BlackRaven

why did RBS fail? my notes from the FSA report.

2011-12-13T00:38:00.000Z

After a tiring day I thought there would be nothing better to do than read and take some notes on the FSA's report into RBS's failure. They are not comprehensive, the full 452 pages are here; FSA report into why RBS failed

7/10/08 RBS funded by Emergency Liquidity Assistance from the BoE.
13/10/08 RBS £20bn rights issue, only 0.24% taken up by private holders, government the balance.

public commentary was that £40.7bn operating loss being the problem is inccorrect. Of that £32bn was intangible writedowns, which don't have an effect on regulatory capital.

"Only" £8.1bn of capital was written down.

end of 2007 had £68bn of reg cap + £12bn of rights issued raised capital, => £8bn would have been absorbed.

1) less capital than peers, therefore first in firing line (although later charts show HBOS was in worse position but Eric Daniels had a brain fart).

2) "excessively" dependent on short term funding (I use the inverted commas because, well the FSA didn't seem that bothered at the time and its NR report shows an even worse example they didn't care about).

3) asset quality concerns

4) large losses from credit trading

5) ABN amro "wrong deal, wrong price, wrong way of paying and at the wrong time"...

6) Systemic crisis.

under Basell III RBS would have had 1.97% capital ratio rather than the required 8%.

in sep07 when NR failed, RBS was still able to raise debt. thought they were experiencing a "flight to quality", really?!

customer funding gap for the whole of the UK system rose from being zero in 2000 to ~£750bn by 2008 in pretty much a straight line.

rbs had a big reliance on short term wholesale funding, even when it was levering up to buy ABN it paid in borrowed cash of less than 1yr term.

ABN effectively doubled their trading book; that only required £2.3bn of capital for £470bn of balance sheet assets. from which they took £12.2bn of losses.

FSA make a big deal about losses on credit trading, because they believe that this causes a loss of confidence, in both the institution and the system which leads to recession, which leads to defaults. Sure tighter credit hurts the economy, but part of that is signalling. trading p&l for 2007,8,9,10 were; +1.3,-8.4,+3.1,+4.5. So over the four years they made £1.3bn.

Whereas losses from loans are £32.4bn.

credit losses were £14bn over 07/08. FSA make valid point that there was a lot of uncertainty around it though, which inevitably leads to funding issues.
credit trading pnl for 2008;
they lost 2.3bn on counterparty defaults; 0.7 Lehmans, 0.6 Madoff, 0.6 Icelandic banks
-0.6 CDPC
-0.6 principal finance
-2.4 structured credit
-7.8 "strategic assets unit" ?? is that a prop desk name?
-3.2 impairments
+2.1 commission
+4.0 interest
-4.4 staff costs - is that payouts from tinning people??

organic growth of the balance sheet was 24% p.a from 2004 onwards!

losses on loans over 08-10
Residential mortgages; £2.5
personal lending 4.6
corp property 10.4
corp other 9.7
other 3.2

IMHO their enormous quickly grown loan book is the issue, and the market knew that at the time and yanked their funding. They were too reliant on short term wholesale funding so they got stopped out.

ABN deal;
paid in cash, which they borrowed rather than funding with equity.

effectively doubled their trading book.

took the risk of being consortium lead, meant they had to consolidate the purchase and then split it up, and I think is the reason they got so much of conduit losses of abn assigned to them, because that was still being discussed in early 08.

thought that because they had integrated a same country retail deal that was bigger and had good reputation on cost control and synergies they would make a lot of money on the deal. described as a "vanity purchase", "didn't know what they were buying".

because deal was competitive and of a public company, due diligence was minimal, although that wouldn't have made much difference IMHO, they had similar risks on already.

rbs board unanimous and shareholders over 90% voted in favour of the deal.

no regulatory oversight of the deal on the UK end of it - Dutch were surprised by that.

there is a lot of discussion of management styles and processes, a lot of it is waffle looking for scape goats, and a lot more of it is hindsight trading. however there are some interesting issues;

RBS were slow to take their marks. Goldmans were really quick and good at this.

RBS used the 96% for their VaR, everyone else used 99.9%, how and why were they allowed to do this. Everyone else is planning for a 1 in 1000 even, whereas RBS are planning for a 1 in 24??

losses were 8x what their VaR models were predicting. The fact they are surprised by this was worrying. Little real stress testing.

saying No to Europe.

2011-12-09T18:09:00.000Z

"interesting" comments from some European politicians.

Let us be absolutely crystal clear on a few things;
1) France and Germany have shown that they wish to implement a tax on the City of London that would be paid into EU coffers. As far as I am aware there is no other example of such a tax.
2) The treaty changes that were on the table will do nothing to change the course of the crisis, the idea that implementing a slightly stronger wording of deficit controls is going to change the solvency, competitiveness issues and lack of fiscal union is naive at best.
3) Even if this would work, there is no "bluff calling", if they are going to build a new version of the EU institutions that they are not legally allowed to use, it will take years not months.
4) Making a big fuss that the British are being obstructive is helpful, because it distracts both the markets and the electorates from the really big issue; the currency union doesn't work, the solution to fix it; fiscal union has no democratic support or legitimacy.

Parachuting in an army of Monti-style technocrats to run nations in the periphery, imposing German austerity, brings no guarantee of producing the reforms that will yield the vast improvements in competitiveness that are necessary for a country like Portugal or Italy to deal with the level of the euro. Regardless, the process will take years, look how long it took a rich developed nation (West Germany) to change a poorer one (East) when it had far more control, wealth and helpful global demand. It is easy to forget that German unemployment was at 12.5% in 2005.

Extremely high unemployment, a feeling of imposed austerity and loss of sovereignty and pride are a highly volatile and dangerous mix in Europe.

Imagine if China slowed down.

Timing a Greek default;

2011-10-03T11:47:00.000+01:00

There are three main mechanisms that could precipitate a default;

EZ and IMF pull future lending
Greek banks face a domestic run on deposits
Greece finally starts running a primary budget surplus and political cover allows them repudiate "odious debts".

(1) seems unlikely. Not because I believe that these institutions are committed or well organized, but because it would require action, as we have seen they clearly need a lot of prodding to do anything.

(2) would be very hard to predict as it is based on group confidence, so in modelling or thought process terms, its just a poisson process.

(3) on the other hand *should* be easy to forecast. (well if one could have any confidence that Greek reported figures were accurate or not deliberately manipulated).

There have been several rumours that Greece has been inflating their budget deficit figures.

Their most recent projections however show that they should be running a primary budget surplus next year. In which case it makes even more sense that they promise reform programmes that kick in with savings in 2015 to secure immediate loans.

I am cynical so it is easy to speculate that Greece is deliberately trying to maximize the receipt of a fiscal transfer. What I find much more difficult to understand is the German position.

Many commentators have tried to explain their actions as 'pot committed politicians'. That it is just politicians trying to save their pride and hide the folly of their euro project designs. In reality the polls and general German media commentary actually suggests that not to be the case, that the population actually support some form of action, perhaps because they don't understand the true cost?

It appears to me that Merkel is deliberately obfuscating and is reluctant to face the consequences on ANY decision, be they supporting the euro, drawing a line in the sand, or turning their back. That is very weak.

Roland Berger published a plan which they called "Eureca". Which essentially said that Greece should take €125bn of assets (clearly overvalued for the purpose) and put them into a SPV in Luxembourg, and sell them to the EZ, use the proceeds to do a massive bond buy back. Then the SPV could be unwound, if the proceeds were lower than 125bn Greece would be liable to top it up, but would retain any upside if the assets were more.

