Reversion to the Mean - Capital Markets - CFO.com

Wow. I did not see this one coming. It is from the Economist and reported on CFO.com but is research by Deutsche Bank.

For the past 25 year Treasury Bonds have outperformed equities, even BEFORE this recent market collapse.

Reversion to the Mean - Capital Markets - CFO.com:

"...over the last 25 years. As the graph shows, Treasury bonds have actually outperformed riskier asset classes over the last quarter century. That is despite the long equity bull-market from 1982 to 2000....

Asset classes can go through long periods when they underperform, leaving them cheap and ripe for revaluation. That happened to Treasury bonds, which suffered four consecutive decades of negative real returns from the 1940s through the 1970s....It was one of the great historical buying opportunities.....Since 1900, the average annual return from Treasuries has been 4.6%, or 1.5% after allowing for inflation. In contrast, American equities have delivered 9.3%, or 6% in real terms.

The current poor performance of stock markets reflects, of course, a reversion to the mean after the excesses seen during the dotcom bubble, when the rolling 25-year annual return of US equities reached a remarkable 16%. On a 10-year basis, the return from equities has now slumped to minus 3.5% in real terms."

If my self-evaluation and stuff for the assessment group can wait a bit longer, I might have to check the data on this for myself. I can see a few years, but 25? Wow.

UVA: Sorry, Alumni, We Gambled Our Endowment And Lost

Few things are more humbling than the stock market (and maybe a speed workout on a quarter mile track). Case in point: many of the big time universities with Billions in their endowments (I always wonder why people give more to those that already have so much, but I digress) have seen much of their wealth evaporate.

From Clusterstock: UVA: Sorry, Alumni, We Gambled Our Endowment And Lost:

"...university endowments have been clobbered in the past three months, especially the ones that were trying to 'be like Yale.' (Overweight private-equity, hedge funds, commodities, and real-estate; underweight cash and bonds). The situation is so bad that some funds are resorting to fire sales"

Depending on your ilk, this story could be used to discuss Market Efficiency (even "smart money" loses), Behavioral finance (herding behavior), asset allocation, asset liquidity, private equity investments, and the limits of diversification.

BTW: I confess I had not read much from ClusterStock before today, but have been very impressed. Several very interesting articles. Check it out!

Bailout just keeps getting bigger and bigger

The government bailout continues to grow with seemingly no end in sight. First AIG gets both more money and more lenient terms.

A.I.G. Rescue Grows to Billion - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times:

"The Bush administration revised its rescue of the American International Group, raising the total amount to $150 billion, amid signs that the interest on its current credit line of more than $100 billion was putting too much strain on the ailing insurer.

The Treasury Department and the Federal Reserve said early Monday that they are abandoning the initial bailout plan and invest another $40 billion in the company. The government created an $85 billion emergency credit line in September to keep A.I.G. from toppling and added $38 billion more in early October when it became clear that the original amount was not enough."

It was a few week's ago when the shortfall became apparent and the question remains where does this all stop? And while it is easy to throw around numbers that start with a B, let's put this in perspective, that is approximately $500 for every US resident.

In addition to the more money, AIG was also granted more lenient terms. From the Treasury's press statement:

"The existing FRBNY credit facility will be revised to reflect, among other things, the following: (a) the total commitment following the issuance of the perpetual preferred shares will be $60 billion; (b) the interest rate will be reduced to LIBOR plus 3.0% per annum from the current rate of LIBOR plus 8.5% per annum; (c) the fee on undrawn commitments will be reduced to 0.75% from the current fee of 8.5%; and (d) the term of the loan will be extended from two to five years."

The extension is designed to "give AIG time to complete its planned asset sales in an orderly manner. Proceeds from these asset sales will be used to repay the credit facility." So we all have a vested interest in the sale going well, but any guesses what happens in the meantime? More investment?

Oh and lest you think we have seen the end of this (once the precedent is started it is very hard to stop), the WSJ reports that the new administration has signaled its intent to help the US auto industry. So get in line!

