I’ve posted my second update to Current Market Tactics

I’ve written the second part of my update to Current Market Tactics.   If you’re on the blog, you can also reach the post by clicking the tab at the top of the page.

I’ve just updated Current Market Tactics

This is the first of two updates of Current Market Tactics (the second will come on Sunday).  If you’re on the blog, you can also click the tab at the top of the page.

Bernie Madoff and the New York Times

a Times article

Yesterday, the New York Times published a front page article based on correspondence with, and an in-prison interview of, Ponzi-schemer Bernie Madoff.  The reporter is turning her investigation into a book.

what Madoff said

Madoff had a number of comments:

1.  Discovery of his crime has had a much more severe negative impact on his family than he expected.

2.  He has given important information to Irving Picard, the trustee appointed by the court to recover investors’ assets (despite the fact he refused to help prosecutors after he was arrested).

3.  Internal bank and investment firm correspondence he has seen while in jail convince Madoff that these partners of his deliberately failed to do due diligence before recommending him to clients.  Why?   They knew they would find fraud–and thereby kill the goose that laid the golden eggs for them.

4.  In contrast to the banks, the Wilpon-Katz family, New York real estate developers and owners of the Mets baseball team, were clueless.  Despite having a cadre of highly educated financial and legal experts, and being sophisticated investors themselves, they “knew nothing.”

5.  There is no need to pursue Madoff clients who received the assets that belong to defrauded customers.  Why?  If other lawsuits seeking punitive damages from institutions that Picard maintains were “complicit” in the fraud are successful, there will be more than enough money to pay off investors who lost part or all of their principal.

is there any reason to think Madoff is being honest?

What are we to make of this?  Is any part of it true?

We do have one indication:  …Madoff’s gloating soon after arriving in prison about how he sized up business partners and clients–and refused to have anything to do with anyone he thought might be capable of uncovering the fraud.  He wouldn’t talk to them, wouldn’t take their money.  In other words, Madoff will only speak to people he’s confident he can successfully lie to. (I realize there’s a whiff of the famous liar paradox about Madoff’s statement, but I choose to think he’s being honest here.)

If so, what does this say about the reporter, to whom Madoff seems to have given a significant amount of time?

a human tendency

More generally, it seems to me that there’s a human tendency to think of oneself as somehow special…to say, in effect, “Yes, I know he’s defrauding others, but I’m part of the “in” group.  He won’t do that to me.”  Con men cultivate this feeling and take advantage of it.

In the Madoff case, early investors seem to have believed that the superior returns he advertised came from his illegal “front running” of clients in his brokerage business (that is, buying for himself before executing orders from brokerage clients, using the client volume to push prices up).  Yet, they were happy–no, eager–to give him their money, in the belief that 1) he wouldn’t cheat them, and 2) that he was willing to gift them with some of the money he stole from others.  Sounds crazy, doesn’t it?  But that’s what a lot of people did.

my take,

for what it’s worth:

1.  Madoff gave no thought to the effect that discovery of his fraud would have on his family, so of course he’s surprised.

2.  Some of the information cited in the Picard lawsuit against the Wilpon-Katz family sounds as if it came from Madoff, or perhaps Madoff confirmed surmises Picard’s forensic accountants made, but I doubt he provided other information.  He would certainly not be a credible witness in court, even were he to choose to testify.

3.  Madoff was very clever in arranging his fee structure.  The vast majority of the hedge fund-like fees charged to customers were kept by the selling agent.  So I can imagine there was immense pressure by top managements of his business partners to look the other way.

Consider the case of GE, a blue chip company made up of decent, hard-working people.  Less than a decade ago, even parts of that corporate icon wilted under pressure from a former chairman and falsified their financial accounts, so they could be seen to be achieving earnings goals.  I’m not condoning this activity, just saying that it happens and that potential whistleblowers would likely have gotten a very frosty reception.