There were some worrying features;

Putting the assets in an SPV in Luxembourg really is meaningless, if Greece decided to nationalize the assets again International law would be pretty much useless, or they could apply huge tax rates to those assets and perform a defacto nationalization.
Clearly this is just a secured loan, because Greece would still be liable for any shortfall, in which case unsecured creditors would still be wary on an ongoing basis of making new loans to Greece.
For the assets to have real value rather than to be trophy assets, then they must have some associated cashflow, in which case the secured loan must actually have a cost, ie. If they include public offices, then clearly the SPV must be paid rent, in which case the improvement in fiscal position is a lot smaller than the headline figure.
The point which was repeated several times that was most worrying however was the boast that such a plan would "burn speculators". Which they believed would cause spreads on the rest of the peripherals to collapse.

This last point just shows that they don't have a clue.

FTT - Financial Transactions Tax.

2011-09-29T04:45:00.001+01:00

Tobin's tax was designed to reduce volatility in the fx market.

Its also been suggested that the FTT, which would be a 10bps tax on stock, bond and derivative trades would be a good way to raise revenue.

Several commentators who really SHOULD know better, cite stamp duty in the UK as being a model.

Perhaps they'd care to look at the thriving CFD market, and the amount raised from retail investors and compare that to institutional investors? and reappraise their view! The tax simply does not work within the UK.

As to whether it reduces speculation? or volatility? well lets just say that if you think 10bps is going to stop somebody buying into a bubble or selling into a panic, well you need your head examined.

bubbles??

2011-09-22T00:40:00.000+01:00

the headline is a little unfair to the following link;

BlackRock Buys Junk Debt at Spreads Exceeding Bearish Scenarios

but there are several things that I dislike about it, as I commented on twitter;

1) the first is a general point. VALUATIONS ARE NOT AN INVESTMENT THESIS. Especially when you are comparing a risky number to a historical realization for a long term instrument. Yes it is appropriate to look at historical default rates, but to compare them to a risky market number is not. It is naive to ignore liquidity risk, risk of recovery, a market price to those risks AND then to forget about how short a sample of history one is looking at.

2) it is very consensual to believe that commodity producers and China are more stable. That the represent the future, and that Asia is insulated from the economic cycle. Although it is en-vogue to laugh at decoupling, there are more than enough people that treat it as a resting principle. The sectors that they proceed to say they are targeting demonstrate this;
"[the] firm is targeting bonds of speculative-grade companies involved in energy, mining, oil, natural gas, cable and wireless operations"

because;

"You want companies that have more stable and visible cash flow streams, so their earnings quality is a lot higher and more stable to withstand economic downturns"

now these two statements are very much at odds with one another in my mind.

Mining, Oil, Nat Gas, these are all dependent on the industrial cycle. Sure you can see a mine, and see that there has been good historical demand, and that China had a massive fiscal stimulus, but to extrapolate that into the future isn't clear cut.

"a bubble is any kind of debt-fueled asset inflation where the cash flow generated by the asset itself—a rental property, office building, condo—does not cover the debt incurred to buy the asset."

I believe that he is talking about Chinese property in this quote from his interview with Bloomberg Business Week, but surely that applies to mines, oil and nat gas investments?

Marx

2011-09-04T17:30:00.000+01:00

There have been several people pushing the ideas of Karl Marx recently, from the FT's Alphaville, UBS economist George Magnus to the "neutral" BBC article that appears to have no author.

http://www.bbc.co.uk/news/magazine-14764357

Marx was a terrible economist.

At the heart of Marxist economic theory, in fact I would say its central pillar is the Labour Theory of Value. LTV asserts incorrectly that the value of a good is the amount of man hours required to create it. So a portion of hot chilli con carne taking an hour to make is worth the same amount as a few litres of freshly squeezed ice cold orange juice. The most common objection is that Marx's theory is demonstrably wrong because it does not include input costs, ie. a gold ring is worth more than a silver ring. Marx took that simple incorrect theory and then proceeded to the conclusion that the difference between the selling price and the labour value of the product is the profit, which the bourgeois capitalists extract.

Marx doesn't really care if its by ripping off the consumer (I think because he believes they will act in self interest in a free market), but cares about the extraction coming at the expense of those providing the labour. He believes that the value that capitalist create is purely their ability to own the means of production enabling them to purchase labour at an unfair price.

In short, capital, capitalists, inventors and entrepreneurs only generate returns because they are in a privileged position to manipulate workers.

This is utter nonsense. If anything in a democracy it is labour that is able to manipulate the system rather than capital, witness the UAW or public sector unions destroying the fiscal position of their employers.

In our earlier example, the reason on a very hot day that cold orange juice will make a profit and the hot chilli con carne will not, is not because the owner of the means of production is able to bully his workforce, but because the decision to allocate capital correctly provided a popular and valuable choice to the market.

Additionally Marx makes some rather bold predictions that are neglected in the article above. According to Marx, what should be happening in the West is that profit margins should be falling, leading to companies cutting the pay of their staff, there should be mass over production of goods and chronic under consumption as workers purchasing power declines.

Instead we are now seeing very high profit margins, higher worker productivity and pay but weak cyclical demand. That really has almost nothing to do with Marx, other than the enormous sense of entitlement in large parts of Europe and a dollop of leftwing hunger to return to the rhetoric of class war.

What I personally find particularly jarring is the juxtaposition of the West, with a massive social benefits system, free education, health care, and living standards the highest they have ever been in the history of mankind, that is nominally a free market system, that consumes the enormous production of a supposedly communist country, with a much lower standard of living, poor working conditions, low/no employee rights, no benefit system, no state healthcare and pensions. Yet it is those in the rich west complaining that they don't have a big enough slice of the income and resources pie??

It is as absurd to claim the "system" isn't fair because your neighbour has a bigger mansion than you in Chelsea.

a little break down; from 27th April to now

2011-09-04T17:10:00.000+01:00

Utilities 2%
Consumer Defensive (3)%
Healthcare (8)%
Communication Services (11)%
Consumer Cyclical (13)%
Real Estate (15)%
Energy (17)%
Basic Materials (17)%
Industrials (23)%
Technology (23)%
Financial Services (24)%

What is interesting to me is the return on technology, its very idiosyncratic given the relatively "normal" systematic returns that we see with the other sectors, ie. we expect to see utilities outperforming fin serv and cyclical industrials and base materials in an anticipation of a double dip/slowdown, I'm not sure/ well I didn't think that we would see such a dramatic fall in tech in the same scenario.

Looking at factor returns;
size 4.99%
value 15.81%
dividend 7.52%
momentum 9.42%
balance sheet (0.43)%
"cloud" 11.62%
model 6.07%
conc. Model 6.97%

I find it even more surprising that the return on the balance sheet model has been so poor over the period. What does stand out is that the value and dividend models have performed very well over that time frame, to me that means that there has been a lot of relatively unsophisticated participation in the market before and after the sell off started.

The "cloud" factor is interesting as well, although mostly driven by the awful performance of normal tech.

I feel comfortable posting numbers like this because these factors are quite robust. Something often neglected much to the detriment of real returns in the long term.

an interesting tax proposal;

2011-09-03T13:30:00.000+01:00

Prof L.J. Kotlikoff presents an interesting tax reform plan; http://www.bloomberg.com/news/2011-08-31/a-tax-reform-to-kick-start-the-economy-laurence-kotlikoff.html

What I think is interesting is effectively shifting the burden on taxation onto consumption, rather than profits and income.

There are several questions I think need to be answered that are more practical than political;
1) LJK suggests taxing imputed rent; I think that is very difficult to achieve.
2) What revenue would this raise theoretically? and what revenue would it raise after one calculated the effects of normal avoidance schemes?
3) It would be interesting to see how much of the savings from tax return filing would be eaten up in the calculation of implied value of rent consumed?

economist link; China's Military Power

2011-08-30T09:05:00.000+01:00

http://www.economist.com/blogs/banyan/2011/08/chinas-military-power

management matters

2011-08-26T01:25:00.000+01:00

Molins is nothing short of a basket case company.

Ms. Palmer-Baunack impresses me, Mrs T. would have been impressed with her handling of the unions in previous roles.

I like that.

If she can get a penny of value out of the company, then there are a couple of pounds of real value there according to the financial statements and a large dose of wet finger in the air.

dd in progress...

bank of america

2011-08-26T00:39:00.000+01:00

its not a name i really care about. but i like to price things.

