Tag Archives: money

Ray Dirks, Kevin Chang and other stuff

October 7, 2013 By in Getting financial advice, hedge funds, How your broker gets paid, insider trading, sell-side analysts, Trading Tags: , , , , , , 1 Comment

a $30 million fine

According to the Wall Street Journal, Citi technology analyst Kevin Chang was fired last month.  Citi was fined $30 million by state regulators in Massachusetts for his leaking the contents of a research report to influential clients the day before it was published.  Other investigations are ongoing.

What happened?

The Journal, whose account appears to be taken from the Massachusetts consent order, says Mr. Chang found out from an Apple component supplier, Hon Hai Precision, that Apple had cut back orders–meaning, presumably, that sales of iPhones were running considerably below expectations. Chang wrote up his findings in a report that he submitted to Citi’s compliance/legal departments for review.

While his report was being processed, Chang was contacted by at least one hedge fund, SAC, which was looking for corroboration of similar conclusions drawn in an already released research report by Australian broker Macquarie.  Chang promptly emailed the guts of his report to four clients, SAC, T Rowe Price, Citadel and GLG.

The legal issue?   …selective disclosure of the research conclusions.

not the first time:  the Ray Dirks/Equity Funding case

Mr. Dirks was a famous sell-side insurance analyst back in the early 1970s.  In researching Equity Funding, a then-high flying stock, he discovered that the company’s apparently stellar growth was a fiction.  The firm had a bunch of employees whose job was to churn out phony insurance applications for made-up people, which EF then processed and showed “profits” for, just as if they were real.

When he found the fraud out, Dirks immediately called all his important clients and told them.  They sold.  Only then did Dirks inform the SEC.

Rather than being grateful for his news, the SEC found Dirks guilty of trading on inside information and barred him from the securities industry–a verdict that was reversed years later by the Supreme Court.

two observations

1.  Why put important clients first, even at the risk of career-ending regulatory action?  After all, many sell-side analysts take home multi-million dollar paychecks.

Their actions show who the analysts perceive their real employers are.  Ultimately, they collect the big bucks because powerful clients continue to send large amounts of trading commissions to pay for access to their research.  If that commission flow begins to shrink, so too does the size of the analyst’s pay.

Also, an analyst’s ability to move to another firm rests in large measure on whether these same clients will vouch for him–and will increase their commission business with the new employer.

2.  What happens to people like Dirks and Chang?

Dirks was eventually exonerated.  While he was appealing the SEC judgment, his thoughts on insurance companies continued to be circulated in the investment community.  Only they appeared under the byline of a rookie apprentice to Dirks–Jim Chanos.

Dirks eventually established his own research firm.  Interestingly, when I Googled him this morning, I found that the top search results were all basically rehashes of the favorable information put out by Ray Dirks Research itself.  No one remembers the real story.

Chang?  I don’t know.  He lives in Taiwan, where I suspect he will catch on with a local brokerage firm or investment manager.  As far as Americans are concerned, disgraced analysts or portfolio managers tend to end up in the media.  For example, Henry Blodget, who wrote all those laudatory “research” reports for Merrill touting internet stocks he actually believed were clunkers, now works for Yahoo Finance.  You can watch similar characters every day on finance TV.  Crooked, maybe.  But they’re articulate and look presentable.  And that’s all that matters.

 

 

J C Penney (JCP) issues stock

September 27, 2013 By in Current Market Thoughts, hedge funds, Stock ideas Tags: , , , , , , , , 2 Comments

the JCP offering

JCP filed a preliminary prospectus with the SEC indicating it is selling 84 million shares of common stock to the public at $9.52 a share through Goldman Sachs.  (In a typical provision of any offering called the “overallotment,” Goldman has permission to sell another 12.8 million shares if it can.)

Let’s say Goldman gets a commission of $.22 a share.  That would mean proceeds to JCP of $781 million – $900 million.

business stabilizing

Just in advance of the red herring, JCP filed an 8-K in which it said it expected comparable store sales to be positive during both 3Q13 and 4Q13.  The reason?  …merchandise that JCP customers want to buy is now in stock, and in the sizes that JCP customers fit.

three aspects of the offering

I hadn’t intended to write so much about JCP, but I think there are three interesting aspects to the offering.

1.  the size

This is a big offering, amounting to over a third of the shares already outstanding.

2.  why a stock offering?