4.  Long-suffering Mets fans realize that the Wilpons don’t have what it takes to run a sports franchise.  We also know that Madoff spent lots of time with the Wilpons and took huge amounts of their money.  So, no matter what Madoff says, his actions tell us what he thought of them.

Nevertheless, the Wilpon family would doubtless be classified as sophisticated professional investors–and subject to the much higher standards of conduct that this entails–based on the size and breadth of their operations, their education, training and experience, and the high quality of the financial and legal staffs they employed.  Separately, the Wilpons are also apparently being sued for failure to supervise their employees’ 401k plan, virtually all of which was directed to  Madoff.

These will be interesting cases to watch.

5.  I don’t understand the logic of Madoff’s wish that customers who received money stolen from others should be allowed to keep it.  I have no idea what the law is on the matter, though.

investment implications

Two that I can see:

I think we’re all susceptible (I know I am) to the idea that our own intrinsic worth shines through so clearly in all we do that complete strangers will offer us “special” investment opportunities as soon as they meet us.  Caveat emptor is a better rule to use in investment.

I started out as an oil analyst.  One of my earliest industry contacts told me that in his experience “good” oil wells always produced continual positive surprises.  “Bad” oil wells, on the other hand, continually disappoint.  I think that’s generally true of stocks, too.  In the case of unethical conduct, a given instance may be the first you have heard of.  But it’s a very bad assumption to think that this is the first instance that has occurred, or that the negative news is limited only to the area you have identified.  In all likelihood, the opposite is true.  The instance is almost certainly not the first, and chances are it’s indicative of a corporate culture that pervades the entire enterprise.

Life is too short and there are too many good investment opportunities for us to need to bet where the odds are stacked against us like this.

China’s trans-Colombian railroad proposal: good for Latin America

Railroad Tycoon

Sid Meier’s Railroad Tycoon has always been one of my favorite video games.  I wasn’t particularly good at it (it took too much time), but the idea was to build a corporate railroad empire in the US during some period in history.  In addition to laying your own track and building your own depots and stations, you could also own the raw materials providers that depended on rail transport, as well as the processing plants that turned these inputs into finished goods.  You could also buy out your competitors’ empires by astute stock market dealing.

Sino-Colombian projects

Someone high up in the Beijing government must also be a Sid Meier fan.  The president of Colombia, Juan Manuel Santos, in an interview with the Financial Times, says that his country is in advanced talks with China about constructing a 130-mile rail line running through Colombia connecting the Atlantic and Pacific coasts.  Combined with a new port to be built on the Atlantic side, the project would serve as an alternative to the Panama Canal.

Talks are farther along than this on another Sino-Colombian project, which would expand the Pacific port of Buenaventura and build another 450 or so miles of track that would speed the flow of Colombian coal to the Pacific, and to China in particular.

what’s at stake

What does Colombia gain from such deals?  …in the first instance, modern infrastructure and access to the Pacific Basin to market its natural resources (most of its existing rail capacity reaches toward the Atlantic), without much spending of its own (Colombia’s idea is to use build-operate-transfer concessions, in which China will make the capital outlays in return for the right to operate the ports and rail lines for a specified period of time).

And China?  …goodwill; access to Colombian coal; the possibility of extending the rail network into Venezuela, where it is developing extensive oilfields; a way to get around the potential bottleneck caused by restrictive work practices at the Los Angeles area ports.


Is there more?  Yes.

Much as a generation ago foreign firms used the UK as a jumping off point for the rest of the EU, Colombia may play the same role for China in the Americas.  One could see a reverse flow to the natural resources traffic that would be headed to Asia–components shipped from China to Colombia for final assembly, to be sent from there to the rest of Latin America–and potentially to the Us and Canada as well.