Buffett has stuck $5bn down, for that he gets pref shares that are worth $5.5bn, what is 10% between buddies..

the real KICKER is the warrants he gets, 700mm warrants that i think are worth $3.5, so $2.6bn.

in essence that means BAC is letting Buffett buy stock at a discount of 5/(5+2.6) it at 66c on the dollar.

BAC recently said that their tangible book value was $12.65

They just let Buffett buy the stock at effectively 36c on THEIR dollar if they think that $12.65 is fair value...

'yem kidding me.

jackson hole

2011-08-25T22:41:00.004+01:00

at the beginning of the week it was easy for some people to think that other people thought there would be one of these;

but anyone reading anything finance related will have realized that Bernanke is not going to play ball tomorrow, no dice.

there are not the same signs of deflation to justify the launch of QE3.

there is however the risk that Bernanke says the economy is weak and that they are keeping an eye on it. saying this would be a policy mistake in my view, even if that is what he thought. we have seen before the the market fears these sorts of comments because they think Bernanke can see lemons they don't have the data to see.

Bernanke is not a mug, i don't think he will make that mistake tomorrow, and therefore i think there is upside risk.

to balance that, today's price action was fugly.

Ian Dyson.

2011-08-24T23:54:00.000+01:00

Another "Captain of Industry".

When in charge of Punch Tavers, had a basic salary of £675k.

Now that he has split the company in two and is managing just the profitable easy bit, has a salary of £675k.

If I did 30% less and got paid the same amount of money I would be pretty pleased. Especially if I got a pension contribution of 25% of that salary, a 150% bonus, £18k BIK. We're talking almost £2mm. The market cap of the company is £277mm, no thanks to management. That is a 73bps management fee!

I guess shareholders, not so much.

why didn't anyone look at the SMP balance yesterday?

2011-08-23T21:44:00.000+01:00

well I didn't check how much the ECB bought of peripheral debt last week, and I didn't see any market chatter on the matter. The week before however there were millions of comments on that the ECB were out there buying €22bn.

Last week they clearly took it a little easier and only bought €14bn.

I think they only had/have the appetite to double the SMP, so they have €130bn of powder.

They don't expect to be buying once the EFSF is operational, although its not entirely clear to me when that will be, at first glance the earliest is in 4 weeks time, but it could be later.

That leaves them with €94bn. Which means they have the capacity to do €23.5bn a week.

OR they actually expect it to be longer, as the ECB clearly prefer the shock and awe approach. Their steady state approach will probably be more like the 14bn they did last week, which implies EFSF buying starting in 6weeks time.

ERP

2011-08-15T22:54:00.000+01:00

No not something from a John Irving novel... but the Equity Risk Premium.

There have been several commentaries highlighting how "cheap" equities are versus bonds. In essence the ERP is the difference between the earnings yield, ie net profits / market cap for equities against 10yr government bond yields, ie the so called Fed Model.

Does one expect these yields to move in the same way though? in all economic environments? and does it provide a good signal?

Firstly one would expect these two yields to move in opposite directions, ie when the economy is improving, then bond yields should be rising as demand driven inflation rises and long term growth expectations rise, at the same time equity valuations are increasing so equity yields are falling. Whereas in a a recessionary environment the opposite will be true, bond yields fall and equity yields rise. Thus the ERP naturally is going to be counter cyclical, we expect it to be high during recessions, and low/negative in booms. However is it PREDICTIVE?

You tell me?

and would you bet on it?

any guesses for what those charts would look like in Japan??

quick notes again...

2011-08-09T01:56:00.000+01:00

August markets are thin. Any selling or buying can push markets to extremes far more easily.
People have spent a lot of time talking about valuations, imho they really aren't that important, or supportive on the macro level.
Profit margins are fat and inflated, probably meaning profits are 10-20% above their long term average.
Reflexivity is going to bite, there is a big demand shock.
Asia has a LOT of froth and bubble in it, there has been serious over investment.
Government debt levels, demographics, etc are a long term headwind.

I'm not ready to run out and join the rioters and call for the end of civilized society, but it does look awfully gloomy, and that has been rapidly priced in. I've made some pretty decent money out of the move, calling how much further there is to go is a lot more difficult.

Monkey's pick bottoms. Its a lot easier to buy when its going back up than to catch a falling knife, etc, etc. cliches abound...

Arb trading...

2011-08-03T22:54:00.001+01:00

A good proportion of the portfolio is dedicated to "arbitrage". Now, in the last few decades almost all relative value trading has been called arbitrage of some kind, ie. buying very 'cheap' value shares is now "time arbitrage". I use the term slightly more tightly than that, but more loosely than buying and selling exactly the same instrument, at exactly the same time for a penny difference in profit.

When I say arb, I mean things like merger arbitrage, credit basis trades, rights issues, convertible bond arb (with everything hedged!). These strategies are first order market neutral, ie. their pnl doesn't show any correlation to small moves in the overall market. They do tend to show correlation over big moves to the downside (which is what you really care about).

Some strategies have a fundamental reason for the weak downside beta. For example the probability that an acquirer walks away from a deal increases when the economy changes for the negative, the credit basis can often move in unexpected ways because of differing funding spreads and expectations of restructuring, etc.

In general there is also a second mechanism, liquidity and contagion. Holders of these arb, basis, RV trades tend to have similar positions and when the market takes a real beating there is often an increase in risk premiums and blow out in relative value spreads (whether fundamentally justified or not) as investors look to increase their liquidity. Additionally you can have real contagion as any stat arb fund that was around in 2007 can tell you, ie. a fund that runs several strategies blows up in one more directional one and then has to liquidate all their strategies, that can set off a cascade of liquidation.

The general point that came up in conversation however is that with all these type of arb spreads, one is short a put on liquidity. That diversification is an illusion, and if anything its better to panic first.

nothing interesting to say, just some personal notes

2011-07-28T00:21:00.000+01:00

market very choppy, with a lot of negative expectation now built into the next couple of trading days
any 'value' stock, or event stock that has even slightly come in under the whisper, ie. it might have beat analyst estimate but is below where hot money was wet dreaming for has been decimated, viz $aks, $stx, $mu, and I hope $gt tomorrow.
it has only taken a week for the market to totally discount the EFSF bailout package, although the Greek PM is calling it the first step the an e-bond, Schauble is clearly saying that Greece is a special case. IMHO, as much as it pains me to talk about the market as some independent entity, "they" are going to gun it until there is cold hard cash, signed, sealed, delivered. Its not because of some evil conspiracy, but because holders of debt will slowly get more nervous the more they feel they are relying on political intent rather than legislation.
Earnings commentary out of China has been mixed, half of companies have been very bullish, and half have been neutral, not that I expect corporates to see a hard landing before prices react!!
Vol isn't elevated enough
GBP is a sale, and gilts deserve to be smashed, the market is giving far too much credence to Conservative intentions.

seagate q4 call notes

2011-07-21T10:30:00.000+01:00

I have about three clips of this on, so my read is going to be biased whether I want it to be or not. clip one from when its deal was announced, clip 2 was a slow add on pull backs, and clip 3 was added yesterday as a punt on earnings. stock is down 11% amc, I was wrong and got my fingers burnt, mentally its very tempting to try to go through the call and find reasons that the market was wrong and to look for excuses, going to try to NOT be biased.

seeking alpha have the transcipt of the call, which I find very handy; seekingAlphaLink

$2.9bn revenue for quarter
$0.28 eps non-gaap
tam 166mm
32% market share
- believe june TAM is not inventory build but true demand
margin improved, not as much as they would have historically in this environment
*THAT* is the disappointment. they say because of four factors;
1) agreed pricing with OEM before demand surge
2) 'didn't achieve out time to maturity targets'
3) commodity price rises
4) able to service demand, but in lower margin segments

sold $600mm of senior unsec notes
sep tam think 165-170mm, $2.9bn revenue, see 200bp impact of commodity prices on margins, looking to offset them (but sound skeptical), also say that they'll look to pass them on.
r&d and sga @ $350mm
0.29-0.33 forecast eps

cerium oxide

q&a shows they aren't executing transitions well, and are wasting resources and tech -> not what I or the market expected.

