Monthly Archives: January 2012

prospects for fixed income in 2012 (II)

January 18, 2012 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Shaping a portfolio for 2012, Strategy Tags: , , , , , , , , , , , , Leave a comment

This is the second of three installments of a yearend analysis of the bond market by Strategy Asset Managers, LLC.

Follow the money

The Federal Reserve recently released its quarterly flow of funds study for the period ending September 30th.  Despite a brisk pace of federal government borrowing, aggregate credit demands remained weak.  Total non-financial debt grew at about a 4% pace as households shrank their borrowings.  This provided plenty of space for federal government debt to expand.  Meanwhile, the Federal Reserve was dumping huge amounts of money into the economy.  A broad measure of money supply–so-called M2–increased 9.8% over the last year.  Lots of money and little credit demand resulted in very low interest rates.  This could change quickly, however.

The US consumer has been tightening his/her belt since 2007.  The bursting of the housing bubble resulted in lower home prices, lower turnover and a decline in mortgage debt outstanding–from $14.8 trillion in June 2008 to $13.6 trillion in September 2011.  Faced with a troubling job market, consumers reduced non-mortgage debt as well.  This peaked at $2.6 trillion in 2008 and now stands at $2.47 trillion.  This borrowing metric seems to have stabilized recently as consumer confidence in future economic prospects has improved.

While the household sector of the economy has been paring back debt, the financial sector–commercial banks and savings & loans–has been reducing debt and balance sheet leverage.  This explains why few are worried about the leakage of European banking problems into our financial system.  So, once folks are ready to buy a new car or upgrade to a bigger house, banks will be able to provide them credit.  Despite the massive (+300%)  growth in federal government borrowings over the last decade, households remain the largest sector of the credit market with $13.2 trillion of debt outstanding versus $10.1 trillion of federal government debt.  If household borrowings increase by just 5%–less than half the rate experienced in the first half of the last decade–aggregate credit demand could rise by 7%.  This rate of expansion is not compatible with the current low level of interest rates.

That’s it for today.  SAM, LLC’s conclusions tomorrow.

Here’s yesterday’s initial post in this series.

fixed income prospects for 2012

January 17, 2012 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Recent Market Action, Shaping a portfolio for 2012, Strategy Tags: , , , , , , , , , , Leave a comment

My first boss on Wall Street, who taught me securities analysis in the late 1970s, switched to the fixed income arena in the early 1980s.  He runs Jamison and McCarthy Investment Advisors LLC, which manages money for institutions and high net worth individuals.  His 4Q11 letter to clients gives a polished industry veteran’s view of the current global economic situation and its implications for bonds.  He’s relatively bearish.

The analysis is very worthwhile reading.  It’s long enough, however, that I’m going to publish it in three posts, all sans charts.  Here’s the first, an outline of the current bond situation:

Is it time to get off the bus?

2011 was a remarkable year.  The bond market encored its 2008 performance as investors flocked to the safety and liquidity of US Treasury securities.  We brought back the same actors–inept central bankers, anxious politicians, sketchy borrowers and frightened investors.  The accents were a little different–more European–but the plot was the same–a financial system supposedly on the verge of collapse.  And the ending for investors was also the same–the frugal, risk averse bond buyer won the prize in the final scene.  The prize in this case was a whopping 30% return from investing in long term US Treasury bonds.  And this came on top of a good showing in 2010–a 9.4% return for US Treasury bonds.  But as all moviegoers know–the third installment in a series is usually a dud.