For its part, Colombia is worried about catching the “Dutch disease,” meaning the economic distortions that excessive reliance on natural resources creates.  With about half its citizens living below the poverty line and per capita GDP not much higher than China’s, Colombia would welcome the economic oomph that being China’s entrepôt to the Americans would bring.

where the US stands

Politically, the US may consider stronger China-Colombia ties to be a blow to its prestige.  On the other hand, Washington is one of the biggest catalysts behind China’s moves.  I don’t mean the AFL-CIO’s success since 2006 in blocking a bilateral trade deal with Colombia (which would result mostly in Colombia dropping its taxes on goods exported from the US–go figure that one out!), however.

Just as it did with Japan a quarter-century ago, Washington is vetoing any direct investment from China on “national security” grounds, effectively preventing Beijing from spending its huge dollar holdings on anything other than more Treasury bonds.  China is also interpreting (correctly, in my opinion) the unwillingness of Washington to tackle the three largest sources of government spending–the military, Medicare and Social Security–as evidence the US has no real commitment to preserving the purchasing power of the dollar.  So Beijing shouldn’t have a particularly high investment hurdle to beat–just not losing money would be enough–in considering projects like those in Colombia.

what should an investor do?

From an investment point of view, I don’t think there’s any need to rush out today and buy Colombian stocks (I don’t even know in practical terms how open the market, soon to merge with Chile’s and Peru’s bourses, is to foreigners).  But that country seems to  me to be the clear long-term winner from these developments.  It may well also be that one or more of the Chinese port companies, which I think are attractive on their present merits, will end up with a significant Colombian exposure.

Skandia Life: we’ve made money on private equity

Who says insurance companies don’t have a good sense of humor?

the Skandia Life study

The Financial Times reported today that Skandia Life has done a proprietary study that “proves” its investments in private equity have made money for the company, even from purchases made during the wildest days of the middle of the last decade–when loans were flowing like water and everything not nailed down was being bid for at very high prices.

Despite this, Skandia concludes that its private equity investments earned it “between six and 14 per cent per year” better than publicly traded equities (which would likely have lost some money during the period).  The print newspaper article said the margin of outperformance was “between 0.8 and 1.5 per cent,” a set of figures that the FT apparently subsequently changed.  I don’t know which is correct.  (I’ve looked for the study on the internet but have been unable to find it.  So all I have to go on is the FT newspaper and website.)

the study’s assumptions

To get the Skandia results,  you have to make a number of (heroic) assumptions.  They include:

1.  that the private equity people who sold Skandia its deals worked for free.  That is, they collect no fees and have no carried interest.

2.  that estimates of the current values of the companies bought, which are made by the private equity firms doing the buying, are fair and accurate.  There was apparently a “third party” check on the figures,  presumably by the investment banks who were paid by the private equity firms to line up and help finance the deals.

3.  that the highly leveraged acquisitions of poorly-performing companies are no riskier than buying, say, a stock index ETF, so no adjustment to returns for”extra” risk needs to be made.

are they believable???

How likely are any of these suppositions?  In New York they say…”If you believe this, I have a bridge you might be interested in buying.”

The icing on this comedic cake is the answer to the question, “What financial professional could possibly have approved this study and endorsed its dubious results?”    …why, the guy in charge of giving Skandia Life’s money to private equity, that’s who.

In the thrust and parry of bureaucratic infighting in large companies, I can see why someone might call for a justification for making private equity investments at the top of the market to be made.  And I can see how a study like the FT writes about might have been the response.  What I don’t understand is why the authors would want it made public in any form.

On the other hand, maybe they didn’t.





insider trading and ETF stripping

insider trading

Over the past couple of months there has been a constant drip, drip, drip of news conferences by the SEC on the topic of its ongoing investigation of insider trading.   Most have been to announce arrests of hedge fund-related professionals accused of this white-collar crime.  The “timed release” nature of the news flow has several objectives that I can see:

–it unsettles as yet uncaught lawbreakers, perhaps causing them to make foolish mistakes that will make their apprehension easier,

–it discourages anyone tempted to trade on confidential company information,

–it burnishes the reputation of the SEC as guardian of the securities markets, and, of course,

–it keeps unflattering stories, such as the one that the agency’s own financial statements have chronically failed to meet minimum government standards, off the front page.

