July 3, 2008 | posted by Michael Baxter in Markets | comments (0) |

Down went the Dow Jones yesterday, falling to a level which is now 20 per cent below last October’s high.  Down went shares in GM, the world’s largest automobile manufacturer yesterday, with the share price falling to its lowest level since 1954.  Down went shares in Marks and Spencer yesterday, falling 25 per cent.  Down went shares in Taylor Wimpey, Britain’s largest builder, falling 45 per cent.

The falls follow recent sell-offs in Asia, which have seen the Chinese and Indian bubbles, apparently burst.

It was yet another day of carnage.

For Taylor Wimpey, the problem lies in its ability to raise money. It wants £½ billion. Yesterday, its plans were supposed to be announced.  But, when it asked its shareholders to look into their piggy banks to dish out more money, the piggy bank was empty.  

“However,” went a Taylor Wimpey statement, ”in light of current market conditions we have not been able to conclude a satisfactory transaction.”

So it’s off to the bank to tap them for some more money, while they look around for some more ideas.  “We think that we’ve got the time and options to complete the capital raising in the near future,” said Pete Redfern CEO at the company… “We don’t rule out any funding options,” he added.

The problem right now is this.  It is still profitable to build; house prices would need to fall an awful lot more before the price of homes is lower than the cost of building them.    The snag is the cost of land.  The builders have already bought the land, and perhaps paid over the top for it.  They could build and sell properties, and boost their cash flow, but that would play havoc with their balance sheets.    It would also mean a rise in supply, and that would prompt a full blown property market crash too.

The banks, presumably, are aware of this.  So they must, surely, give the likes of Taylor Wimpey all the support they ask for.  If they don’t, well, let’s put it this way.  If the UK’s builders went bust, some investors, sovereign wealth funds most likely, will buy the land on the cheap, and will start building, prices will fall to a level that makes buying attractive to first time buyers.  This will leave many bank’s customers with negative equity, meaning banks will find less of their loans are covered by securities, prompting further big write-downs, making them reluctant to lend.     You can see the downward spiral, that will follow.   The banks dare not let builders fail.

As for Marks, well, Stuart Rose set the alarms ringing when he talked of “stormy times ahead.”  As was told here yesterday, like-for-like sales at the retailer were down 5.3 per cent over the last three months, and analysts didn’t like the sound of that at all.    Shares fell 78p to 240p.

Incidentally, the Marks and Spencer share price is now less than a third of the price it hit during the first half of last year.

When Philip Green made his offer for Marks, he was wiling to fork out 400p, and initially he was willing to pay cash.  Sir Stuart has done a wonderful job for Marks, and maybe the brand is stronger today than it would have been under Green.  Maybe if Green really had forked out all that money, he would now be regretting it.  But, to be quite mercenary about it, right now it seems shareholders would have been better off selling.

There are no prizes for guessing the main reason why GM is doing so badly.   The high price of oil has hit auto sales in the US hard, and GM was far too slow to read the signs.    Far too slow to ditch the pick up trucks and SUVs and go for fuel economy.  GM, like the other two big US car makers, Ford and Chrysler, has its fair share of structural problems too of course.   There are pension commitments, and massive disagreements with trade unions who want to cling to the agreements made in happier days. 

But then yesterday, Merrill Lynch didn’t help much it when it put out a note saying the company may need to raise $15bn to shore up its balance sheet, or bankruptcy was “not impossible”.

Funnily enough, GM did better in June than analysts had expected.  Sales fell, but not as much as feared, and for once, Toyota saw even bigger falls.  Ford and Chrysler outdid it too.

But then, Toyota’s falling sales were in part due to a shortage of hybrid cars, so that’s fixable.  The ‘Detroit’ three, on the other hand, seem to be battling against the tide.

As for the Dow, it fell to 11,215, meaning over the last week it has lost nearly 600 points.  It is around 1,800 points down from the start-of-year position, and 2,948 points down from its all-time high set last October.     It is also 506 points below the pre-dotcom crash peak. 

But frankly, the real puzzle with the Dow is not so much why it has fallen so far, but why did it rise so high in the first place.     It was quite early in 2007 that Alan Greenspan warned of a one-in-three chance of a US recession, yet from the time he made that comment, the Dow just soared.

Last October, he said: “The world has gone mad. Everywhere you look you see valuations that suggest insanity has become endemic amongst the world’s traders. Whether it’s oil, property or shares, prices just seem to keep going through the roof. And, as every investor will tell you, what goes up must come down, so presumably it will all go pop.”

“Take the US. Of late,” we said, “the country’s biggest export seems to have become woe, and yet markets continue to flirt with all-time highs.”

Some people blame the media for the current crisis, saying the media has talked up the gloom.  That is not true.   The problem was lack of realism in the first place. 

