Monthly Archives: January 2017

refinancing/repricing bank loans

January 17, 2017 By in Banks, interest rates, Uncategorized Tags: , , Leave a comment

One way that an investment bank can win merger and acquisition business is to offer financing to bidders through what are called bank loans.  These are essentially long-term corporate bonds that carry high variable-rate coupons based on libor.   The successful bidding company issues them to the bank to pay for an acquisition.  The bank resells the loans to institutional investors.

There has been strong interest in such loans over the past couple of years for two reasons:  yielding, say libor +4%, they offer high current yields; and, at least in theory, there’s the possibility of rising income as libor increases.  Some of these bonds have the further fillip that the variable (libor) portion can’t go below a fixed amount, say 1%, no matter what the actual libor rate is.

Three-month libor is now approaching 1%, up from as low as 0.2% in 2015.  This benchmark rate is certainly heading higher.

Fro the perspective of holders, one flaw with these bank loans, however, is that they offer little call protection.  What’s now happening on a massive scale is that banks are approaching institutional customers who bought high-yielding bank loans and offering to replace a loan yielding, say,  libor +4% with an equivalent loan from the same borrower yielding libor +3%.

Customers are taking up such deals in droves.  How so?  Technicially, the original loan instruments are being called, meaning the issuer is exercising its right to pay the loans off at par.  The customer can either get his money back in cash–and therefore be forced to find a new place to invest the funds–or accept payment in a new, less lucrative, loan.

The customer has two incentives to take the latter:  the new terms are still attractive; and the borrower will have developed deeper confidence in the issuer through continuing study of company operations and a history of on-time coupon payments.

 

The real winners here are the banks, who collect another round of fees for providing this service. In all likelihood, this won’t be the last round of repricing, either.

 

productivity diffusion

January 13, 2017 By in economics, government economic policy, labor productivity, Uncategorized Tags: , , , Leave a comment

Happy Friday the thirteenth!

The Financial Times has an article today that talks about productivity diffusion, referencing a prior FT article and an OECD study on the topic, both of which I somehow missed.

In its simplest form (which suits me fine), economic growth can be broken down into two components:  having more workers (or having existing workers put in more hours); or being more productive, meaning investing in machines, new business processes or worker training.

One of the bigger economic issues facing the world (US included) is the sharp dropoff in productivity growth over the past ten years or so.  The OECD report that sparked the FT articles argues that the problem isn’t a drop in innovation across the board.  Rather, the most productive firms in the world continue to show strong productivity growth.  What’s changed is that the once-fast followers are only adopting best practices today at a much reduced rate.

Why is this?  The OECD answer, which best fits the EU, I think, is that big banks are protecting low-growth, heavily indebted “zombie” firms.  Their reason?  The banks keep the zombies afloat (mixed metaphor, sorry) so they won’t have to write off the dud loans–calling into question the banks’ own financial viability.  What’s scary about this analysis is that it calls to mind the experience of Japan in the 1990s, the first of that country’s three lost decades.  Given that the Tokyo government actively protects managements from the consequences of failing to innovate, the problem of economic stagnation still afflicts Japan today.

To me the real relevance of the current lack of productivity diffusion for the US is that it speaks to the thrust of Donald Trump’s macroeconomic ideas.  However well intentioned, the effect of dissuading firms from adopting productivity enhancing measures for fear of being publicly shamed and of shielding non-competitive firms from import competition will likely be the zombification of the affected portions of American industry.  That is not a long-term outcome anyone wants.

 

Dow 20,000, S&P 2260

January 12, 2017 By in Technical Analysis, Uncategorized Tags: , , , Leave a comment

I’m not a fan of the Dow.  It’s a weird index whose main virtues are that, way back when, it was the financial media’s first try at measuring the US market and that, despite its peculiarities, it’s easy to calculate.  It’s no longer a useful gauge of US stocks, however.  So it’s never used by professionals, only by media people who have little industry background.  (One caveat:  the Dow indices are now controlled by the same people who own the S&P–who now have a vested interested in keeping the Dow alive, despite its drawbacks.)

Still, it’s striking that for the past six weeks 20,000 on the Dow has shown itself to be a strong point of resistance to the US stock market’s upward movement.  The equivalent figure for the S&P 500 is 2260, not a memorable number.