BTW the NY Times also gave a fast look around at what others were saying on this front. One look-in:

"Joe Weisenthal, writing on the Clusterstock blog, suggested that the “whole thing is being spun to make it sound like something other than just throwing more money onto the fire.”"

Steve Horan on mutual fund fees

Steve Horan used to be a colleague at SBU and is still a friend, so when I heard he was on CNBC (even if only via a call-in) I was positive I was going to link to it.

So here is the video of his discussion on mutual fund fees from CNBC.com

3 'superbanks' now dominate industry - Economy in Turmoil- msnbc.com

In an article that quotes many financeprofessors, MSNBC looks at some of the controversy of making the strong stronger. A must must read for any money and banking class!

3 'superbanks' now dominate industry - Economy in Turmoil- msnbc.com:

Some visual bites:

“Large institutions are impossible to manage prudently, let alone regulate,” says Amar Bhide, a professor at the Columbia Business School.

In fact, existing federal banking laws say that no bank can have more than 10 percent of the domestic deposit market — a threshold recently surpassed by all three superbanks.

When asked whether the government would take any action, a Justice Department official was noncommittal."

Now in fairness this consolidation had started LONG before the current crisis. For instance

"...the number of commercial banks and savings & loans in the United States has fallen in the past 20 years to 8,451 as of June, compared to 16,574 in 1988, according to FDIC data."

and as the article points out, this may be the lesser of two evils:

"Gregory F. Udell, Chase Chair of Banking and Finance at the Indiana University Kelley School of Business.

The risk of creating monopolies, he says, “is a lot less than the risk of having a lot of zombie institutions out there.”"

On the monopoly issue, one thing not mentioned is the idea that due to technology, small banks can at least provide the threat of competition.

Treacherous Sands For Adelson - Forbes.com

It is rare to find a better example of ratios and bond covenants than in this piece from Forbes.

Treacherous Sands For Adelson - Forbes.com:

"Las Vegas Sands said in a regulatory filing that it doesn't expect to comply with its maximum leverage ratio covenant in the fourth quarter. That would trigger defaults that might force it to suspend multibillion-dollar development projects in the U.S. and Asia and 'raise a substantial doubt about the company's ability to continue as a going concern,' it said.

The question that needs to be answered is how much of that capital Adelson himself is willing and able to provide. Adelson, whose personal wealth is largely tied to his stake in Sands, has taken a painful haircut as his company's stock price has dropped 93.0% over the past year. .....if it defaults on its loans, lenders would be able to exercise their rights under the agreements, including bringing financing maturity dates forward."

and later in the article another great teaching point that casino and travel spending is from disposable income and hence more volatile:

"...the casino business has been struggling as consumers continue to curb spending due to the U.S. housing downturn, diminishing credit, rising food costs and recession worries. Sagging U.S. consumer confidence and spending power has hurt business in Las Vegas, "

Black Swans and recent returns

Yahoo video of Nissan Taleb (Black Swan)

Yahoo has a copy of the video from CNBC on Taleb's performance of late. It also has a discussion of his holdings and strategy. Short version: it is VERY good!

Remember his Black Swan book is recommended reading for all my classes! (here are some other videos of Taleb)

Wall Street’s Pay Is Expected to Plummet - NYTimes.com

A follow-up on last month's bonus discussion.

Wall Street’s Pay Is Expected to Plummet - NYTimes.com:

"Bonuses, which soared to record heights in recent years, could drop by 20 to 35 percent across the industry, according to a private study to be released on Thursday. Bonuses for top executives could plunge by 70 percent.

But to some, those figures, from the consulting firm Johnson Associates, demand the question: Why should Wall Street executives get any bonuses at all?....

and later

“Given this economic situation, how do you justify any performance bonus at all, is my initial point,” Mr. Cuomo said.

Bankers and traders have been rewarded for taking risks that Wall Street clearly failed to manage. “When you incentivize that type of behavior, you shouldn’t be surprised when you find very risky, overly creative, short-term, highly leveraged products,” he said."