Yes its disappointing, especially as its really execution failure when the market is presenting good opportunities, and if you're and investor like me, that bought the stock because of improving sector dynamics you're probably even more frustrated. It certainly marks down management in my books. What will enrage me is if management still take fat comp.

I messed up adding to the position yesterday. Am glad that I have sensible risk limits and will review whether to add based on price action today.

not something to look at before you try to go to bed tonight

2011-07-13T12:02:00.000+01:00

government accounts

the total liabilities are £2.4trn. The 'assets' really aren't assets in the sense that they can't be sold without having to then purchase the use of them annually. 200% real debt to GDP is a harrowing thought.

FISCAL UNION IS NOT THE ONLY OPTION

2011-07-12T10:12:00.000+01:00

Fiscal Union is muted as the silver bullet.

If only EU citizens will unite behind the idea of a Finance Ministry of Europe, all will be ok.

WHY? essentially because then NAG (Netherlands, Austria and Germany) will be able to permanently subsidize Greece et al, and then there will be no defaults.

Greece has two problems, (1) an unsustainable fiscal position and (2) an uncompetitive and contracting economy.

FU would solve (1), but shows why FU is impossible unless the FME has total control over tax and spending. German taxpayers can't and shouldn't vote just to hand over money to Greece, when they pay more tax, and work longer and don't have rampant tax evasion. German taxpayers should not be funding swimming pool tax dodging Greeks.

Greece has to solve its own fiscal hole, and to do that it must actually collect the taxes it tries to levy and to cut its spending. Public sector workers will moan that its not their fault, they should count themselves lucky that they got that unsustainable spending in the first place, rather than feel entitled to more.

Now (2) is harder. Many will argue that a fiscal contraction can only make matters worse, BUT, are having interest rates of 20% better for the economy?? NO WAY.

What has to be recognized is that the standard of living in Athens was unsustainable. It has to fall if Greece is to become competitive.

There are some that would now try to argue that if the EUR was much lower, then Greece would be competitive, however if that was the case, their purchasing power would be significantly lower, and so would their standard of living, the two are different sides of the same coin. Greece's economy is not sluggish because of Germany productivity, believing Germany should pay Greece for some of the benefit of having a slightly weaker euro is absurd nonsense. Germany could demand payment as recompense for having lower purchasing power.

Greece can devalue, but then it must accept a lower standard of living, or they can demand the same standard of living and become incrementally less competitive and watch the rest of their economy sink.

micro cap notes

2011-07-12T00:08:00.000+01:00

FSTA:LN #56.208 @ 675p Fuller, Smith & Turner

Several revenue streams, managed pubs (£138mm revenue), tenanted pubs (£27mm), Fuller's beer sales (£104mm). I quite like London Pride. the numbers look pretty solid, with some good growth, and a decent brand, sensible organic use of FCF, opening up some small accomodation, spending on refurbs. In liquidation the firm would be worth ~ 540p, so there is a good floor to the valuation, its on about a 15x multiple, which is not cheap, BUT, it is well run and is a good brand. However the really bitter thing is the shareholding structure, they have three classes of shares.

A shares, listed on the LSE, which you or I could buy, in total have 58% of the economic exposure, but only 24% of the control, because the B shares effectively 10x the number of votes compared to their economic value, making up only 10.7% of the economic exposure, but having 65% of the votes. These shares cannot be sold on the open market, and effectively the families that still own these shares have first dibs on them if they come up for sale. Then there are the C shares, which are just like the A shares except they are not listed, but can be listed with 30days notice.

That puts me right off, I don't want to own a business and not have any say over it. Even when you get down to the liquidation floor, there isn't really that much you can do, because the family will want to continue to run the business.

Redhall group RHL:LN #29.589 @ 75p

hits nearly every red flag on my last list, absolutely terrible cash conversion, and appalling contract management. a bag full of semi unrelated businesses, being poorly run, with very little board level ownership of the stock, stay well clear. The Vivergo contract saga permanently excludes this stock from my investment universe.

Dignity PLC DTY:LN #54.757 @ 812p

without making jokes about this business, because I have a black sense of humour, it is important to note that there is a stable and increasing revenue stream, it is unlikely people are going to stop dying any time soon, so a funeral business does have some structural demand. The issue with this business is that it effectively has too little working capital for the expansion that it should be making, and is running too much leverage for my linking. Sure the cash flow is steady, but effectively £350mm of debt is too high for £72mm of FCF, because they need to invest £35mm to grow, with financing costing £30mm, it doesn't leave a lot for shareholders, so you're banking on growth, a lot less fun than picking up burnt cigarette butts. a fair value of ~ 827p being aggressive doesn't leave much meat on this one.

Molins PLC MLIN:LN #20.172 @ 109p

They've made what appears to be a good change of management, APB seems like a good pair of turnaround hands, and has taken a stance against unions with which we agree. Again its a mix of businesses, at least the there is a theme though, and the valuation looks ok, a 138p valuation doesn't look too difficult, thats 25% of good upside, without having to fight the tape too much one should imagine, especially as the balance sheet appears to give you a bit of a backstop. Need to do a bit more work on this one...

some red flags

2011-07-11T22:44:00.000+01:00

if a firm regularly takes out more than half of the actual costs to get "adjusted" earnings, that is a big red flag, especially if it is amortisation of goodwill, and they appear to want to create value with aquisitions
they have slightly off key job titles, especially if its an engineering firm.
very low shareholdings in the firm by the ceo and cfo, ie less than one years salary.
low cash conversion on sales
boastful and unrepresentative patter in the annual report, boasting about growing sales, when they've bought a business, and margins have declined, while paying themselves more; outrageous.

sky falling in??

2011-07-11T14:49:00.001+01:00

There has been more than enough ink spilled over the NOTW scandal; only a few points really need to be said;

if hacking is institutional within NOTW, then it will be present in other papers
the police's role is a much bigger issue, witness Guardian reporters getting information illegally as to where Coulson is being held, etc. venal.
the attacks on news corp are politically driven, as are the attempts to block the bid for bskyb, the bbc moaning about too much media power is ridiculous.

so what though, none of that is going to make me a penny, the price action in b sky b (BSY) share may well do though. They've fallen about 150p down to 700p, what is the price level where one would take a punt then?

Well looking at the pre-bid price of 560p, the 30% return in the FTSE since the bid and the stock having a pre bid adjusted beta of 0.92 that would give 714p as the floor, which its currently trading through. There the very low probability that somehow Newscorp actually get made to reduce their BSY shareholding, or it becomes permanently blocked. Additionally the FTSE isn't a great index to measure BSY against.

Bottom up, fair free operating cashflow of ~£1,300mm, inc growth of 10% a year for the next few years, at we're talking about a forward multiple of ~ 11x, that's not too ugly a price.

Thinking of picking up a clip at 680p, with another at 570p.

The trade that has made money though, has been selling Trinity Mirror shares which popped on the news that NOTW was closing. If anything, from this point forward its only going to be negative news, without even looking at valuation we slapped out a clip this morning.

Jeffrey Sachs makes the Eurocrat case;

2011-07-01T10:07:00.000+01:00

http://blogs.ft.com/the-a-list/2011/06/30/greece-can-be-saved-heres-how-to-do-it/

to paraphrase, Greece doesn't have to default if it has 3% interest rate, and breathing space and can magically get its economy growing again and cut its 18% deficit into a surplus....

if you punch all of those assumptions and hope into a model you'll see that the debt load is sustainable.

(red lines are historical data from Eurostat, that we've aggregated, blue lines are the forecasts with all of the assumptions above)..

