Keeping Score, October 2023

I’ve just updated my Keeping Score page for October 2023. The S&P 500 fell during the month, but by a surprisingly small amount, in my view, given the difficult political environment in the US and in the Middle East, as well as the relatively minor index declines in September, which is usually deeper in the minus column than this year.

No clear bullish or bearish tone in the returns by sector, other than that Consumer discretionary took a considerable beating.

Exxon (XOM)/Pioneer and Chevron(CVX)/Hess

Two big purchases of fossil fuel companies, one right after the other. What does this mean?

–among the traditional global oil majors, Europe-based conglomerates have long since reoriented themselves to become energy companies rather than simply integrated oils. In contrast, XOM and CVX have now reiterated forcefully that their business is fossil fuels, not other, more climate-friendly, forms of energy. Both firms are doubtless fully aware of global warming. In fact, news reports suggest that XOM, which is known for its excellent economic research, has been aware of the long-term ecological damage done by fossil fuels but has elected to keep its findings secret

–my experience (I started out as an analyst covering oil and mining companies) is that disclosure of the value of company mineral assets is murky at best. Absent a CEO who drinks champagne out of a cowboy boot, mining companies (including oils) are usually very conservative in what they reveal about the value of properties they own or have mining/drilling rights for. The only people who really know the true potential are a firm’s own geologists, partners in a given venture, and owners/developers of abutting prospects. While smaller firms use third-party geologists to develop SEC-mandated oil and gas disclosure, industry giants typically use their own–presumably guided to be more conservative–in-house experts. In my experience, companies worried about being taken over are the least motivated to declare high values for themselves. All in all, it’s likely that XOM and CVX think they’ve gotten very good deals.

–what really jumps out to me is that both buyers are using stock, a more expensive form of capital than debt, to finance these acquisitions, This is even though both acquirers have strong cash flows and modest financial leverage. In addition, XOM and CVX are both trading at single-digit PEs, in a market trading at 20x+. Both stocks yield close to 4%, to boot.

So, why not bank loans, or a bond issue (maybe a junk bond even) instead? If these acquisitions are such great deals, why not capture the largest amount of possible value for existing shareholders by using debt?

I can’t imagine that neither oil behemoth has been able find a bank–US or foreign–willing to make a large, petroleum-related loan at a reasonable price. But if so, why not issue a corporate bond, or a convertible? Assuming potential lenders/underwriters aren’t shunning the deals, using stock says to me is that both acquirers think fixed income is too risky. How so?

We know that relatively small changes–meaning 2%-3%–in supply or demand for oil can cause the crude price to move a lot. Suppose, say, that EVs become an important part of the world transportation scene by 2028 rather than ten years later, and that the resulting decline in demand for gasoline causes the crude oil price to drop to (I’m just making this up) $60 a barrel–and stay there. Would XOM and CVX still be able to service a $60 billion loan? Yes. But the interest expense would take a bigger bite out of considerably lower profits. And repayment of principal in the $50-$60 billion range might prove more problematic.

what caught my eye today

Two things:

–I’ve been struck by two savvy observers noting that interest rates on government bonds are now around the same place they were in 2005 and early 2006. That’s a time when we were past the internet collapse of 2000, world economies were expanding, China was roaring away, and the massive mortgage loan fraud committed by the major money center banks in the US was only in its early stages–and unrecognized by almost all investors.

Today, China’s a mess and the population of the US and Europe is considerably more gray-haired than back then. So overall economic growth is slower now. The US economy also has to deal with the strength of the US$, which has gained about 30% against the yen and half that against the euro since 2005-6.

So, yes, central banks have turned from being buyers of government bonds to sellers. But maybe where long-term interest rates will settle in is no longer a front-burner issue

–this is just weird. The ARK fund group announced this week that it has, if I understood the Bloomberg clip I listened to correctly, $2 billion in aggregate realized losses inside its fund group, vs. $14 billion or so under management in July, the fiscal year end. These losses are enough, ARK thinks, to offset taxable gains from the sale of securities for the next two or three years.

What an odd thing to say–that perhaps the group’s single largest attraction for a new investor is the extensive losses prior investors have incurred. And if the world were to take this to heart and massive inflows were to come into the funds, existing holders’ share of these losses could be substantially diluted.

The statement also invites at least one other question. Are there also substantial unrealized losses in the fund group–meaning shares trading at below their purchase price but not yet sold? If I’m reading the ARK annual report correctly (marked p. 55, but p. 57 in the index), the answer is that there are–about $16 billion worth. This compares with about $500 million in unrealized gains.

Since there’s a time value to these losses–the sooner used the more they’re worth–is there a plan to trade around existing positions to try to make short-term gains?

an unusually confusing time

It’s a given in any market that there’s never 100% clarity about everything. There are always situations where there are reasonable people willing to take both sides of a trade. Today’s world, though, seems unusually murky.