ETF stripping

One the of the latest SEC announcements involves something new to me–ETF stripping. What is it?

The securities exchanges and their regulators maintain continual computer surveillance of public market trading, both of securities and derivatives.  They look for unusual patterns in volume or price movement that may indicate insider trading.   For example, three days before a merger announcement, trading in near-term call options of the target firm spikes to 5x normal volume; or the day before a surprisingly bad earnings report, puts for the stock of the company in question do the same thing.  Such deviations from the norm ring alarm bells and prompt the regulators to investigate who was trading and why.

According to the SEC, one way traders on inside information have been able to outwit this surveillance has been by buying shares in a sector ETF that contains their target stock, and shorting all the other names the ETF contains.  They end up owning only the name they want to.  But they don’t show up on the regulators’ screens as owning the target stock at all.  Instead, they’re seen as holding an index security (the ETF) and a bunch of short positions.

my thoughts

I have several thoughts:

–Most traditional investors can’t short stocks.  For those who can, there’s a very good chance that clients would notice and question the synthetic construction of a long position through ETF stripping.  So the SEC is talking about hedge funds here.

–Hedge funds would presumably piece the trading out to several brokers so that no one counterparty sees the entire picture.

–ETF stripping would be particularly hard to find if it were done by the trading desks of brokers, particularly those who act as intermediaries for ETFs and are constantly buying and selling both ETFs and their component securities.  Trading costs would be the lowest for such brokers, as well.

–There’s no reason to go to the trouble of ETF stripping other than to try to evade regulatory scrutiny.  So the practice seems to me to be a two-edged sword.  On the one hand, the chances of being detected are lessened.  On the other hand, the ETF stripper is like the burglar caught in the bank after hours with safe-cracking tools.  If caught, he can’t claim he’s there by accident.

–I can’t imagine the SEC figured this out by itself.  Instead, I presume the agency learned about ETF stripping through an arrested inside trader who offered information in exchange for a lesser sentence.

It will be interesting as this story develops to see how widespread the practice has been.


Wynn Resorts’ 4Q10: spectacular results from Wynn Macau

the results

WYNN reported 4Q10 and full year 2010 earnings results after the market close in New York on February 10th.

On February 1st, the company announced it would release its figures on February 24th, but a week later moved the date up to the 10th.

(I read this as signalling that the results were extremely good and WYNN was worried about their somehow leaking out in the intervening two weeks.  I appear to have been the only one to do so, however, since the stock traded flat on the two days before the conference call.)

Wynn reported revenues of $1237.2 million for the December quarter, up 52% year on year.  Earnings were $114.2 million, or $.91 per share.  That compares with  loss of $5.2 million or -$.04 per share in the closing three months of 2009.  Wall Street analysts had been estimating $.66, so the actual number was over a third higher.

Interestingly, the stock initially sold off by several percent in the aftermarket Thursday night, both before and after an upbeat conference call.  Stock price weakness continued in early-morning Friday trade.  Selling abated quickly, however, and WYNN ended the day up 7.45%.

the details


As I pointed out on January 5th, the Macau market experienced record gambling business in the December quarter.  Wynn Macau also gained market share, implying–at least in part–that it was unusually “lucky” during the period (what casinos report as revenue is not the amount bet by customers but the (small) portion of that figure that the casino wins).  In that post, I said I thought quarter on quarter revenues might be up by a third, and that (like any other well-run company) WYNN would encourage its accountants to find ways to tamp down the windfall gain.

As it turns out, 1128 reported revenues of $912.1 million, up 36% quarter on quarter.  Win percentage at high-stakes baccarat, the staple of the Macau market, was 3.15% of the amount bet for 1128 during the December period vs. 2.88% in the third quarter.  (WYNN thinks a normal range for that percentage to be from 2.7% to 3.0%.)

