo insiders regard devaluation as a substitute for reform, not a precursor.  I’d point to the experience of former Prime Minister, Junichiro Koizumi, who was given an overwhelming electoral mandate for reform but who resigned as PM after five mostly fruitless years (2001-2006) of trying to effect change.  As soon as he left, the Diet immediately began to reverse the progress he was able to make.

For Japan’s sake, I hope I’m wrong again.  But I’m not willing to bet on the possibility.  As for the new wave of foreigners, I find it hard to figure whether they have a much more sophisticated read on the political process in Tokyo than I do or whether they’re completely clueless.  Given that reversal of the deep social/political aversion to disruptive change should make me wildly bullish about Japan, in some sense I must think the latter is more probable.  My official position, though, is that I don’t choose to bet.

 

 

Wall Street strategists vs. analysts: who to believe…

May 15, 2013 By in Current Market Thoughts, Getting financial advice, Portfolio management, sell-side analysts vs. strategists, Strategy Tags: , , , , , Leave a comment

…or…

…what to do with your equity portfolio now.

The S&P 500 made an another all-time high yesterday.  Now at 1650, the index has already made greater gains than any professional I’m aware of had predicted for the entire year.

Analysts say the market will be higher in 12 months.  Strategists say the opposite.

What to do?

earnings aren’t the issue 

Stocks are reasonably valued at 15x 2013 earnings and less than 14x next year’s.  They’re not as cheap as they were at the bottom in 2009, but they’re not wildly expensive either.

The traditional comparison with the other big class of liquid investments–government bonds–is to measure the 30-year Treasury bond yield against the earnings yield (that is, 1÷PE) on stocks.  On this measure, stocks are already trading as if the long bond were at 6.5%.  This suggests that most, if not all, of the eventual rise in bond yields that will occur when the Fed returns interest rates to normal, is already factored into today’s stock prices.

earnings growth isn’t the issue

Both analysts and strategists think that corporate profit growth will accelerate from here and reach about a 10% year-on-year rate of advance in 2014.  (By the way, the 10% figure is not itself a very controversial one.  It describes an average year.  It’s also the figure I’d start with as the most likely outcome, and move up or down depending on whether I felt strongly positive or negative.)

the issues?

Stock investors seem to me to be vaguely uneasy that the market has gone too far too fast.

It’s a little scary that retail investors who sold in 2008-09 are only now–after a four-year, 140% rise in the S&P 500–putting their money back into stocks.  Arguably, when blunted pencils start moving into the box, it’s time to move on.

Saying the same thing in a different way, the current rally isn’t based on the fact that corporations are reporting surprisingly good earnings.  Rather, the market’s price-earnings multiple (the price people are willing to pay for a unit of earnings) is rising.

More relevant, in my view, is the worry that as the Fed raises interest rates from today’s ultra-low levels the resulting fall in bond prices will have a negative effect on stocks.

counterarguments

We can interpret the PE expansion the market is undergoing as simply a return to more normal levels after years of recession-induced fear.

The eventual rise in interest rates will be preceded by strong corporate earnings growth, which will mitigate the negative effects of higher rates.  That’s perhaps the biggest lesson world central bankers have taken from the quarter-century of economic misery in Japan, where the government nipped economic recovery in the bud twice, by tightening prematurely.

In similar instances of Fed rate-raising in the past, stocks have gone sideways to up.

We’re very close to the time of year when in normal times Wall Street begins to look at, and discount in current prices, earnings prospects for the following year.

The technical tone of the market remains bullish.

what I’m doing

My inclination is not to make major portfolio changes but to do routine maintenance instead.

Specifically, I’m:

–going through my holdings, position by position, and asking if the reasons I established it are still valid, and

–checking position sizes, to make sure none are so large they pose a risk, or too small to do any good.

finding clunkers

Everyone has blind spots.  And everyone has clunkers that his eyes somehow skip over when doing a portfolio check.  One way I’ve found to help myself to see these “invisible” losers is to imagine that I’ve got to raise, say, 10% cash immediately.  What would I sell to do so?  Unfortunately, but not unexpectedly, one or two problem cases pop up.