It is a *little* rich for Mr Sachs to call those expecting a default naive, especially when the scenario that avoids default has so many conditions and unrealistic political movements.

I'll say it again, Greece will not default while they are still getting more loans, they'll borrow more money, but when the time comes for budget surpluses to be run, then they'll default and use the cover of the rioters and language of 'odious debt'.

Betfair

2011-06-29T12:17:00.000+01:00

When this came for IPO I remember being very interested. It is a fantastic product, and I can't see why most punters wouldn't use Betfair rather than their bookies once they have opened an account. It also has the critical mass and liquidity, given the fact that its pretty much the preferred exchange for spread betting firms to lay off their exposures, to give it a bit of a moat.

It does suffer from some serious negatives;

gambling as an industry should always trade at a bit of a discount because of the legislative and political risk that it faces.
lack of growth in its core market, it can really only grow its market share, as moving into different sectors it loses its edge, ie. its not going to grow a poker business or online bingo business, as they are competitive and will suffer serious and terminal margin decline
its going to struggle to break into different geographic segments because of regulation, and would need to get to critical mass

As such its valuation when it IPO'd was a bit of a mystery, we're now getting to the price levels where it gets interesting though;

http://www.google.com//finance?chdnp=0&chdd=1&chds=1&chdv=1&chvs=Logarithmic&chdeh=0&chfdeh=0&chdet=1308519778090&chddm=82782&chddi=604800&chls=CandleStick&q=LON:BET&ntsp=0

What are fair numbers? and what is a fair multiple?

Firstly the firm has no real debt and has net current assets of ~ £46mm

A 'fair' EBITDA of ~£50mm, which you're fairly comfortable with given the business model.

what's a fair EV/EBITDA then? 10x seems like a fair stock exchange multiple => 510p

that's still a long way south of here, but one for the watch list if we do have a real sell off.

French Letter

2011-06-29T12:05:00.000+01:00

here is the French proposal; ftalphaville link to french proposal

I think the mechanics in the flow chart are not too clear, here's my take on what happens;

Investor redeeming €100 of Greek bonds;
1) gets €30 cash
2) gets 30yrs on €5.5*0.7 + 0-2.5*0.7 risky coupon from Greece
3) gets a zero coupon bond, ZCB, worth ~ €30*0.7 today that will pay €70 in 30yrs time, that is guaranteed by the EU

Greece has to;
1) pay €30 to the investor
2) issue a ZCB to the EU for €70
3) pay coupons for the next 30yrs of €3.85 plus max(min(2.5,gdpRate), 0)*0.7

the EU
1) gets a zcb from greece
2) issues a zcb which gets held by the ecb

The euro value for the investor redeeming their bonds is thus approximately €78.

This is CLEARLY a restructuring. One can understand why a bank might accept it though, in part because of the dishonesty in the proposal.

Listed on an EU regulated market, but with restricted trading in the New GGBpg until 1^st January 2022[1].

[1] Trading and transferability restrictions do not apply to ECB financing transactions

This is trying to create a false market in these securities. By not allowing them to be traded they hope to make sure that banks will be able to carry on pretending that these bonds are worth this fictional amount. If I did that as a private investor, I would be sued for fraud, and rightly so.

I can accept that banks would accept this restructuring, because a 78% recovery rate on Greece is very high in my humble opinion. What nobody should accept is the idea that we can pay out such a high recovery rate from taxpayer funds, increase the taxpayer credit exposure, and be complicit in trying to create a false price for Greek debt.

When is the German public going to realize how much money they are giving to Greece?

induction

2011-06-23T00:36:00.001+01:00

I get the feeling the market is already thinking about QE3 in a big way, and for some is acting as an insurance policy on their long equities/commodities/risky asset positions. Clearly this must be building valuations.

The more interesting point however are the second order effects of any potential QE3, and a question of its scale. IF it happens, and that is a very big if, it will be under some serious political flak, and as such its only worth then bothering doing if its a meaningful size, but clearly not going to be truly shocking and awe size.

QE2 had very wide reaching side effects; stock prices rallied hard, but more importantly, do did commodity prices, and food in particular. Another round of QE will put huge pressure on China, exporting inflation from the US to China in a big way. China will have to tighten, but even then, the political pressure from higher commod prices and higher food prices will have to lead to one of three outcomes;
1) substantial revaluation of the RMB
OR
2) excessive monetary and fiscal tightening within China
OR
3) revolution

(2) seems the most likely, but that is like somebody pulling very hard on the handbrake for the resource economies like Australia.

I am short $audusd, and doing a lot of work on Australian banks, and highly leveraged companies looking very actively for good short opportunities.

Labour overspending in a chart

2011-06-21T10:05:00.000+01:00

Ed Balls still wants to pretend that it was just the recession that destroyed the UK's finances, well here are the figures from Eurostat. The chart is of the cumulative net spending as a % of GDP, so ignore where the finances are coming from, and focus on what government spent excluding interest payments versus their tax income, it is very clear that from 2001/2002 the Labour government significantly overspent, to the tune of ~20% of GDP. The entire terms of the debate on the austerity measures would be so different if the UK's net debt was going to top out at ~60% of GDP, additionally we'd probably not be running such a large deficit.

So when Mr Balls calls for emergency VAT cuts, he really should answer the question as to why he fired that fiscal ammunition in 2003?

inflation and stock returns

2011-06-17T16:18:00.000+01:00

http://features.blogs.fortune.cnn.com/2011/06/12/warren-buffett-how-inflation-swindles-the-equity-investor-fortune-1977/

is a piece by Warren Buffet from 1977, in which he talks about the effect of inflation on stock returns.

some interesting points;

But the potential for real improvement in the welfare of workers at the expense of affluent stockholders is not significant. Employee compensation already totals 28 times the amount paid out in dividends, and a lot of those dividends now go to pension funds, nonprofit institutions such as universities, and individual stockholders who are not affluent. Under these circumstances, if we now shifted all dividends of wealthy stockholders into wages -- something we could do only once, like killing a cow (or, if you prefer, a pig) -- we would increase real wages by less than we used to obtain from one year's growth of the economy.
The Russians understand it too
Therefore, diminishment of the affluent, through the impact of inflation on their investments, will not even provide material short-term aid to those who are not affluent. Their economic well-being will rise or fall with the general effects of inflation on the economy. And those effects are not likely to be good.
Large gains in real capital, invested in modern production facilities, are required to produce large gains in economic well-being. Great labor availability, great consumer wants, and great government promises will lead to nothing but great frustration without continuous creation and employment of expensive new capital assets throughout industry. That's an equation understood by Russians as well as Rockefellers. And it's one that has been applied with stunning success in West Germany and Japan. High capital-accumulation rates have enabled those countries to achieve gains in living standards at rates far exceeding ours, even though we have enjoyed much the superior position in energy.

This parallels to some extend our current situation, and should frame thinking towards government debt. Even though Krugman et al would like us to believe there is no consequence to government spending in a deep recession as there is no inflationary risk, it is still consumption, and by definition building up debt is the opposite of saving. By CONSUMING today, we reduce our ability to generate wealth going forward. Almost all government spending is really consumption, paying high wages, increasing future pension liabilities, hiring more equality officers, is all consumption, and dramatically reduces the countries wealth generation capabilities.

link

2011-06-17T13:02:00.000+01:00

captures a lot of what I have been thinking....

http://macro-man.blogspot.com/2011/06/hiding-behind-greek-smoke.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+MacroMan+%28Macro+Man%29

shopping list;

2011-06-16T11:06:00.000+01:00

characteristics of stocks I would currently like to own;

revenue dependent on American business spending and consumer spending
cost of revenues largely dependent on commodity prices
no unionised labour, and low dependence on low skill workers
fixed rate borrowing, but generally low leverage.
plus all the usual requirements...

stocks I would like to short;

highly leveraged, floating rate
large fixed investments in commodities and supplying China

under the hood of a sentiment change

2011-06-15T23:28:00.000+01:00

there has been a dramatic change in sentiment over the last month and a half.

the spy is down -7.41%, iwm -10.11%, qqq -8.51%.

tlt is up +3.50%.

gld is down -0.86%

there have been many blog lines spilt on this topic, suffice to say, this has absolutely nothing to do with the debt ceiling, nothing to do with Japan, or Libya, and probably not that much to do with Greece either.

