Monthly Archives: September 2012

the end game for the Eurozone

September 7, 2012 By in Current Market Thoughts, economics, Strategy Tags: , , , , , , , , Leave a comment

the ECB plan

After consultation with the the heads of Eurozone governments, the ECB yesterday announced its latest efforts to stem the Eurozone financial crisis.  The central bank will buy one- to three-year government debt of Eurozone members like Spain and Italy, which have been unable to borrow at reasonable rates of interest in the public markets.

There’s no cap on the amount the ECB will buy.  The action is subject only to the requirement that the countries in question abide by policy (read: austerity) rules agreed to with the ECB and the IMF.

The plan has been an open secret in securities markets for the past month or so, with European stocks and 10-year Spanish/Italian bonds rallying by over 10% during that time.  In contrast,to my mind the first really substantial positive reaction in US stocks came in post-announcement trading yesterday.

sterillization

The bond buying will be “sterilized”–that is, it will be offset by equivalent buying elsewhere along the yield curve.  The intention is not to increase the overall money supply, thereby creating possible future inflation.

This is an important procedural point, given the continental European (read:  German) obsessive fear of any rise in the price level.  However, given the crushing burden of high real interest rates in the weaker parts of the Eurozone, a little inflation is the last thing the ECB has to worry about.

Although I haven’t seen details, other than that the purchases will be in money market securities, presumably the offsetting buys will be in German and French debt, which are trading at negative interest rates at present.

where to from here?

The most important aspect of the ECB move is that it sets a direction–and a precedent–that can be quietly modified as time goes on.  Yes, the current program is limited to at most three-year maturities.   But maybe that limit will gradually be relaxed.  Yes, the current intervention is being totally sterilized.  But maybe that will change, as well.

The key to the ECB plan working is the continuing good faith implementation by the weaker Eurozone nations of the fiscal policy reforms they’ve already agreed to.  My guess is that this will prove not to be a problem in the case of either Spain or Italy.

Greece?

Greece is another question, though.  Objectively speaking, Greece–and Greek sovereign debt–are small enough in the overall Eurozone context that they don’t matter that much. But the country’s continuing refusal to implement already agreed to fiscal belt-tightening measures, and its incessant haggling for better aid terms from the EU/IMF, make it a thorn in the side of the Eurozone.  My guess is that there’s already a plan in place to force Greece out of both the Eurozone and the EU.  Bad for Greece–and for any publicly traded companies holding Greek assets. But it might be necessary to keep, say, Italy from backsliding.

The details of a possible ouster would doubtless also be messy, since integration of Greece into the wider EU has been going on for over a decade.  And the move might roil securities markets for a short while.  Still, my guess, however, is that most investors would greet the move with a sigh of relief, not with increased angst that the EU itself is unraveling.

what to fret over about now

If we strike the imminent collapse of the Eurozone off our list of worries, what’s left?

The upcoming US election, as a proxy for long-term growth prospects for the United States, is probably, by default, at the top.

European money market funds–charging to hold your money?

September 6, 2012 By in Banks, Industry Analysis, Investment firms, Portfolio management, Recent Market Action, Securities regulation, Strategy Tags: , , , , , , , , , 1 Comment

That’s what the Financial Times suggests is about to happen, based on what the largest European money market fund managers have told them.

money market funds

Money market funds are a kind of mutual fund that specializes in holding very short-term government and corporate debt.  They became popular as a much higher-yielding, but safe alternative to bank deposits well over a quarter-century ago.  Although not insured by governments in the way bank deposits are, their investing operations are designed to preserve net asset value at a constant level.  That’s usually $1 or €1.  Interest is paid in new shares.

defending net asset value

Over their entire lifespan, there have been only a small number of incidents, involving a small minority of funds, where investors have received less than their initial purchase price when redeeming shares.  There have been cases–only a few–where funds have made imprudent investments stretching for yield.  But the financial conglomerates sponsoring the wayward managers have invariably made investors whole, typically by buying the dud paper at the initial purchase price.

today’s situation in the EU

Why is today any different in Europe?  Two reasons:

–the European Central Bank has recently reduced the interest rate it pays on overnight deposits from 0.25% to plain old zero.  And it says it might reduce rates further, meaning it will begin to charge banks for holding their money.

–the long-running EU debt crisis has created a two-tier structure of sovereign borrowers, haves and have nots.  Interest rates on short-term French and German notes are already negative (meaning you lend €1 to either country and get €0.995 or so back when the note comes due).  Yes, a money market fund can get a positive yield by lending to Spain or Greece, but only by taking on extra risk.  Also, once your clients learn what you’re doing, they’ll probably move their funds elsewhere.

A manager can, of course, think about buying longer-dated securities that do pay interest.  But he takes on interest rate risk by doing so.  Just as important, the fund’s charter will doubtless bar, or at least limit, such investments.