Any money I “find” this way I’m probably going to take my time putting back into the market.  That’s as much defense as I usually do.  And it’s all I’m going to do now.

corrections are a fact of life

At some point, the S&P is going to fall by 5% – 10%.  That’s just the way stocks work.  This is a worry for day trades.  But for investors–especially one who are doing routine portfolio maintenance and culling losers–this shouldn’t be a concern.

 

 

 

 

 

Wall Street strategists vs. analysts: S&P index and earnings forecasts

May 14, 2013 By in Current Market Thoughts, Getting financial advice, Portfolio management, Recent Market Action, sell-side analysts vs. strategists, Strategy Tags: , , , , , , , , Leave a comment

a little history

Pre-Great Recession, the peak for annual S&P 500 index earnings came in 2006, at $89.49.

The subsequent low, in 2009, was $60.78.

The index established a new earnings high in 2011, at $96.58.

2012 produced a 6.6% advance over 2011, at $103.04.

2013-14 earnings projections (all from Factset )

strategists

Wall Street strategists, who had originally been predicting virtually no earnings growth for the S&P in 2013, have grudgingly upped their estimate to $109.15, a year-on-year gain of 6%.  They’re penciling in a more substantial yoy advance of 9.2% for 2014, to $119.20.

Despite this positive news, they expect the S&P to decline from the current level over the coming year.

analysts

As I mentioned yesterday, both analysts and strategists have underestimated the earning power of S&P companies.  Analysts, who are usually the wide-eyed (over-)optimists, have been much closer to reality, but even they have fallen short in their prediction of S&P profit growth by a percent or so.

Analysts think the S&P will earn $110.36 in 2013 and 122.86 in 2014.  Those are gains of 7.1% and 11.3%.

As Factset interprets their calculations, analysts expect earnings reports to cause the S&P to rise as the market discounts them–by about 5% from here.

earnings growth by sector

According to Factset, analysts see sectoral earnings gains for the S&P for 2014 over 2013 as follows:

Telecom          +20.1%

Materials          +18.4%

Consumer discretionary          +16.5%

Industrials          +11.5%

S&P 500          +11.2%

IT          +11.0%

Financials          +10.1%

Staples          +10.0%

Energy          +9.7%

Healthcare          +8.9%

Utilities          +4.5%.

what strategists and analysts have in common

Both think that slow global economic recovery will continue.

Strategists expect very tepid upward movement in corporate until close to yearend, after which they expect the pace of growth to pick up.  Analysts are anticipating better near-term performance, but also with acceleration as the new year begins.

where they differ

1.  Analysts think earnings growth will be considerably better than strategists do.  If you look at the breakout of expected earnings performance by sector, you’ll notice that analysts are expecting economically sensitive areas to have the most robust earnings advances (note, in particular, Materials).  Energy prices will apparently be staying low–another plus for most world economies.   Defensive sectors will lag.

One caution:  analysts are always optimistic. Also, it raises eyebrows a bit if the bulk of the growth is several quarters in the future, where strong evidence is harder to find.  On the other hand, analysts have been right so far in being optimistic.  And it’s the strategists who are back-loading their growth forecasts.

2.  The more significant difference is that analysts think the market is going up; strategists think it’s going down.

Factset doesn’t give an explanation for this;  it just reports the numbers.

I don’t think this difference has much to do with earnings growth, though.  Strategists think the market’s price-earnings multiple is going to contract over the coming 12 months, even though they think earnings growth will accelerate.

Why would this be?  My guess is that strategists are thinking the Fed will begin to raise interest rates late this year or early next, and that this will cause the price investors are willing to pay for S&P earnings to shrink.

Tomorrow:  my take on all this.

where is the stock market headed?: Wall Street strategists vs. analysts

May 13, 2013 By in Industry Analysis, Investment firms, securities markets, sell-side analysts vs. strategists, stock market, using research Tags: , , , , , , , , , , Leave a comment

 Factset:  what Wall Street thinks

Last week I got a press release from Factset, a financial data collection and analysis service, on the topic of where the S&P 500 is headed over the coming twelve months.  The short answer from Factset:  brokerage house analysts think the market is going up a little bit, strategists think the market is going down–again by just a touch.