Naked Short Selling Is Said to Decline - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times

To quote Paul Harvey, "Not why nor how.... "

Naked Short Selling Is Said to Decline - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times:

"According to data from three exchanges — including publicly available figures from the Nasdaq stock market — the number of stocks on the naked short-selling watch lists has fallen dramatically. The Nasdaq, for example, has just 56 stocks on its list, down from about 500 in September....Naked short selling, long a controversial practice, is a variant on short selling, which is legal. That involves borrowing stocks and selling them, hoping to buy them back at a lower price and profiting from the shares prices’ decline. In naked shorting, however, the investor doesn’t borrow the shares first."

not sure if the SEC crackdown or the falling prices and increased volatility was the cause.

FWIW this is included because it came up in conversation in class yesterday.

At the Supermarket Checkout, Frugality Trumps Brand Loyalty - WSJ.com

While many of you outside of SBU know I run BonaResponds, not nearly as many know I help out with my family grocery stores as well. In class we have mentioned several times that one way sales will decline as a result of the recession (and hence worsening it as well) is that customers will switch from more expensive items to cheaper store brand products. This trend has been noticeable at our four stores and now the WSJ provides more evidence of the same thing.

At the Supermarket Checkout, Frugality Trumps Brand Loyalty - WSJ.com:

"Sales of private-label detergent rose 12% over the 52-weeks ended Sept. 6, to $189 million, according to market-data company Information Resources Inc., or IRI. Lower-priced brand-names are posting gains, too. Last week, Procter & Gamble Co. reported that volume sales of its bargain-priced Gain detergent rose 10% in the quarter ended Sept. 30, offsetting weaker results for the market-leading and pricier Tide.

Meanwhile, estimated retail sales of value-oriented Purex fabric softener, owned by Henkel AG, rose more than 60% over the past six months, the company says. 'We view the economic slowdown as an opportunity for our brand,' says Greg Tipso"

At least at our stores, this seems to be partially a mental story as much as anything else. I have never done it, but it would be fascinating to examine store brand vs name brand sales on a daily basis and see if it is tied to economic news and/or stock market performance.

SSRN-Costly External Equity: Implications for Asset Pricing Anomalies by Dongmei Li, Erica Li, Lu Zhang

In a paper that will definitely be mentioned in my corporate finance classes, Li, Li, and Zhang look at whether capital structure impacts pricing anomalies. They find they do. This at least is consistent with the idea that financial flexibility is important in choosing capital structure

SSRN-Costly External Equity: Implications for Asset Pricing Anomalies by Dongmei Li, Erica Li, Lu Zhang: From the abstract :

"...document that the value, net stock issues, investment, and asset growth anomalies tend to be stronger in financially more constrained firms than in less constrained firms. This effect of financial constraints is distinct from that of financial distress on anomalies. Intuitively, costly external finance makes marginal costs of investment more sensitive to investment in more constrained firms, giving rise to a stronger negative correlation between investment and the discount rate."

Two fast look-ins:

"Using bond ratings to measure costly external finance, we find that in the unconstrained sub-
sample consisting of firms whose bonds are rated, the value-weighted average return, CAPM
alpha, and Fama-French (1993) alpha for the high-minus-low investment-to-assets quintile are
−0.33%,−0.41%, and −0.14% per month. These estimates are either close to or more than halved in magnitude from their counterparts in the constrained subsample consisting of firms whose bonds are not rated. The differences across the unconstrained and constrained subsamples are all more than 2.8 standard errors from zero."

and also :

"[This] work adds to the literature that explores asset pricing implications of financial constraints. Lamont, Polk, and Sa´a-Requejo (2001) show that more constrained firms earn lower average returns than less constrained firms. Campello and Chen (2005) find that the bonds of more constrained firms earn higher ex ante risk premiums, which also covary with macroeconomic fluctuations. Building on Almeida and Campello (2007), Hahn and Lee (2005) study the effect of debt capacity on stock returns across constrained and unconstrained samples. Whited and Wu (2006) construct an index of financial constraints via structural estimation and find that more constrained firms earn insignificantly higher average returns than less constrained firms."

The take-away? It again seems that capital structure matters and that access to capital markets is an important consideration in both returns and in understanding anomalies.

