Category Archives: bond market

capital raising by Tesla (TSLA)

August 17, 2015 By in Autos, battery power, bond market, securities markets, Stock ideas, stock market, Technology Tags: , , , , , , Leave a comment

the offering

Last Friday, TSLA filed a final prospectus with the SEC, indicating that it is selling up to 3.099 million new shares of common stock (including underwriters’ over-allotment) at $242 a share.   This will net the company close to three-quarters of a billion dollars, which it needs to fund ambitious expansion plans–the Gigafactory to make batteries the chief among them.

I presume the precipitous decline of TSLA shares over the past ten days or so was triggered by underwriters soliciting indications of interest in this offering from hedge funds and other institutional investors.  Two bullish signs:  the offering was initially pitched as being 2.1 million shares, but raised to 2.7 million on Friday (not counting the underwriters’ allotment, which will have been bumped up as well).  As I’m writing this prior to Monday’s open, TSLA shares are trading at around $255 each.

my thoughts, (somewhat) randomly presented

  1.  TSLA made what I consider a firm-transforming offering of $3 billion in convertible bonds (at a conversion price of $350 (!!!) a share) last year.  This says something about how professional fixed income investors feel about the attractiveness of straight bonds.  More important for TSLA, the successful offering took talk of building the Gigafactory out of the realm of fantasy and placed it solidly into reality.
  2. The automobile world has changed significantly over the past year, with the plunge in oil prices and the rise of ride-sharing services like Uber.  The former may mess up the economics of electic vehicles; the latter calls into question the highly operationally leveraged corporate structure of traditional car companies (translation into English:  if they need to run at, say, 80% of plant capacity to break even, will that be possible if Millennials en masse use Uber instead of buying a car themselves.  Will the car industry be a replay of the current commodities debacle).
  3. My guess is that these shifts: (i) increase TSLA’s attractiveness to stock market investors vs. conventional car companies, and (ii) make Teslas relatively more attractive abroad, where petroleum products are more expensive than in the US.
  4. It seemed clear to me from the outset that the 2014 bond offering didn’t totally solve TSLA’s need for capital.  Another offering had to happen in 2015.  I’d expected more bonds.  Why stock instead?  Market etiquette says that a new offering should be at a higher price–here meaning a higher conversion price–than previous ones (otherwise last year’s buyers look like idiots).  Also, potential lenders periodically want companies to prove that they still have enthusiastic equity backers.  This is a combination of lenders not wanting financial leverage to be too high, their not wanting to be the only ones holding the bag if things go sour, and their knowledge that bonds are going to be under pressure as interest rates begin to rise.
  5. Last year’s offering signaled a near-term top for TSLA shares.   My instinct is to think that this offering establishes a near-term bottom.  I own a small position in the stock, however, so I may have an interest in thinking this is the case.

 

selling: different styles

August 10, 2015 By in bond market, Current Market Thoughts, from growth to value: the life cycle, growth vs value, securities markets, stock market Tags: , , , , , , Leave a comment

I’ve been thinking some more about what I wrote last week about selling in Disney(DIS) stock.  The thrust of my reaction to the sharp decline was, and still is, mild bemusement that selling only emerged as the company reported weak results from ESPN.  It’s not that disappointing earnings should not generate selling.  It’s that the handwriting had been on the wall about ESPN–and in vividly hued bold print–for some time before DIS’s 2Q15 earnings report.

Why no stock weakness earlier?  This would have been my strong expectation. I’m not talking about the results somehow being leaked to outsiders by the company.  Rather, I’d have thought that the market would have put two and two together and acted weeks or months ago on publicly available information about the cable industry–like Nielson reporting of subscriber losses at ESPN.

My conclusion was that the sharp fall in DIS shares on its earnings report might be evidence that Wall Street just didn’t know there were problems at ESPN, despite what I consider clear signals of trouble being visible for a considerable time.

I still think it is generally true that the stock market is becoming less efficient–and more like I perceive the bond market to have been throughout my time as an investor.

I’m no longer sure that DIS is evidence for my thesis, though.  Here’s why:

The key to successful investing in growth stocks is being able to sell them at the right time, meaning exiting as the firm is going ex-growth and before the rest of the world realizes this.

To me, the key signal is the breakdown of the conceptual “elevator speech” explanation of what gives the company in question its extraordinary growth potential.  In my experience, if we’re waiting for the first disappointing earnings report, we’re almost always hanging on too long.

The presupposition here is that the potential upside from my exit point is (far) less than the downside from being a holder of the stock when the disappointing earnings are released.  This assumes, of course, that I can recognize the point at which all the possible future good news–and maybe more than that–is already factored into the stock price.

My approach didn’t work so well for me in the case of DIS, where I failed to anticipate the fabulous success the company has had in its non-Marvel, non-Pixar movie business.

There is a second approach to growth stocks.  It argues that a well-managed company normally has more earnings growth tricks up its sleeve than any outsider is able to understand.  Therefore, it’s always too risky to sell when the conceptual story begins to unravel.  Better to wait for actual proof to come in through bad earnings.  Yes, one might lose 10% by selling after the bad report.  But that’s better than exiting at 40% below the stock’s peak.