April 2, 2008 | posted by Michael Baxter in Markets | comments (0) |

Something strange happened yesterday.   As you know, some economists are now drawing parallels with 1929, and predicting the worst slow-down since the 1930s.   Yesterday the Independent plastered the headline USA 2008: the Great Depression, all over its front page. Tuesday’s news was pretty grim, but what did the markets do?  They went out and celebrated, with the Dow surging by 391 points, for example. The index is now 914 points, or 8 per cent, up on the year-low set on March 10. But the rises were not just restricted to the US, indices across the world were up yesterday, and in the Far East this morning.

And as if to confirm the new mood of optimism, gold fell,  dropping below $900 an ounce, more than $100 lower than the records set in March.  

Why were the markets so jubilant?

The logic went like this.   The results revealed by UBS were so bad, that they can’t possibly get any worse. 

The feeling is that in attempting to come clean, and getting all the bad news out of the way, the bank had gone too far.     With its new management team – all of the senior directors who were at the helm before the credit crunch have gone – there was a sense that the bank was trying to wipe the slate clean, and in the process made bigger write-downs than was absolutely necessary, and that as result it would be, as it were, writing-up the write-down later this year. 

The Swiss bank also announced a $15bn rights issue – which had financiers chomping at the bit.    Once this fund-raising  is complete, they reasoned, UBS’s balance sheet will be strong enough to handle all kinds of woe.

But the markets had other reasons to celebrate too – Deutsche Bank also revealed $4 billion of write-downs in the quarter – and the markets loved that, with shares in the bank rising by 3 per cent.

As for Lehman Brothers, it successfully managed to raise $4bn in cash.  In fact the investment bank, which just last week was subject to rumours it could be going the way of Bear Stearns, initially planned to raise $3bn, but so great was the demand that it upped the scale of fund-raising.

Markets already knew big write-downs were on the cards, and were relieved to get so much bad news out of the way.  At the same time, they were impressed by the strength of demand for Lehman’s new shares.

But sentiment is the real factor that moves markets at times like this.  And over the last week or so, sentiment has been good.

Yesterday also saw the unveiling of the latest Purchasing Managers Index from the Institute of Supply Management.  The index rose ever so slightly over last month’s awful score.  Furthermore, it appears the main reason for the rise in the index was a change in the way the data that makes up the index is weighted.     According to Capital Economics, “If the old weighting system used up until the start of this year was still in place, the headline index would actually have dropped quite sharply.”

Markets weren’t bothered by that.  Spring was in the air, and traders were convinced they could smell the green shoots of a recovery.

Yet, the US housing market is still experiencing the biggest falls ever recorded – and inventory levels are now so high that even if there was a sudden and inexplicable surge in demand for housing, it seems prices would continue to fall for some time.      Bill Gross, the famous bond investor from Pimco, warned earlier this week that the new tighter regulations will reduce the level of lending that leading “US banks will be able to undertake,” and as result profitability will be lower in the longer-term.  Also this week, Morgan Stanley London-based analysts said that, “The industry is facing the most severe investment banking crisis in 30 years.”

There are no reasons to assume an economic recovery in the US any time soon – plenty of reasons to believe things will get worse.

It is true that the history of recessions and markets tells us that when an economic downturn is underway, markets tend to hit bottom and then start recovering while the economy is still getting worse.

True, it seems unlikely that the economic slowdown will be as bad as the 1930s – that is surely hype, but equally it seems the slow-down will be nasty. 

So far the markets have not adequately allowed for this.    At it’s lowest point this year, the Dow had fallen to around 17 per cent below last year’s all-time record.

If you believe economic conditions are set to worsen, than that fall was nowhere near far enough.  They say that in bear markets, stocks keep falling to levels where investors give up virtually all hope, only then do they start to rise. But, as yesterday’s rallies show, world markets are far from ready to give up hope.    Somehow it seems fitting that the markets chose April 1 for such backwards logic.  

March 3, 2008 | posted by Michael Baxter in Markets | comments (0) |

There’s a theory that you can’t make money from shares, because all the information that is available on a specific company is allowed for in its share price.

When a company is valued by the markets, this is what economic theory says happens: analysts work out the future dividend stream of that company, based on all information legally available, then from that expected future revenue stream, calculate a net current value by discounting future income against a rate of interest.

Not all analysts will agree on the correct current value, but as they trade with each other, a market price will be determined which is in effect an average of these different calculations.

So, why have faith in this market price? Well, consider the ‘guess the weight of the turkey’ competition at a fair. Some people’s guess might be too high, others, too low, but usually the average of those guesses is pretty much spot on. There has been a wealth of research to prove exactly that point.