I’m going to write about this over the next few days.  My short answer:  if history is any guide, neither outcome is likely.  The market seldom drifts along.  It either goes up a lot, or down a lot.

strategists vs. analysts

Who are these people?

First of all, they’re both sets of “researchers” who work for brokerage houses.  Now, they don’t call brokers the “sell-side” for nothing.  The number-one job of any sell-side researcher–analyst or strategist–is to persuade customers to do their trading business with their firm.  In other words, they’re primarily salespeople.  That’s important because it means that at least to some degree they both tailor what they say to fit what their buy-side audience wants to hear.

strategists

Strategists are typically economists or statisticians by training, although they are also sometimes former portfolio managers (snide pms would probably say failed portfolio managers).

Strategists normally work “top down.”  That is, they use data about the macroeconomy to make forecasts about GDP growth and  the course of interest rates.  They then derive expected future earnings growth for the overall stock market and the price earnings multiple at which they think the market will trade.  That gives them a forecast of the future stock market price.  For the S&P over the next year, Factset says the strategists’ consensus is down, but my less than 10%.

Based on their analysis, strategists also recommend sector- and industry-based portfolio structure.  In conjunction with analysts, the may also suggecst individual stock holdings.  They may also help set policy–like the official forecast of the oil price–that analysts more or less adhere to in making their company earnings forecasts.

Strategists are normally much more conservative than sell-side analysts.  Their earnings growth projections are almost always lower than analysts’.  Clients occasionally permit strategists to be bearish, and–as is the case now–to say the market is headed south.  But a prolonged bearish tilt is almost like buying a ticket for the unemployment line.

analysts

Analysts are specialists in specific industries or economic sectors.  They may have academic training in engineering or other subjects pertinent to the industry they cover.  They may have worked in the industry, often in strategic planning or M&A.  They’re invariably deeply knowledgeable about company financials and about the competitive dynamics of their coverage. They often also have privileged access to the top management of the firms they analyze.

That access usually comes at a price.  Analysts can come under considerable pressure not to deviate–either up or down–from the official earnings guidance announced by these firms.  A “sell” recommendation can sometimes trigger a violent reaction from the company in question.

Many investors–childishly–don’t like to hear bad news about the companies they own.  At the same time, the analyst won’t earn much if he doesn’t have good things to say about at lease some firms in his industry.  As a result, analysts tend to err very substantially on the side of optimism.  They turn bearish, even for a short time, at their peril.

year-ago predictions

Industry analysts make projections of earnings growth and set stock price targets for the companies they cover.  They don’t make projections for the S&P.  Factset gets an implicit analyst forecast for the market by aggregating the analyst projections for each company in the S&P 500.

Getting a strategist forecast is much more straightforward.  Factset just takes a median.

Anyway, in April 2012 the implied analysts’ forecast for the S&P was much more bullish than the strategists–at +11.9% vs. +2.6%.

No surprise there.

What is a surprise (“shock” may be a better word), however, is that the analysts were a lot closer to the actual S&P 500 results of +13.8% (capital changes only).

year-ahead projections for the S&P

That’s tomorrow’s topic.

Microsoft (MSFT) buying the Nook e-reader?

May 10, 2013 By in Current Market Thoughts, e-readers, Industry Analysis, Publishing, Stock ideas Tags: , , , , , , , , Leave a comment

the news

Yesterday, the stock of Barnes and Noble (BKS) soared 22% on more than 10x normal volume.

The reason?

…a TechCrunch post saying MSFT is preparing a $1 billion offer for the company’s Nook-related digital assets.  The assets are held in BKS’s Nook Media subsidiary, which also contains the company’s college bookstore operations.  Leonard Riggio, who controls 31% of BKS, owned the college bookstore business privately but sold it it BKS in 2009 for $514 million.