In fact, I took this second approach myself, early in my investing career.

The difference in my thinking from last week and now:  my first thought was that information is not circulating on Wall Street as fast as it used to; my second thought is that investors may have the same information as always but they’re just using it differently.

Practical implications?  …they may be substantial.  My conclusion is still to look for more evidence.  My tendency is going to be to hang onto growth stocks for a bit longer than I might otherwise, though, figuring that others are going to do the same thing.   So the cost of waiting to find out if there’s another growth spurt left in a maturing company may be lower than it has been in the past. And I may no longer be committing the cardinal investment sin of underestimating the information the other guy has.

bracing for higher interest rates

August 5, 2015 By in bond market, Constructing a Portfolio, Current Market Thoughts, Portfolio management, securities markets, stock market, Strategy Tags: , , , , , , , Leave a comment

Long-time readers may remember that in an embarrassingly premature fashion, I began writing about the upward path away from non-crisis interest rates toward normal several years ago.  It looks like liftoff day has finally come, however.

The consensus expectation, informed by judicious leaks by the Fed, is now that the Fed Funds rate will rise by .25% next month, and by another .25% before yearend–meaning short rates will exit 2015 at .50%.  A highly stylized view of the Fed’s intentions is that it will continue to raise rates at the same 1/4% clip at every second Fed meeting next year–meaning another 1.0% increase during 2016.  The goal of rate normalization is an endpoint for Fed Funds of around 3% (but probably lower).

This is a potentially important change of direction for two reasons:  rates have been at emergency lows for an extraordinarily long time, and the thirty-five year war against inflation has been long since won.  The secular trend of ever lower nominal interest rates–for many financial market participants, the only trend they have ever seen in their working lives–is over.  Barring another world financial disaster, nominal rates may be higher in the future, but there’s no chance they’ll ever be lower.  So the thought habits of a lifetime are about to be shaken up.

What does this mean for stocks?

Past tightening cycles have been bad for bonds, but stocks have been flat to up.  The generally accepted explanation for the latter phenomenon is that the negative effect of higher rates is offset by robust profit growth.  Said another way, positive earnings surprises (more than) offset the negative effect of price earnings multiple contraction.

Personally, I think this explanation is the right one.

Critics of the applicability of the idea to the present situation point out that this time rates will be rising long after the business cycle has turned.  Therefore, they argue, the chances of a surprisingly large corporate profit surge are slim.  In consequence, the “normal” protection for stocks against Fed tightening is absent.

Four thoughts:

–the reason rates are still at 0% is that the “normal” cyclical profit surge hasn’t happened yet.  Maybe surge isn’t the right word for today’s situation, but world economies certainly aren’t firing on all cylinders yet.

–profit rises and Fed tightening aren’t independent events.  The Fed has made it clear that it intends to tighten only to the extent that economic strength allows.  The agency has often referred to the repeated disastrous mistakes Japan has made over the past quarter-century by tightening too soon.  If profit growth doesn’t permit, tightening will go more slowly than many expect.

–for the S&P 500, half the index’s profits come from abroad.  The EU (25% of profits) will likely be stronger next year than this; China may be, too.

–where else will money go?  Certainly not into bonds.  Cash is the only safe haven.  It’s possible there will be a large outflow of money from stocks into cash.  I don’t think so.  That’s partly (mostly?) because I like stocks.  More substantively, institutional investors may shade their portfolios a bit toward cash, but their large size means they can’t maneuver quickly, so the risk to them of betting against stocks in a major way and being wrong is enormous.  In addition, my sense is that a defining feature of the bull market that began in 2009 is the lack of retail participation.  If so, retail has already bet heavily–and incorrectly–against stocks.

A final point:

–yielding 0%, cash isn’t an attractive alternative to me at.  However, given that the period of zero interest rates is coming to an end, I’ve got to ask myself at what level would it be?

If we assume that inflation will be steady at 2%, I would find 3% cash and a 4%+ long bond very attractive.  That may be evidence that we’ll never get there.

Still, what I’m trying to get at is that there will come a point in the tightening cycle where even an equity fan like me will have to reallocate toward fixed income.  We’re nowhere near that now, in my opinion.  But I think this, not the start of tightening, will be the real showstopper for stocks.  This is not an idea to act on, but it is one I think we should keep in the back of our minds.

valuing the S&P 500

July 15, 2015 By in bond market, Current Market Thoughts, securities markets, stock market Tags: , , , , , , 2 Comments

Le’s start with the premise that, according to market authority FactSet, the PE on the S&P 500 based on current earnings is just above 16.

Investors (maybe we should read “me”) tend to value the S&P 500 in three different ways:

1.  relative to bonds, which is the second main class of liquid investments open to us as individuals.  Cash is the third and final asset, but can be ignored for the moment since the income from cash–its main attraction–is effectively zero.