We don’t think the numbers add up for another bond market rally in 2012.  Last year’s increase in bond prices lowered yields sharply.  For example, the Barclay’s Long-Term US Treasury Index closed the year with an effective yield to maturity of just 2.7%.  This compares with 4.1% a year ago.  The smaller yield means a smaller cushion against any price decline.  Meanwhile, the mathematics of bonds is such that lower yields equal greater price risk for any given change in interest rates.  The measure of risk is called duration and the duration of the Barclay’s Long-Term US Treasury Bond Index on December 31st was 16.2 compared with 13.9 for a similar basket of bonds a year earlier.  Now, investors should expect that a one percentage point change in interest rates would cause a 16.2% change in the price of the bonds, a very nice gain if interest rates for twenty year government bonds fall to 1.7%.  If, however, the yield of such securities rises to just 3.7%–a level 50 basis points below the average of the last five years–get ready to book a 13.5% negative total return (yield plus price change).  Of course, the returns from bonds with shorter maturities would be less damaged.  Nonetheless, there would be plenty of red ink for all.

If you think current bond market returns aren’t very generous, you’re right.  The sub-2% ten year government bond yields produced during the final quarter of 2011 were the lowest on record.  In fact, they were lower than the rate of inflation.  This has rarely occurred.   This occurred during the inflation tsunami of the Seventies, and again, briefly, in 2005 and early 2008 when oil prices spiked.

The bond market has reached these low levels because of:

(1)  fears of a European banking crisis,

(2) the free money policies of the Federal Reserve, and

(3) modest non-government domestic credit demands.

The impact of these factors is being amplified by hedge fund “risk-on, risk-off” trading that pushes short term money between various capital markets.  If any of the three legs supporting the bond market cracks in the months ahead, a substantial interest rate increase is in the cards.

That’s it for today.  More analysis tomorrow and Wednesday.

TIF’s 4Q11 earnings misstep

January 16, 2012 By in Current Market Thoughts, earnings conference calls, Industry Analysis, Luxury goods, Retail, Stock ideas Tags: , , , , , , , , , Leave a comment

background

When TIF reported 3Q11 earnings (Tiffany’s fiscal year, like that of most retailers, ends in January), it lowered its 4Q profit guidance (see my post).

By then, the company had seen sales for virtually the entire month of November and had detected weakness in spending by residents of the Northeast and Mid-Atlantic regions of the US.  At that time, it still expected a “low-teens percentage increase” in worldwide sales during 4Q11.  But it effectively clipped $.10 from its estimate of per share profits for the year’s final three months, saying it expected to earn $1.48 – $1.58 per share during the period.  That would be 6.3% more than the $1.44 it earned in the comparable period of fiscal 2010.

the weakening holiday selling season

Last week, TIF reported the results of its worldwide sales for November plus December.

The news wasn’t good–especially in the US and Europe.

Rather than the low-teens increase in sales the company had been anticipating, revenues were only up by 7%.

By region, they broke out as follows:

Americas    total sales = +4%,     comp store sales = +2%  (3Q11 comps = +15%)     ←

Asia-Pacific (ex Japan)     +19%, +12%, (+36%)      ←

Japan     +13%, +6%, (+4%)

Europe     +1%, -4%, (+6%).

In the US, sales to residents were down year on year.  Buying by foreign tourists pushed results into the plus column.

In its press release, TIF reduced its eps forecast for 4Q11 by another $.10-$.15.  It now expects to earn $3.60 – $3.65 for the full year.

The stock fell 10% on the news.  Unlike other stocks with negative earnings surprises, TIF hasn’t rebounded.

my thoughts

December must have been a particularly disappointing month for TIF, since management had already revised down its expectations  based on November weakness.

Recent macroeconomic reports are almost universally signalling that the US economy is improving.  In the jewelry industry in particular, Signet reported on the same day as TIF that its same store sales in its Kay business were up +9.8% and in Jared, +10.0%.  Similarly, Zale reported that its non-kiosk US jewelry business had same store sales growth of +9.0%.  Neither is showing anything like the weakness in TIF’s business.

TIF is much farther up-market than either Signet or Zale.  Presumably, that’s the source of the difference.  It looks like TIF’s high-end US customers left their credit cards at home last month.  My guess is that the problem resides in the waning fortunes of executives in financial services and the industries, like legal, which support it.