Whether the resistance level is 20,000 or 2260 makes little economic or financial difference.  Psychologically, however, 20,000 is much more daunting, I think, than 2260.  This is especially so now that the US stock market has risen far above former highs.

My bottom line is that, whatever number you choose, the post-election rally has run into its first substantial roadblock.  It’s also at least thinkable that the Dow is developing, at least for the moment, more relevance than I’m willing to give it credit for.  This would suggest that the balance of market power is shifting away from professionals to individual investors who have little stock market experience.    I find this hard to believe, but it’s something I should keep an eye anyway.

 

reading a financial newspaper

January 11, 2017 By in Uncategorized, using research Tags: , 1 Comment

Early on in my investing career, I came to realize that it’s better to read financial newspapers by starting on the back page and working toward the front.

How so?

As investors, we’re searching for information that is potentially important but not yet well known.  Arguably, the best information won’t yet be in print.  But as it does appear, it will usually come in the form of small articles on the back pages.  Typically, when information is on the front page, or when it appears as a magazine cover, investors normally begin to think hard about adopting the contrary stance.

At first blush, reading from back to front is hard to do with online news services.  Worse,  the order of online news is constantly being curated, meaning that the most popular items are pushed toward the front.  The less well-received–that is, the more interesting for us–are progressively pushed toward the rear.

Interestingly, the Wall Street Journal and the Financial Times both have introduced what is being described as a “new” way of reading the newspaper, a digital form of the print newspaper.  Personally, I prefer the print newspaper.  But I find this digital form just as useful when I’m on the road.

the S&P after the Trump election raly

January 10, 2017 By in Strategy, Uncategorized Tags: , , Leave a comment

Taking numbers from Factset, a very reliable source, the S&P 500 is trading at about 17x estimated 2017 earnings.  That’s based on the assumption of slightly more than 10% eps growth from the S&P components this year–a figure I think is reasonable.

This is a potential problem for stock market returns in 2017, since that PE is maybe 12% higher than average for the S&P 500 index over the recent past.  And, of course, interest rates will likely be rising throughout this year and beyond.

Arguably, the elevated PE means that the sharp rally in stock markets since the Trump election has already factored into today’s prices everything positive that Mr Trump is likely to get done during the next 12 months.

That’s the safest assumption.  Concluding that doesn’t imply that there’s no money to be made in stocks in 2107, however.  Instead, it suggests that sector and stock selection will be the only money-making game in town.

Also–and this may simply be my inherently bullish nature taking over–that assumption may be too conservative.  It seems to me an important characteristic of fundamental changes in market direction is that they’re not driven by changes in consensus earnings.  Rather, the market tends to move considerably in advance of changing earnings.

We see this most often as the business cycle waxes and wanes.  At the bottom (top) of the cycle, when the Fed signals that it is going to lower (raise) interest rates, there’s an immediate, significant change in market direction and tone–even though it will take many months for the new interest rate regime to play out in earnings.  We can also observe this in commodity price-driven industries like oil, where stocks react sharply to changes in spot prices.  Oilfield services firms are especially instructive in this regard, since their stock prices tend to react in a high-beta way to oil price changes even though the firms may have long-term, fixed-price service contracts.  That’s because experienced investors realize that when an oil major simply returns a drilling rig to a service company and says it will no longer pay, there’s little that can be done   …if the services firm expects to have any business during the next upturn.

 

It seems to me that the S&P is now anticipating a similar kind of (favorable) economic step change during the early years of a Trump administration.   I see no reason to bet against this outcome.  This has little to do with Mr. Trump’s obvious flaws; it’s mostly because the electorate has put power decisively into the hands of one party.  If I’m correct, I’d expect the market to move sideways until we get evidence in legislation that substantial fiscal stimulus is under way.  Assuming this occurs, the second half of 2017 will likely be substantially better than the consensus now expects.

Of course, one has to keep the potential for downside clearly in mind.  My biggest worry:  my reading of his business career is that Mr. Trump has saved himself from his substantial bet-the-farm misjudgments (think:  Atlantic City casinos) mostly by throwing his partners under the bus.  In the present case, that’s you and me.