What then is driving this repricing? digging deeper than just the headline numbers;

size +1.20%

value vs growth +8.33%

momentum +1.69%

liquidity provision strategies +0.81% (unlevered)

consistent with the market shifting to more defensive footing in anticipation of slowing growth and macro economic weakness. My narrative is this; the commodity spike over the last couple of months hurt consumers, a small disruption to supply chains from Japan have undone a lot of the monetary policy heavy lifting of the last year. Demand remains weak.

What is not being talked about enough, is the tightening of Chinese monetary policy, and the risk that we see a hard landing there, which could seriously impact the commodity economies such as Australia.

$CSCO, the wrong song...

2011-06-14T20:10:00.000+01:00

Dasan commented that Barton Biggs didn't understand CSCO's valuation of 12x p/e thinking it could grow at 12% a year.

This is interesting, because Dasan is a very good tech investor, and I am not, my knowledge of Biggs as a stock picker is minimal, meh.... he does write a good book though.

I think if you are used to looking at beaten up industrials and searching for "value" you could make justify buying a whole handful of names; $INTC, $HPQ, $DELL, $MSFT, $PHG, all of whom have forward p/e's of under 10x, all of which have had positive top line growth over the last year, and three years compounded, all have pretty decent looking balance sheets, and certainly let you feel safe and familiar.

What is an appropriate multiple for these sorts of companies, tired, almost utility like structures, with fewer growth opportunities I'm not so sure market like multiples make that much sense, neither do these companies have hard barriers to entry, or perpetual demand for their particular products like you do with a water company. For these names to be attractive, one might actually need to see deep value multiples.

Where does that leave CSCO? well firstly there are a few other stocks that look a lot better, but on a 5xadj ttm p/e and adding in the spare cash on the balance sheet $3.86 + 5x1.32 = $10.46

So we are a long way from where I care...

em-dm... am?

2011-06-11T16:52:00.000+01:00

http://www.ft.com/cms/s/0/23fe4b4c-91be-11e0-b4a3-00144feab49a.html#axzz1OilUgBtD

Interesting article in the FT, basically suggesting that by many metrics, EM emerging markets, have progressed to be close to or at the level of the DM, developed markets. More interesting than the history is the prediction that high savings rates in EM's will moderate, creating new demand, and that capital flows of recent years will reverse, ie capital will flow from DM to EM's.

Perhaps though there is another category that one will need to classify economies, and that is AM, ageing markets, such as Japan and parts of Western Europe, that will probably have a very different dynamic to that of developed markets that don't have the same demographic challenges.

update on trend following in a bubble

2011-06-04T00:01:00.000+01:00

This is a chart of the a simple trend following strategy sharpe, on the x axis is the time window used for the entry and exit signal in trading days, the green line is the sharpe for commodities and the red line is the sharpe for equities bubbles. These sharpe's do NOT consider transaction costs. Including that would dramatically shift the optimal window to a the right, because you'll trade less often. So the pseudo optimal window for commodities is the 6yr average, and for equities its a lot shorter, at the 252d approximately.

That would have bought you gold at $300 in 2002....a 17.46% compounded annual return. It would also put your robust stop at $866 now, a pretty huge drawdown.

another potential chinese fraud;

2011-06-03T23:31:00.000+01:00

http://www.muddywatersresearch.com/wp-content/uploads/2011/06/MW_TRE_060211.pdf

without commenting on the company in particular, its another example of a potential fraud. It was striking reading an FT alphaville article quoting a Chinese 'expert' saying that he saw long term problems for China, medium term problems, but had faith in the government to engineer a soft landing. There has been an enormous shift in media and 'expert' thinking that has blind faith in the Chinese government and the Chinese development model.

US officials have decades of experience and collective wisdom managing a market economy, one which is smaller, has more transparent and reliable data, yet one would be called mad if one were to place that level of faith in the US government to guarantee a soft landing. Or even more absurdly, that the Fed could fine tune the economy by setting interest rates to the nearest 0.01% (Chinese base rate is the absurdly precise 6.31%), when the Fed has to move in 25bp increments at least.

Fraud typically really starts to accumulate in the late stages of a bubble....

why the eurocrats think that re-profiling Greek debt will work.

2011-06-01T11:27:00.001+01:00

I started off yesterday, with another post about Greece, it was boring....

digging through the numbers it just becomes so clear that Greece fudged its way into the euro. Greece ran a primary budget surplus of 3.62% before joining the euro, and then really just let it all hang out and since has been running -2.47%, whereas over the same period Germany ran 0.27% and 0.34% respectively.

Greeks' not paying high real net tax rates is not a new thing, preEuro (pE) tax revenues as a % of GDP, 39.64% versus aE 39.21%. So it really is the spending side of the equation that has made all the difference; going from 36% to 42%. ie having a Northern European welfare state, but also low taxation, and plenty of EU funds.

It has been incredibly puzzling that European ministers believe that reprofiling will sort out what I believed, like other commentators, to be a solvency crisis.

After the 90% net debt to GDP, its a when not if case of default, and lets call it default not modification, restructuring, etc.

Banks might be willing to pretend that a reprofiling (ie saying you can have your money back in 20yrs rather than 10yrs) is not a default, but a zero coupon german government bond would go from 71 to 51, a 30% haircut. Banks that have this crap in their "banking book" should still be able to pretend that there isn't a loss.

anyway

can Greece reach a stable equilibrium without default?

In eurocrat world, the answer has been muddled.

Under what parameters does Greece avoid blowing up?

Its current interest payments/total debt outstanding gives us the average interest rate which stands at 3.83%. Germany at 2.87%, so the credit spread that Greece "feels" is only 130bps. Even at that low level it was forced to ask for aid.

Believe it or not, it managed to feel a credit spread of only 56bps on average since joining the euro, instead of the 329bps before.

IF Greece were to reprofile, in terms of modelling that is just a guaranteed rollover of a bond into a longer maturity with the same coupon. BUT given that Greece is having to borrow to meet its coupon payments at the moment then it will still see some uplift in its effective average interest rate, unless it is given even greater access to EU funds.

So lets assume we lose our minds, and give the Greek government a pass, and assume they can bring their primary budget balance to a pre euro surplus of 3.4%, and that they have strong nominal GDP, what is the interest rate that avoides them spiraling out of control and needing to default. Well it looks like at about 600bps credit spread is the cut off point, above that and Greece is bust, below that it *could* turn its self around, if the Government managed to turn a 4% primary budget deficit into a 3.5% surplus over a few years, with very high economic growth. THIS IS WITH REPROFILING...

without reprofiling....then that stable credit spread is only 450bps.

assuming the market lost its mind and allowed Greece to roll its credit at current spreads, in less than 5yrs half of Greece's increased tax revenue would be spent paying the interest alone.

why you're not listening if $wdc earnings disappointed you...

2011-04-21T13:44:00.001+01:00

the company has been guiding the market, telling you that the eps is going to be lower because of overhang, clearly margins were not great.

our notes from the call;
tam ~165mm, they shipped 49.8mm down 2.5% y/y (industry 2.3%). $2.25bn sales ~ BR asp $45.18 (-$6 y/y)
demand next quarter seasonally weak, however because of earthquake supply disruption should create a supply shortage.
2.5 inch shortages greater than shortages in 3.5 inch.
..sounds to BR that WD is going to try to win share as other suppliers are disrupted..
gross margin 18.2% (25% y/y) (19% q/q)
r&d ~10% of revenue @ $252mm
net income $142mm 0.62 eps (0.66 non gaap) run-rate-p-e ~15.

q&a;
is there a signed purchase agreement with hitatchi? its in the 10q
samsung-seagate, does it change the way you talk about your deal with regulators? ... no. still going to say merger is going to better serve customers, benefits of scale will be shared with customers.
intel expect low double digit growth, what is your oem colour? 2010 industry shipped more than end demand, too much inventory in channel, two year growth rate will be about 12%, 18% in '10-'09, so low growth this year.
any indication from oem's about hit aquisition? customer reaction has been very positive.
customers asking for more supply, do you ask for higher price, fixed orders, etc? work with customers for years, have flexible model, consistent, if their costs are higher, they share them, BR yes.
thought there was 8-10mm excess TAM, there was then a shortage in cpu in quarter, but they are pretty much back where they started. will take a full year to not be supply contrained for june, sep, dec get to equilib.
does toshiba have the ability/will to invest? their press release says yes
that is very significant piece of information that we've missed! need to find that ASAP...