Cite: Li, Dongmei, Li, Erica X. N. and Zhang, Lu,Costly External Equity: Implications for Asset Pricing Anomalies(September 8, 2008). Ross School of Business Paper No. 1111
Available at SSRN: http://ssrn.com/abstract=1154002

Looking for stock information?

In the SIMM class students are constantly making presentations on firms that I often know little about. In addition to the normal Yahoo and Google finance pages, I have been using Tickerpedia. It is really useful and super easy to use. (and no this is not a paid commercial! lol)..

To Treat the Fed as Volcker Did - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times

The NY Times points to an interesting BreakingViews article on the fed. Short version: The Fed is trying to do too much and some of the things (example maximum employment and stable prices) are seemingly at odds. A possible solution? Simplify it and have the Fed worry only about stable prices.

From the Fed's own website:

"...the Federal Reserve's duties fall into four general areas:

• conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates
• supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers
• maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
• providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation's payments system"

From the NY Times: To Treat the Fed as Volcker Did - Mergers, Acquisitions, Venture Capital, Hedge Funds -- DealBook - New York Times:

"The president-elect should change the Fed’s legal structure and mandate so that it will maintain monetary stability, even if a person of Mr. Volcker’s stature is not running it, Breakingviews says. The objective should be to force even the feeblest political appointee to keep broad monetary growth in line with the growth of the economy. That means raising interest rates as high as necessary to keep consumer and asset price inflation low, it says."

Lending rates fall to pre-Lehman levels - Nov. 4, 2008

While the financial markets are getting some traction and the worse may be behind us, there still are issues to deal with. For instance, in last two days we have seen that while rates in the markets are returning to more normal levels, Banks are making it more difficult to get loans. This is probably what we want, but does come with the problem of potentially slowing the economy.

From CNN: Lending rates fall to pre-Lehman levels - Nov. 4, 2008:

"Libor rates have been trending downward since mid-October, when the Fed took the unprecedented move to flood 13 central banks around the globe with unlimited amounts of dollars. Libor, the London Interbank Offered Rate, is a daily average of what 16 different banks charge other banks to lend dollars in the U.K.

Less than a month ago, 3-month Libor was at 4.82%, and the overnight rate was at an all-time high of 6.88%. Lower rates are a major boost for the strangled credit market because more than $350 trillion in assets are tied to Libor"

But simultaneously Bloomberg and the BBC reported that a new Fed survey finds tougher borrowing standards.

BBC NEWS | Business | US banks cut back their lending:

"US banks have tightened up even more on lending, despite the Wall Street rescue deal designed to encourage the renewal of normal lending practices.

A quarterly Federal Reserve survey in October found 70% of banks tightened standards on prime mortgages while 60% had done so with credit card debt.

Some 95% of banks had tightened their standards for providing credit to large and medium-sized businesses."

And from Bloomberg:
"

``It has never been harder for businesses and individuals to get a loan from the bank,'' said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. ``Banks are turning away borrowers left and right.''

Some 95 percent of U.S. banks raised the costs on credit lines to large firms, and ``nearly all banks'' increased the spread on borrowing rates over the cost of funds on loans to large and mid-sized firms versus July, the Fed said.

``Higher fractions of banks reported having reduced both the maximum size and the maximum maturity of loans or credit lines to large and middle-market and to smaller firms,'' the survey said."

moreover this may, at least in the short run, negatively impact the economy. Interestingly, and predictably, real estate lenders have kept rates high there even as shorter term rates (driven in part by Fed and Treasury intervention) have fallen.

``The supply of credit is coming under ever increasing tighter conditions,'' said Fisher. This ``exacerbates the downward slippage of the economy.''

The Fed has reduced its main rate 4.25 percentage points over the past 14 months to 1 percent. Still, the average rate on a 30-year mortgage stood at 6.46 percent last week, up from 6.26 percent a year ago, according to data from Freddie Mac."

While not wanting to play political prognosticator (even on election day), it would not be surprising to see this be the area of next government action (meddling?).