Yes, 1128 did increase its reserve for bad debts by $11 million but its operating income still rose from $124.5 million in the September quarter to $214.5 million in the December period.  (That’s what operating leverage is all about.)

Las Vegas

Slow recovery continues.  Convention business is gradually coming back.

But there’s still a glut of hotel rooms in Sin City, a fact that is holding room rates down.  CityCenter and the Cosmopolitan, the last venues to open in a flurry of capacity expansion, added almost 10,000 new rooms, or 15%, to the total on the Strip in a little more than a year.  Ouch!  That’s especially bad for the Las Vegas casino companies because their properties have been built with the idea of generating  half the firms’ operating revenue from being resort hotels, not from gambling.

So in Las Vegas, WYNN remains cash flow positive but earnings negative. For the December quarter, WYNN had an operating loss of $13.4 million.  At least that’s better than a year ago, when the red ink crested on the operating line at $56.7 million.

2011 to date

–Macau continues to boom, with the market growing by about a third, year over year, in terms of casino “win” in January.  1128’s win percentage for the quarter to date, however, has dropped from its recent highs to an unusually low 1.9%–meaning the company’s gaming profits aren’t much better than flat for the month v.s 2010.

That’s just a fact of life when dealing with high rollers, and has no investment meaning.  Nevertheless, this is the likely reason 1128 has sold off by 20% or so in Hong Kong over the past few weeks.

WYNN clearly thinks that the best is yet to come, as transportation links with Hong Kong and the mainland are improved.

–Chinese New Year was good for WYNN.  It produced the biggest night in the history of the Wynn Resort in Las Vegas, with table win of $16 million +.  And it yielded one-day casino win in Macau of $46 million +.

–In contrast with Macau, WYNN’s casino win percentage is Las Vegas is unusually high at the moment.

–1128 is planning to add two more to its current roster of ten junket operators (who bring groups of high-rollers to the casino) during the spring.  It hopes to receive final permission before summer to begin construction work on its new $2.5 billion casino in the Cotai section of Macau.  That would mean opening in early 2015.

the stocks

1128’s current market capitalization is HK$96 billion.  WYNN’s ownership interest in 1128, therefore, is worth about US$9 billion.  Wynn itself, which has outperformed 1128 by about 10% over the past year, has a market cap of just over $16 billion.  In simple terms, this means investors are paying $7 billion for:  the company’s Las Vegas operations, the royalties/management fees WYNN receives from 1128 and exposure to possible new ventures outside of Macau.  My guess is that this works out to cash flow return of 5% or so, assuming Las Vegas breaks even on the operating income like this year.

I hold both, with about a 3:1 ratio of WYNN:1128.  My overall holding is big enough that I’ve been forcing myself to sell bits and pieces just to control risk.

Neither stock is exactly undiscovered.  Still, I think that both will be at least mild outperformers of their markets in the year ahead.  If both stocks traded in the US, growth investors would gravitate toward 1128 and their value counterparts would tend to select WYNN.  The latter might even short 1128 to get “pure” exposure to the parent company.

The reality, though, is that the two trade in different markets (see my post on this topic), with different investment preferences and knowledge bases.  So the either/or strategy has risks that are not obvious.  In particular, it’s possible that 1128 could get caught up in a general asset shift away from emerging economies toward developed ones.  I don’t see that yet with 1128, and I don’t expect it will happen, but it’s possible.

My only useful thought in this regard is that a negative market reaction to 1128’s current run of bad casino luck in 1Q11 could present a buying opportunity.  I think that’s happening now with 1128.  Given that Wall Street analysts and US investors don’t seem to assimilate this kind of information very quickly (look at how badly they missed 4Q10 eps), the same may occur with WYNN when the 1Q11 earnings report comes out.