For companies like JCP that want to raise a lot of capital, their first thought is to borrow.  It’s easier to do.  Transaction costs are lower.  Also, Americans firmly believe that debt is a lower-cost form of capital than debt, so borrowing is more beneficial for shareholders.

There comes a point, however, when lenders perceive the capital structure of a firm has become too lopsided.  When that happens, they will refuse to lend any more until the firm demonstrates Wall Street’s confidence in it by raising equity capital.

I assume we’re at that point for JCP.

why not six weeks ago?

After all, the sales projections JCP made in the 8-K are better, I think, than Wall Street had been assuming.  So it’s unlikely that JCP’s need for cash is greater now than it was a few weeks ago.

It’s also hard to think that a big company like JCP would not do continuous financial forecasting of its future cash flows that would indicate when it would need fresh funds, and in what amounts.

I don’t know the answer.

One obvious difference between now and the end of August, however, is that in the meantime two insiders, Pershing Square and Vornado, have unloaded their entire stakes, 52 million shares (!!), at a reported price of about $13 each.  That’s 36% higher than JCP itself is getting today.

I guess you might argue that everyone knew the two activists would be selling, and that this overhang would be enough to scupper a potential offering by JCP.  Seems pretty lame, though.

Me, I’m nonplussed (the first time I’ve used that word in my life).  If I were a JCP shareholder, I’d be stunned.  Maybe we just chalk this up as one of the perils of riding the coattails of latter-day robber barons.  But if I were a shareholder, I’d want to know how the board allowed this to happen.

On September 20th, JCP’s controller left the company.  Is this connected?

rumors, stories and “hot tips” on Wall Street

July 2, 2013 By in Constructing a Portfolio, market rumors Tags: , , , , , , Leave a comment

I spent about half of my time during my professional career studying Wall Street and most of the rest looking at foreign, mostly Pacific Basin, stock markets.  In both arenas, you’d invariably hear a ton of gossip, stories, rumors that purported to contain information bearing on publicly traded companies.  But what to make of them?

As I gained experience in foreign markets, I began to realize that a good percentage of the rumors and stories I heard turned out to be true.  Of course, by the time they came to me they typically suffered from the effects of oral transmission of any message through several parties–the truth was all jumbled up.  Company X might not want to buy a smaller rival; it might want to sell a division to the competitor.  Earnings might not be surprisingly good; they might be unbelievably awful.

Yes, there was chaff.  But my picture was that in countries where the financial press isn’t well-developed and where analysts and portfolio managers would, in baseball terms, generally be regarded as low minor leaguers, the companies themselves would start the rumors.  They’d grab an analyst by the lapels and yell the information they wanted investors to know into his ears, hoping some of it would stick.  Sometimes it did.

The US is a different case.  In my experience, market rumors are virtually always deliberately deceptive.  And they’re spawned by someone who aims to gain a financial advantage from having them publicized and believed.  Listening to them isn’t necessarily harmful.  Acting on them invariably leads to heartache and financial loss.

I’m writing this because one of the more interesting stories floated in the US recently is that Microsoft was about to buy the Nook division of Barnes and Noble.  Publication of the report immediately shot BKS stock up by almost 30%.   Then the company reported earnings–and announced that it’s basically closing up shop with the Nook.  The stock dropped back to below the price it had been before the rumor came out.

Where did this rumor come from?

The newspapers said it originated from Microsoft itself.  An owner of BKS stock who wanted to sell?  …a disgruntled employee?  …a manager who was horrified that Steve Ballmer was on the acquisition trail again and hoped to embarrass him into not making an offer for Nook?   …some other bizarre facet of office politics?  Any of these is plausible.  But the most important point is that, like almost every other US rumor, no matter how detailed or plausible-sounding, this one turned out to be false.

how much farther do US interest rates have to rise?

June 24, 2013 By in bond market, Current Market Thoughts, Portfolio management, Recent Market Action, securities markets, stock market, Strategy Tags: , , , , , , , Leave a comment

how much higher will rates go?

It seems to me to be hard to deny that the process of normalizing (read: raising) interest rates in the US from their emergency-low levels has begun.  The 10-year Treasury bond–the security that has the most influence over the determination of the stock market PE ratio–was yielding 1.72% in early April.  Last Friday the yield was 2.52%, a rise of 80 basis points.  The 30-year has moved up by 77 basis points over the same time span–from a yield of 2.88% to 3.65%.