There’s the very ugly, although highly predictable, implosion of the UK ecpnpmy post-Brexit. There’s Putin’s invasion of Ukraine. There’s trouble in the Middle East. There’s the expanding trade war with China. There’s climate change. There’s dysfunction in Congress threatening a potentially hugely damaging US debt default. There’s the continuing rise in interest rates from pandemic-era lows–toughing 5% on the 10-year this morning (a level that would have been considered normal pre-2007, and which would imply a 20x multiple on S&P 500 earnings to be roughly neutral). In the US, there’s been a rash of book bans in school libraries (including one cited in Alabama because of the state’s objection to the author’s surname, Gay), prohibitions against teaching African-American studies and condemnation of drag artists.

And, of course, there’s former president Trump, who attempted to overthrow the government in order to keep himself in office after he lost the 2020 election. He is currently under indictment on 80+ felony counts in four criminal cases, but nevertheless is by far the leading candidate to run in the next presidential election under the banner of the party of Lincoln, Eisenhower and Reagan.

As an American, I’m particularly disturbed by the dystopian turn in the Republican party. The 80% ytd rise in the bitcoin price says I’m not alone (gold is only up by about 8%, which I read as showing its lack of contemporary relevance as a store of value in the developed world rather than a vote of confidence in the state of public policy).

What is an equity investor to do?

Two thoughts:

–for virtually all professional stock market investors, success is measured by achieving performance over and above the return on a benchmark index. The typical benchmark would be either the S&P 500 or one of the Russell “style” indices (meaning containing a tilt toward growth or value, or small cap). The most sensible approach during a time of deep uncertainty, in my view, as well as the standard way of playing defense, is to have a portfolio that looks/acts a lot like the index. For you and me, I think most of our money should look a lot like this most of the time

–the key to success as an active investor is definitely not to know a little bit about just about any topic. It’s way more important to know more than most people about one or two things (or if you’re lucky, three or four), which end up being the keys to portfolio construction. In more concrete terms, for me a reasonable strategy would be to have 90% of one’s equity money in an index fund and the rest in two or three names that you’d spend all of your stock market time researching. The more complex and confusing the environment–like today’s, the more tempting it is to lose focus. But the two essential question to ask, now and really any time, are: whether/how new developments affect the profit prospects for the active bets I’m making, and whether the ups and downs of the market are presenting an opportunity to upgrade my active holdings.

the peculiar Birkenstock (BIRK) IPO


About a week ago, BIRK went public by selling around 37 million shares at a price of $46 each. Despite an all-star list of underwriters, led by Goldman, JP Morgan and Morgan Stanley, the stock opened at $41, quickly peaked at $42.51 and fell throughout the day. The stock closed at $40.20 on volume of 15 million shares, and has drifted a bit lower since.

So buyers in the IPO are down about 10%, so far.

This bare-bones account is all I’ve seen in the financial press, leaving unanswered two obvious questions:

–how is it that the underwriters did such a bad pricing job for investor clients/unusually good job for the private equity seller? According to the prospectus, the latter group paid an average of $17.51 for its shares about two years ago. Easy to ask in hindsight, but what drove institutional investors to go along with this and agree to $46?

–what happened to the overallotment? The share sold by the underwriters break out as follows:

—10.2 million new shares being issued by BIRK

—21.5 million existing shares being sold by the private equity owners, and

—4.8 million overallotment shares.

In this case, the underwriters placed 36.5 million share with buyers, 4.8 million of which are the over-allotment. The underwriters have commitments from clients to buy the 4.8 million at the offering, but they don’t actually receive the shares from the issuer as trading opens. They only have a promise by the issuer to supply them at $46 each, if needed.

During the initial trading day, the underwriters aim to “stabilize” the stock price at or above the IPO level. They enter the market to absorb any selling at or below the offering price, intending to deliver the shares to IPO buyers, until they’ve reached the overallotment amount disclosed in the prospectus–in this case, the 4.8 million . If the issue is a rousing success, the underwriter does nothing and gets the extra shares to deliver to clients from the issuer. If it’s a bust, it absorbs some of the selling pressure by buying in the market–and delivers these shares to IPO buyers.

What’s unusual about this case is that there’s no clear evidence I can see that the underwriters did much to try to hold the stock at the offering price. Was there was a tsunami of selling on Tuesday morning by the same buyers who agreed to $46 on Monday night? or were short-sellers licking their chops at the thought of buyers’ significant misjudgment?

Nothing in the financial press that I could see, other than that the offering didn’t go as planned.

asking AI

…which told me, referencing Forbes and the Motley Fool (far from A+ sources, in my view), and without much more elaboration, that the offering price was too high and that there were more sellers than buyers.