To sum the situation up, money market funds promise safety + a better yield than bank deposits.  In today’s EU, they can’t deliver both.

plans being considered

According to the FT, some fund sponsors are toying with the idea of keeping the net asset value constant, but charging the negative interest rate to accounts by decreasing the number of shares an investor holds.  Others appear to be considering levying charges in some form, but outside the fund, so that neither the asset value nor the number of fund shares will be affected.

bank accounts must be in the same situation

Given that money market fund managers are usually much more efficient than their bank counterparts, the banks themselves are likely beginning to lose money on savings accounts.  So it’s possible that in the stronger EU nations, banks will begin to charge customers a monthly fee to safeguard their money.

more than an oddity

I think the most important information to take from this discussion is that the money market fund sponsors don’t expect the situation to change any time soon.  If they thought that negative returns on government notes were a three- to six-month aberration, they might quietly suffer through the losses.

But they’re not.  They’re planning on the current situation being around for a long time.

“Great quarter, guys!”–the smarmy analyst refrain

September 4, 2012 By in earnings conference calls, Information for investors, Investment firms, Portfolio management, Securities regulation, Stock ideas Tags: , , , , Leave a comment

Bob

A few days ago, my friend Bob emailed me a link to a recent Wall Street Journal article commenting on the omega-dog behavior of brokerage house securities analysts on company conference calls.  The ultimate acknowledgment of this inferior status is the obsequious “Great quarter” comment.

A distant cousin is “Thank you for taking my question,”  which typically means “I know you control who gets to be heard on the call and I appreciate the status you’re granting me.”  It can also convey an undertone of irritation that the analyst has been denied this opportunity on previous calls, despite his obvious stature in the industry.  If so, the analyst is also implying (sometimes, to his regret) that management isn’t clever enough to pick this up.

my take on the sell side, and on earnings calls

Anyway, Bob’s email prompted me to write down these thoughts.

1.  The earnings release and conference call are, in the first instance, the straightforward way that publicly traded companies feel they meet disclosure requirements mandated by regulators.

At the same time, companies understand these are marketing opportunities as well.

Of course, management controls who gets to speak on the call–and it’s virtually always favorably inclined analysts who get the air time.  If you don’t believe this, read anything Mike Mayo has written about the securities industry.  For the better part of two decades he was blackballed by the major banks, not because he was an incompetent (he’s quite the opposite) but because he pointed out banks’ weaknesses and recommended selling their stocks.  Not only was he denied access to managements, but he was repeatedly fired from brokerage houses when firms he covered directed investment banking business elsewhere and when institutional investors who had large bank stock positions shifted their trading away.

No, being seen as the CEO’s boot-licking lapdog isn’t pretty.  Looking on the bright side, though, a lapdog has unparalleled access to his master–and that access is something institutional investors are willing to pay for.

2.  Securities analysts are deeply dependent on the managements of the companies they cover.  Investment banking business is only part of the story.  Will the CEO help an analyst burnish his reputation by attending a conference the analyst organizes or will he dispatch an IR person who will give a canned presentation that’s months old.  When the CEO or CFO travels to meet large institutional investors, will they let the analyst arrange the agenda and travel with them?  If the analyst has a question, will the CEO return his call?  How fast?  These are all factors an institutional investor considers in deciding how much he’s willing to pay an analyst for services.

Companies are also the primary source of industry information for almost every analyst.  Cutting off access to management is like taking away your internet connection.  That’s doubly true today when brokerage house research budgets have been pared to to bone and many laid-off analysts have been forced to open up shop on their own.

3.  The traditional communication system, of which many earnings conference calls are still a part, is broken.  When I was a rookie analyst, publicly listed firms would feed financial information to shareholders and interested investors through “tame” brokerage house securities analysts.  Many companies regarded analysts as quasi-employees whose job was to relay the info–untouched–to shareholders.  After all, everyone had to have a brokerage account.

Lots has changed since then:

–investors under the age of, say, 60 have spurned traditional brokers in favor of a do-it-yourself approach through discounters like Fidelity.  Two reasons:  much lower costs, and a fundamental distrust of the motives of traditional brokers.  Sell side analysts still have contact with institutions, but will almost no individual investors

–Regulation FH (Fair Disclosure, August 2000) has clearly specified that the practice of selective disclosure is illegal

–many of the analysts companies communicate with no longer work for brokers.  They’re in independent research boutiques that repackage the information they receive and sell it.  They talk to some institutions, but not all.  And they have no content whatsoever with individual investors.

The upshot of the traditional practice is that individual shareholders are cut out of the information loop altogether.  Ironically, CEOs can end up giving corporate information (which is the property of shareholders) for free to professional analysts, who are typically not shareholders, while denying it to owners.  To add insult to injury, these middlemen then sell the information to shareholders, who are forced to pay thousands of dollars a pop.

Yes, the “tame” analysts kowtow–but they’re laughing all the way to the bank.

The current system is so broken, I think it’s only a matter of time before there’s wholesale change.  That day can’t come too soon for me.