Look at the Asia-Pacific figures above, as well.  TIF didn’t highlight this area.  Same store sales are still high at +12%. But three months ago they were growing at a +36% pace, or 3x the current rate.

what to do

At last Friday’s price of $59 or so, TIF is trading at 16x fiscal 1011 eps and yielding 2%. That looks cheap to me.

On the other hand, we have only guesses as to what’s causing the current deceleration in company sales.  They’re probably good guesses, but still…

For investors, the more pertinent question is probably when earnings comparisons will begin to pick up again.  My tentative answer is–not soon.  In fact, earnings comparisons could be negative or flat until late in 2012.

So my thoughts remain unchanged from late November.  I don’t feel any need to sell the stock I own, but I don’t think I have to hurry to buy more.  If I didn’t own any I might buy a small part of a position now, but no more than that.

 

the Unicredit rights issue

January 12, 2012 By in Banks, Basic Concepts, Current Market Thoughts, Industry Analysis, Recent Market Action, rights issue Tags: , , , , , , , , , , 1 Comment

the Unicredit issue

Unicredit, a major Italian commercial bank, is in the midst of an equity raising aimed at shoring up its finances to meet new capital adequacy standards being set by the Bank for International Settlements.

It’s doing so in the customary European way, through a rights issue (see my post on rights issues for more detail).  The prospectus is available–but not to people in the US–on the company website.

No E-Z bank is eager to raise new equity today.  Their stocks are trading at well below half of the balance sheet carrying value of their net assets (which is the problem in a nutshell–no one believes the carrying values have much basis in reality).  Nevertheless, many are resigned to doing so.  Therefore, the Unicredit issue is attracting a lot of market attention as it proceeds.

Several aspects of the issue are striking:

its large size

Prior to announcement of the issue, Unicredit was trading at around €6.30 a share.  The issue gives existing shareholders the right to buy 2 new shares at €1.93 each for every one they held at the ex rights date.  The new money coming in from the issue amounts to about 60% of the pre-rights market value of Unicredit.

implied change of control possibility

The shares created by the issue will represent two-thirds of the new total.  The issue has the potential to completely rewrite the share register if traditional large shareholders choose not to participate.  That’s certainly an inducement for them to come up with the money.

the low exercise price

Think of rights as being like short-term warrants.  Suppose the existing shareholder doesn’t want to, or can’t afford to, exercise his right to buy new shares.  What happens then?

Usually, and in this case as well, the issue is underwritten.  That is, the investment bank group arranging the issue agrees to buy, at the rights price, any shares that shareholders don’t.  The underwriters, in turn, sub-underwrite part or all of their obligation to other investors–typically portfolio management companies (this is a whole other, semi-sordid, story–but a topic for another day).  No matter what, Unicredit will get the money it wants.

Underwriters don’t want shareholders en masse to refuse to take up their rights.  It’s embarrassing for all parties, for one thing.  The underwriters, or angry customers who act as sub-underwriters, are stuck with the shares on their books, at a loss and tying up capital.

Their solution?  Coercion.

Underwriters always price the new shares at a discount to the prevailing stock price.  The bigger the discount, the bigger the gun to the head of existing shareholders to avoid having their percentage ownership of the company assets diluted by not taking up their rights.  Conversely, the smaller the discount, the more eager underwriters figure existing shareholders are to give company management fresh capital.

In the Unicredit case, the discount is gigantic.  The new shares will be issued a less than a third of the pre-rights share quote.  More like a cannon than a gun.

the issue appears to be succeeding

…at least in the sense that the current share price is comfortably above the €1.93 level.  The stock hasn’t traded below the rights exercise price since it went ex rights and has strengthened each day, as well.

Unicredit is worth watching closely

This is a bellwether rights issue.  If it goes well–and signs are positive so far–other, stronger banks should be able to raise substantial new equity, too.