The way people usually do the comparison is to take the earnings yield (1 divided by the market PE) on stocks and compare it with the interest yield on government bonds.   The latter is currently around 3%, which would imply a PE on the market of 33+.  We know, however, that we are at an emergency-low level of rates and that the Fed intends to lead long rates back to 4%+.

Nevertheless, bond yields would have to get to 6%+ before they would tempt investors away from stocks, at least according to my rule.

My conclusion:  bonds are, and will remain for some time, dangerously overvalued.  In any event, they don’t seem to be a realistic threat to stocks.

2.  the rule of 20.  This is a seat-of-the-pants empirical generalization about the US stock market.  It says that the sum of the current market PE + inflation should not exceed 20.

We can look at this rule in two ways.  We could argue that the market is fairly valued since the PE on the S&P is 16+ and inflation is 2%+, which equals 18+, or maybe 19.

We might also say that inflation has to get to around 4%–hard to conceive in today’s world–before it becomes a threat to stock market valuations.

Either way, this rule says stocks are fairly valued now.

3.  earnings growth.  Here the rule is pretty vague.  There are two ideas:

–what moves the needle for the S&P is earnings growth.  Say a 10% rise in the S&P indexduring a given year is only justified by a 10% increase in S&P earnings, and (an idea from more inflationary times)

–that the PE and the rate of earnings growth should be at least in the same ballpark.

At the moment the earnings of the S&P aren’t growing–they’re falling.  That’s due almost completely to the drop in oil prices which has cut eps for petroleum companies in half.   That’s currently clipping about 4.5% from the S&P earnings total.  The stronger dollar is another drag, this because of the lower dollar value of earnings and assets that US multinationals have in the EU.

The earnings rule would seem to isay that the lack of earnings growth for the S&P this year would at the very least mean no advance for the index.

If, however , that what I believe–that we’ve already seen the lows for oil and the highs for the dollar–is true, both oil and the dollar are only temporary depressants to earnings.  Once we get six or nine months out, year on year comparisons will be against year-ago earnings already affected by the higher dollar and lower oil.

If this is correct, the real earnings growth question isn’t how eps will play out this quarter or next.  It’s who is there who hasn’t already factored both a higher dollar and lower oil into his calculations already.  My answer:  basically nobody, although admittedly there is inevitably some tiny fraction of people who never get the word.

 

Tomorrow.  the strangeness of 2015 to date.

Greece in a nutshell

July 3, 2015 By in bond market, currency markets, EU financial crisis, Greece Tags: , , , , , , , 2 Comments

Greece joined the euro in 2001.  This gave it the right to print/mint euro currency, as well as to issue Greek sovereign debt in euros.  The second is important because issuing euro debt is like having access to a giant EU credit card–payment was at least implicitly guaranteed by every member of the EU, not just Greece.

Greece probably didn’t meet the criteria of economic health necessary to qualify to join the euro. Everyone in the EU seems to have known this at the time but thought that having the cradle of Western intellectual and political history in the euro was symbolically important.

In 2009, the ruling party lost an election.  The new administration discovered, and announced to the world, that Greece had been systematically falsifying its national accounts–official reports of the country’s fiscal health and growth–for years.  Greece’s apparent prosperity during the opening years of the 21st century turned out to be a combination of lies and living beyond its means, funded by large-scale euro bond issuance.  Most observers agree that Greece run up more debt that it can ever possibly repay.

Negotiations between Greece and its creditors are at an impasse.  Broadly speaking, the EU and IMF want to see structural economic reforms (which may prevent a repeat of the country’s woes) in Greece before any debt forgiveness.  Greece, whose current government has already reversed some of the few reforms implemented over the past six years, wants debt forgiveness first, talks about structural reform later.

The EU put a take-it-or-leave-it offer on the table about a week ago.  The Greek government has decided to call for a national referendum vote on the issue, scheduled for Sunday.  In the meantime, it has shut down its banks, so no one can take their money out of the country.

There are some odd technical issues with the referendum.  For example, one political party is suing to stop the vote, saying it’s unconstitutional.  It’s also coming at the start of vacation season, so it’s not clear whether people can get home to vote, especially with atm withdrawals limited to €60 a day.

Domestic Greek polls indicate that likely voters favor accepting an EU bailout plan by 52/48–even though the administration is campaigning against it.  A “No” vote probably means Greece leaves the euro, and maybe the EU as well.

I have mixed feelings about the negotiations themselves.  On one hand, I’ve got to admire the ingenuity and determination of the Greek side in trying to get the best possible deal.  On the other, everything I’ve I’ve read and heard to make me think Greece regards negotiation as a blood sport.  The point is not to get a fair deal, but to suck the other side dry and toss the husk to the side of the road.  –even a little bit–about the needs of the other side.  It’s turned the negotiations into a fool me once, fool me twice situation, in my view.

I think the current Greek administration may have done a huge amount of damage to the country’s long-term economic prospects by trying so hard.to wriggle out from responsibility for the current crisis.

Ironically, the better outcome for the EU might be for Greece to vote to leave the euro.  The resulting damage to the Greek economy will be enormous, I think.  Seeing what happens will likely silence separatist movements elsewhere in the EU.