BR thoughts; samsung-seagate deal is definitely a negative for the merger, its not positive. Toshiba deciding to invest is VERY negative, and need to find the press release that is referred to on the conference call.

reduced the position substantially until we find that toshiba press release and have a bit more of a think...

tactics for a bubble

2011-04-21T10:30:00.002+01:00

what is the optimal strategy for taking the most money out of a bubble situations.

number one has got to be not trying to call the top, any strategy that is long during a bubble and plans to sell out based on some sort of valuation ratio is almost always going to fail if its truly a bubble. when a bubble is in a truly frothy expansion, participants are piling in because they're afraid to miss the boat, not even a greedy fool can predict that actions of an even greedier crazy fool.

there are good academic papers that point out that a bubble is characterized by "log periodic power laws" lppl. basically, the price goes exponential, the rate of return increases with time. which in itself fits with observation and with the process that is happening, the higher short term returns attract more investors, who push the asset higher, which creates higher returns attracting more money. clearly this is a situation where momentum is increasing and calls for a trend following strategy.

as such a good strategy would be to pick a moving average of an appropriate length say 100days, and to own the asset when it crosses above that price and to stay long until it falls below, and hope to liquidate there with as little slippage as possible. the Raven has backtested this strategy with stock data from the nasdaq bubble and if he remembers correctly the best window to use was the 200day simple moving average. additionally this has the advantage of being rather robust and minimizing on trading costs. the shorter the window length, the more trades and the sooner one is stopped out of a trade, but the less risk one takes.

update of the numbers for some famous bubbles coming up....

WDC pnl update

2011-04-19T13:19:00.002+01:00

Looks like there is going to be some further consolidation within the industry, again, if this passes through trust issues then its great for margin and overhang.

$WDC reports tomorrow night, and it should be a very interesting call; perhaps now is the time for a p'n'l update of the trade put on last month, and as a picture is worth a thousand words;

just to put some numbers on that trade, thats a 15% return in a month and a half, where the stock position is being hedge with a index hedge...

here is a description of why; http://blackraven999.blogspot.com/2011/03/awesome-hitwdc-reaction.html
and here is a description of thoughts on the risk; http://blackraven999.blogspot.com/2011/03/wdc-risk-managing-position.html

unions

2011-04-15T02:11:00.000+01:00

http://online.wsj.com/article/SB10001424052748704150604576166011983939364.html

a really good article in the wsj last month on unions and the right to work legislation.

eurozone defaults

2011-04-15T00:20:00.000+01:00

There were rumours on Thursday that Ireland was going to choose to default, t'anks to an article in the Irish press that suggested there really was no other option for Ireland.

What is being suggested is a selective default we'd imagine, so only foreign creditors take losses. Not cool, retrospective legislation to allow this modification of creditor seniority makes us feel very queazy. Spineless Stigtits will tell you that creditors will forget about it soon enough, however to rational investor, its a huge stain.
Politically this has got to be easier than writing cheques to profligate nations that cheated their way into the euro? easier to bail out the Landesbank than a Greek citizen retired years before Klaus can even dream of taking a break.
It is not a given that a country defaulting would have to leave the euro, although one would imagine that it could actually be better for all parties involved if that was the result. A country like Greece can devalue back to competitiveness and set its own interest rates. Sure this will leave JCT red faced sitting on some chunky ECB losses, but he's going to have a red face no matter what happens.
Ultimately all the debt above 60-90% (60 being the Maastrich debt ceiling, no really...) of GDP for the piigs is going to end up on the NAG's books.

a nice talk by Richard Koo, but....

2011-04-15T00:08:00.000+01:00

http://www.youtube.com/ineteconomics#p/c/2132823B19D1EB46/0/HaNxAzLKegU

google will show you the way to his recent talk at the "Instituted for New Economic Thinking", Soros's talkshop.

Koo makes an interesting point, that with a balance sheet recession, because collateral is so far underwater (Japan and the US now after the bursting of their property bubbles) the private sector will reduce their spending in order to deleverage. But akin to the paradox of thrift, that "saving" (paying down debt) reduces the aggregate net demand/income, which leads to more "saving". He highlights what an enormous drag this could be on the economy by pointint out that Japan could have shrunk by 10% a year because of this were it not for fiscal stimulus.

He runs aground in our mind when he says that there is a lesson for Spain in this example. If there was an excess of saving taking place in the economy surely long term interest rates would be much lower? For a country like Ireland to keep a fiscal stimulus it would be needing to generate 15% returns annually on its "investment". As has been said before, at this point the plight of the piigs has a greater parrallel with countries trapped on the gold standard.

Unless there are going to be fiscal transfers, then default really is the only option, other than a great depression without an end in sight. The single biggest problem with fiscal transfers is moral hazard and the political implications for any leader signing that cheque.

punch interims update

2011-04-12T14:44:00.001+01:00

http://miranda.hemscott.com/ir/pub/ir.jsp?page=news-item&item=647653150964174

Punch interim results with some detail of splitting of Spirit.

Market likes this... not so much, down 5p to 74.5p.

Spirit has 798 managed and 554 leased pubs, will move all over to managed or sell them.
Rev; £379mm (331mm managed, 48mm leased), ebtida £67mm (45mm & 23mm) and OP of £49mm (27mm and 22mm).
Managed business performed strongly, revenue growth of 2%, op growth 12%, whereas leased had falls of 5% and 7% respectively.
More exposure to London and SE, thats attractive as London seems to be quite decoupled from the rest of the UK as we saw today being the only area with rising houseprices in the UK.

Punch (rev, ebitda, OP; £277mm, £137mm, £130mm) going to split into core and turnaround divisions, currently has 5,241, of which 3000 will likely be core, which make up 75% of the ebitda. average income of ~£80k, 95% on "substantive agreements". Turnarounds on ~£40k, 2,300 pubs. expect to sell them over 5yrs at a run rate of 500/yr.
sold 160 in the first half of the year, @ £40mm which had ebitda of £1.1mm. (so average selling price is 250k, if they are turnarounds on 40k income that is 6.25x) (BR: what happens to the debt for these pubs though???)
concessions running at £2mm a month for reduced rent, have also made £17mm of capex over h1.

took a £370mm impairment charge on the carrying value of non core assets, £81mm goodwill write off, turnaround estate being valued now at £278k per pub, 8x their ebitda.

net debt £3,079mm from £3,277mm

more later....

some market macro quick thoughts;

2011-04-12T13:39:00.001+01:00

bull points;
1) rates are still low, Bernanke has still got his chopper out
2) the rear view mirror still looks good for the US and Germany
3) although people are talking about 'extreme bullish sentiment' there does appear to be quite a bit of short term fear

bear points;
1) china has been tightening and its not got much press
2) consumers have been squeezed by commodity prices
3) profit margins are historically very high, and there are long term risks for both wage demands and potentially higher commodity prices

Vickers report....

2011-04-11T17:14:00.000+01:00

There are still calls for banks to be broken up along the lines of "casino" and "utility" lines.

This just doesn't make any sense.