So, apply that principle to the markets valuing a stock, then the share price determined by the markets must be just right. This has an important implication: if this theory is right, then, frankly, investing in shares is a mug’s game. There is no point.

There are many reasons why the theory is probably wrong. Here are two:

First you have the herd instinct. We saw during the days of the dotcom boom, traders were scared to go against the pack. In one of their quieter moments, at home perhaps, all alone, listening to their favourite album, then a trader may have feared shares had gone too high and were in for a fall.

But then, the next day, in the jungle of trading, the terrible truth would dawn. They would not dare go against the pack, for this simple reason. If they were wrong, and they sold while others profited, they would probably lose their job. If on the other hand, they bought when shares were too high, and then took a loss, well, at least everyone else was making the same mistake – their, job, for the short-term at least, would still be safe.

But perhaps there is an even-deeper force at work here.

It’s the bull and bear relationship. The history of economics tells us business suffers from periods of over-exuberance, followed by the complete opposite. The dotcom boom and crash is the perfect example, one moment shares were pushing beyond the stratosphere, the next, no one wanted to even hear the word dotcom.

Traders’ mood went from arch bull to arch bear, virtually overnight. The fundamentals had not changed, rather, there was a change in mood. In a boom market, people buy for no better reason than shares had risen the day before, therefore, they would probably go up the next day.

For the investor this is good news, because it means that if you take a longer-term view on things, sit back and look with cold eyes, you can ignore the ups and downs, and just focus on underlying value, and growth prospects. Your estimate of net current value may well be far more accurate than the market price.

Another example of why this is so, came last week, as markets rose on bad news, and then did a mini collapse, when reason dawned. The markets were irrational – completely, and for the investors whose feet are firmly on the ground, that means opportunity.

And to find out what happened last week, read the next article, below.

March 3, 2008 | posted by Michael Baxter in Markets | comments (0) |

Last week we just couldn’t believe it. The economic news coming out of the US was truly shocking – on Wednesday we headlined, “Is this meltdown for Uncle Sam?” after a stream of economic news painted a picture of real woe.

Yet, what did the markets do while all this bad news was being announced? Well, in the US in particular, instead of making for the nearest tall building, and then preparing to jump, traders went out and celebrated.

For economics news, last Tuesday was something of a black Tuesday – yet the Dow leapt up by over 100 points, and that was on top of a 189 point rise the day before. In fact, by the close of day on Tuesday, the Dow had risen by 400 points in just three working days.

And why were markets so gleeful? Their reasoning went like this. With news that bad, the Fed has got to lower the rate of interest. Three cheers for bad news, it means cheaper borrowing.

In reality, the US has a massive dilemma. Inflation is at 4.2 per cent. Producer price inflation, which can provide a guide to future consumer inflation hit its highest level since 1981 and, of course, the price of oil and wheat are at new all-time highs.

Yet, the Fed is cutting the rate of interest so fast, that its economic scissors must be getting blunt from overuse. US rates have fallen from 5.25 per cent, back in September last year, to just 3 per cent at the time of writing. And now many are predicting further falls to follow, with some saying rates could fall to 2.5 per cent.

This means that the real rate of interest, that’s the rate set by the Fed minus the rate of inflation, is currently minus 1.2 per cent.

On face value, that means it pays to borrow money. You just borrow as much as you can, and let inflation erode the true value of the debt. It also means there is no point in saving, you would be better off spending your money as quickly as it comes in.

In reality, it is not that simple, because interest rates set by the markets are not keeping up with the Fed’s moves. In fact, it’s tempting to say the Fed action is meaningless.

In reality, banks need to attract savers, because they need more money in their electronic vaults to be able to lend out.

So what does the Fed have to do? Before he was chairman of the Fed, Ben Bernanke once made waves when he said the solution to a credit crisis was to scatter money from a helicopter. This earned him the nickname of Helicopter Ben; over the last few months he has been living up to his nickname.

Not literally, of course, but, as an example, on Friday the Fed announced plans to auction another $60bn. The banks won’t lend to each other, so the Fed is lending to them instead. Ben has, in effect, climbed into the metaphorical helicopter and dished out money.

The curious thing though is this. When the economic news was dire, markets soared. Then on Friday, after the Fed announced its latest plan to dish out more money, precisely the kind of thing you would have thought markets wanted, the Dow went into something of a nosedive.

For on Friday, the Dow fell 315 points. Now, there was time a when a fall of 300 points would have been one of the main stories on the national news. Not any more, last year the Dow fell by 300 points or more in one day on no less than five occasions. And it suffered another big fall in January of this year.

Even so, Friday’s fall of 315 points was still pretty dramatic. The Index is now back to the level before the big rises seen at the beginning of last week and the end of the week before.

And if nothing else, it shows just how irrational the markets are.