The TechCrunch report is based on its examination of internal MSFTdocuments which the New York Times says are genuine, though perhaps dated.

is the headline figure, $1 billion, all that it seems?

Maybe not.  The most favorable interpretation of the TC scoop is that MSFT is willing to pay $1 billion for the portion of the BKS digital assets it doesn’t already own.  The least favorable is that the offer values the entire Nook Media at $1 billion.

The difference?  Three factors:

1.  MSFT already owns 17.6% of Nook Media.  Pearson owns another 5%.  Under the more favorable interpretation, the $1 billion would be split between Pearson and BKS, with the latter getting $940 million.  Under the less favorable, which I think is probably the correct interpretation, BKS would collect $774 million.

2.  Does the $1 billion value include the college bookstores, which–as I read the BKS financials–are the company’s most profitable operations?  If so, cut the MSFT offer in half.

3.  In its original deal with BKS, MSFT promised to fund up to $180 million in Nook R&D.  I think this was a loan, not a gift.  If so, part of the $1 billion may be forgiveness of the loan, not a new cash inflow.

In the least favorable case for BKS, subtract $500 million from the $1 billion headline number if the college book stores aren’t included.  Another $176 million represents the stock MSFT already owns.  Let’s say a further $100 million represents repayment of the R&D advance.  Then, the “$1 billion” offer would mean a cash outflow of  about $250 million, of which BKS would get about $235 million.

the Nook is bleeding red ink…

…for three reasons.

In the Darwinian world of consumer electronics, stand-alone e-readers like the Nook are an evolutionary dead end.  They’re being replaced by small, light tablets.

The Nook is an also-ran among e-readers.

As I read the BKS  financials, the company has a razor/razor blade strategy for the Nook.  It prices the device roughly at cost in the hopes of generating a lot of high-profit e-book sales from users.  In fiscal 2013 (ended in April), however, BKS appears to have lost $350 million trying to persuade consumers to take Nooks off their hands.  It’s hard for me to see how BKS can sustain deficits of this size.

why buy the Nook? 

1.  MSFT takes in $1 billion in cash every two weeks.

2.  To compete in the tablet and smartphone businesses, MSFT needs an e-reader feature.  Because of the company’s tiny market share in both businesses, developers aren’t beating down the doors in Redmond to make reading apps for it.  MSFT’s plan would apparently be to stop making e-readers and refocus the Nook division on creating/enhancing e-reader apps, especially for Windows devices.

3.  According to TechCrunch, the MSFT documents project Nook “ revenues to gradually recover, up to $1.976 billion by fiscal year 2017, for EBITDA profit of $362 million.”

Given that sales of e-readers make up the huge bulk of Nook Media’s sales, the most polite thing I can say is that this forecast is extremely optimistic.  Revenue growth appears to assume a rocketship ride for sales of digital content.  The $750 million positive swing in EBITDA looks too good to be true.  But it does make Nook Media look cheap.  My hunch is that this is its main purpose–to justify the purchase.

(One caveat:  it’s impossible for me to judge how revenues and costs for the Nook devices and for digital content are figured and split between the retail and Nook divisions of BKS.  The only way I can see for Nook Media revenues to rise without hardware sales is if the whole basis of revenue calculation is somehow changed.  EBITDA of $362 million is only plausible to me if somehow post-acquisition Nook Media’s SG&A expense of around $400 million a year completely disappears, or if somehow a whole bunch of digital content profits are now being attributed to the retail division but revert to Nook Media post-acquisition.)

For what it’s worth, TC says the MSFT documents value BKS as presently constituted at $1.66 billion.

4.  MSFT is anything but a shrewd acquirer, in my view.  Just look at its $40+ billion bid for YHOO in 2007 (it has taken a 70% rise in YHOO’s stock price over the past year for that company to recover to a market cap of $30 billion-).

5.  Nook Media may be MSFT’s best alternative–and it may feel it can’t allow the business to die.

I don’t have an investment opinion about BKS.  I don’t own the stock and I have no inclination to be a buyer.  Any holder must ask himself where he sees upside from the current level, and how much that might be.

PS:  I wonder who leaked the documents   …and why.

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