Fed plans

If we look at the price of overnight money (the Fed Funds rate), which is the usual tool the Fed uses to influence interest rates, it’s still at effectively zero. This rate is completely under the Fed’s control.  The Fed says “normal” is 4% or so, and that it won’t make any move away from zero until the unemployment rate is below 7%.

The Fed has also been trying to push down longer-term interest rates, particularly the rate for mortgages, through unconventional means–buying tons of these securities in the open market.  The Fed has recently hinted that, although it will continue to do so, it may begin to purchase less than the current $85 billion a month as the economy shows further strength.  This could happen as soon as the fall.  That’s why the yields on the 10-year and the 30-year have been rising.

What’s normal for them?

three simple guideposts

1.  Look back to mid-2007, when the financial crisis was just beginning to unfold and see what rates were then.

The 10-year was yielding 5.03% at the end of June 2007; the 30-year was yielding 5.12%.

To get back to those levels, the 10-year would have to rise by another 250 basis points, the 30-year by 150 bp.

2.  Take the rule of thumb that the 10-year should provide inflation protection plus a 3% real yield.  The Fed’s inflation target is 2%, implying that in a normal economy the 10-year would yield around 5%.

3.  The Fed is going to eventually raise the rate on overnight money by 4%.  Longer-term rates will rise by less, because they fell by less when the Fed Funds rate was going down.

complicating factors…

Inflation is currently significantly below 2%, implying maybe a 4.5% 10-year yield.

Chinese buying has arguably depressed Treasury yields over the past decade or so.  Will that continue? (My answer:  probably not.)

As the Baby Boom ages, it becomes more income oriented.  That may keep rates lower.

…which may end up cancelling one another out

My experience is that the simplest models are most often the most accurate ones.  In addition, whether the ultimate 10-year yield is 4.0% (unlikely, in my view) or 4.5% or 5.0% doesn’t matter at this point.  There’s still a long way to go.

my take

I think the bond market has taken a surprisingly strong first step toward interest rate normalization.

Looking at the stock market PE, it seems to me that equities are already priced for a world where the 10-year is yielding 5%+–and have been for the past several years.

As for my portfolio, I’m waiting to see signs that the stock market is stabilizing so I can buy stocks that have been excessively pummeled during the current slide.

shifting Federal Reserve priorities

June 19, 2013 By in Current Market Thoughts, economics Tags: , , , , , , , , , Leave a comment

long-term unemployed

For some time the Fed has made it clear that its number one priority has been the economic well-being of the millions of workers laid off during the Great Recession who have yet to find work again.  The Fed’s worry is that the longer this group stays unemployed the greater the chances it will morph into a permanent underclass of the type Europe has long had.

Recently, the Fed has been increasingly vocal about the fact that monetary policy can do little for these incipient lost economic souls.  Their rescue is really a job for fiscal policy that promotes job creation–say, reform of the tax code or infrastructure spending–sound advice that is falling on deaf Congressional and White House ears.

shifting gears

The Fed’s priorities appear to be changing, however.  It’s primary focus is shifting to preparing financial markets for a long journey away from today’s emergency-low interest rates to more normal (that is, higher) ones.  The agency is doing this in its usual indirect way.  It has been so long since investors have had to contemplate a higher cost of money, however, that many may not understand the ritual dance that is now beginning.

Fed signals

So far, the signaling has included:

–remarks by outgoing Fed Chairman, Ben Bernanke,

–discussion by other ranking Fed officials,

–mention in Fed meeting notes,

–hints dropped to favored reporters and columnists.  Their identities as conduits for Fed information are well-known to Fed watchers, who immediately understand the true source of the reporters’ statements.

its purpose

The idea is to get the markets to start to move by themselves in the direction the Fed wants.  That way Fed interest rate hikes seem to be only validating positions the markets are already taking, something the Fed prefers.

Two factors make this process more daunting than usual:

–bond investors have been conditioned for over three decades to think that interest rates only go down,

–in the Fed’s view, overnight money has to rise by more that 400 basis points to get back to “normal,” a huge move that will likely take place over several years.

The real trick will be to prevent bond market from rushing ahead and making the entire move in one leap once investors figure out what’s going on.  It seems to me that this is the purpose of the apparent Fed “confusion.”  It’s deliberate–and it’s intention is to get the interest rate train rolling without gathering too much of a head of steam.