Firstly is lending a utility activity? well if it is then there will be an enormous amount of risk in the "utility" bank, after all there was no investment banking involved in blowing up bradford and bingley, northern rock, hbos, or even rbs. It wasn't prop trading, or underwriting, commissions from equity trading, m&a advice that sank these banks, but having too many bad loans against too little capital.

Lets pretend that we can then put loan making into the risky "casino" bank, or perhaps suggest we seperate banks along three lines, deposit taking, lending, and investment banking. The businesses that are lending institutions will still require capital to lend, they are not going to be financed out of equity. In which case they will have to borrow money from.... dum dum dum... the utility banks, in which case deposits will still be at risk, unless the government is going to just guarantee those loans, in which case you've just double the business for accountants, auditors and regulators and not changed a thing.

The fundamental problem is that depositors make a loan, but they don't believe they are taking any credit risk, so take little to no care about the credit they extend, expecting the government to bail them out. The government has to charge for this, and the people to charge are depositors. However thats a real vote loser because the general public would much rather believe they were faultless innocent victums, rather than the greedy speculators they so love to castigate.

hmv warning AGAIN....

2011-04-05T12:02:00.000+01:00

Another month, another ...

HMV warning

it appears that profits will be lower than "expected" at £30mm for the full year. (after posting an interim loss of £41mm)

last year it made £74mm for FY, with interim loss of £18mm, so a profit of £92mm for h2, whereas this year it'll be more like £71mm.

There are a couple of "highlights"; that they have pushed back the test date for their debt covernants, one would imagine that is linked to their announcement on the 25th March that they are board were exploring strategic transactions for Waterstone's and HMV Canada.

The stock reaction is rather telling, its so low it doesn't care, so the Raven will add a few shares to replace the few that he sold when the stock popped on that previous announcement. It is hard to imagine that there is anything other than bad news already priced in...

Tetragon

2011-03-20T22:11:00.000Z

A bank can trade at a premium to NAV, why?

because it can do things that as an investor you really can't; underwriting, m&a advice, borrow from the discount window, get bailed out, etc.

Imagine a bank, but without those pesky staff eating up costs, or costly office space, or the headache of having branches. Being a shareholder would be great, you'd be the one getting the bonus!

This was Tetragon Financial Group's pitch when they were listing this vehicle in 2007. The Raven was more than a little surprised that the bankers' could keep a straight face and although being on quite good terms with the chap at DB pitching this idea, he couldn't stop himself from laughing and hanging up when it was suggested that this should list at 1.3x book, "after all banks trade at a premium to that".

There were several features that made the TFG structure appealing at that time, however it was the funding that stood out; they highlighted that they had good terms to secure locked up funding from a couple of banks.. "evergreen loans" or something equally twee.

What really stank however was the idea that historical default and recovery rates were appropriate for the underlying paper, exactly the same argument as subprime, the banks making these loans and selling them were holding little interest in them, so clearly they would be of a worse quality than they had been when they were left holding the paper, for sure they weren't going to be better! The idea that the loans would be of a superior quality because they weren't making them for a relationship was utter drivel, the bank was still making them, and taking an investment banking fee, except now they didn't have to hold them.

The real sticking point is valuation. With a bank, they can grow their assets and revenue streams, they can provide services and run a business and as an equity holder that is your business, however much the folks on Goldman's renumeration committee think otherwise.

With TFG you don't have that, sure your assets can compound, but none of the growth in the business is yours, that all goes to the managers, who get paid as asset managers with a fixed contract that as a shareholder would be very hard for you to terminate. So in reality you're just an investor in a fund, except you're a permanent investor, you're signing up to paying those management and performance fees forever!!

One would have thought that the issue and frustration of gating would have made investors more cautious, especially to the idea of locking yourself into a credit fund.

So where should this trade to relative to NAV?

Well nobody should pay a premium to buy assets in a vehicle.

But we can see that you are contracted in to pay 1.5% management fee, and 25% performance fee above libor+2.25%. That 1.5% is guaranteed, so take it off as an annuity; that's 35% thank you very much. ie a muliptle of 0.65x book.

Currently NAV is ~ $10 per share.

It doesn't even take a Hedge Fund Manager on 1.5 and 25 to work out that a share price of $6.50 is 'fair value'.

buying puts as protection.

2011-03-18T11:32:00.000Z

Buying options does not reduce your risk.

It substitutes some risks for others, you reduce your immediate price sensitivity and replace it with time sensitivity that is less intuitive and harder to manage for a normal portfolio manager. The lottery like returns tend to mean that buyers emotionally remember their winners rather than the thousands of small losers.

Selling options does increase your risk.

It introduces risk and pays a slight premium for doing so. Unless you have a very long time span, and enormous amount of wealth or are trading with OPM in a diversified and institutional setting, you are not going to capture that risk premium, and if you are a retail investor your commish will have turned that premium into a discount quicker than you can say inverted skew.

Howard Lindzon made a comment today (actually in Feb, have been meaning to finish this for a while) that is perhaps prescient; "after the run up maybe its time to look at buying some puts for protection". Having looked at this problem from more than a few angles while running a "tail risk protection book" for a two billion dollar multi strategy fund its one that has given the Raven a few black eyes and hopefully some robust insight.

Its almost always about the timing.

If you buy a boat load of at the money (ATM) puts and the market pukes, you're going to make money. The issue is that if you've got timing like that, well then who needs puts, just short the bugger and get your beach shorts ready because you're not going to have to work hard again.

The reason you buy puts its two fold; 1) not to get your face torn off by the market roofing it 2) which is very similar to (1) but to stop yourself getting stoppped out on a short. or 3) for implicit leverage, which is actually 1&2 together.

So you've skipped to the conclusion, bought your puts, and have been wearing your lucky underpants for the last month, the market is 5% higher and your puts are worth the square root of not a lot, the market actually does crack and you're mentally banking it, those puts must be worth something now, right? for some reason hitting shift-F9 is making no difference to your pnl??? WTF? what went wrong?

Puts don't give you the luxury of not having to get the timing right, if anything it complicates your pnl, introuducing even more timing risk and path dependancy. A "good" (read sucessful at selling centipeeds (a trade with lots of legs, which means lots of commission) to his clients) broker will handily pop up and suggest all sorts of options to sell against your put buy in order to reduce the "cost", by which he actually means the cashflow on day one, it certainley doesn't ever reduce the real cost, will show why it doesn't work in another post.

The paths that you will make money buying puts, you'd have made more money being short. The only advantage is that if the market has continued to go up you'll have lost more on your shorts.

So the first exploration in this space was to design a product that the Raven would have liked to buy at a reasonable price, ie some sort of look back put, ie a product that has a payoff equal to the (price at maturity - max price in lookback period). Well how much would that cost? and thinking back to the days of being on an exotic option desk, how would one hedge that with vanilla options? Without getting into too much fancy mathematics, or hedging strategy its just a good idea to think about what sort of paths will generate interesting payoffs;

1) close today is the market high and it sells off from today onwards, well then the price would equal an ATM put today
2) more realistically, the market rises, and then sells off, a basket of put weigted by the probability of that price being the maximum reached and the remaining time to expirary. so clearly the upside probability makes this product more expensive.
3) the best pay off profile would be a long period of a strong uptrend... with a '87 style crash on the expirary date.

Clearly there isn't a static hedge for this position, but its easy to think of a few dynamic strategies that would approximate that payoff, the simplest would be to buy an ATM put and slightly more shorter dated upside calls, using the profit from any move up on the upside calls to roll the strike in the ATM put up. One could also decide to implement a delta hedging scheme, which would be very similar to the portfolio protection scheme's that failed so drastically in '87. Any dynamic strategy in options is a wet dream for your broker, and a killer for your portfolio, you'll pay bucket loads of commission and for very little effect.

Statistically looking back these strategies would have cost about 3.5%, with a maximum upside profit of about 35% for 3 months of protection. The cost of which annualizes but your upside doesn't, so "hedging" your book would cost you 14% a year. One would have to believe the market has the potential to be a lot higher and the potential for it to be a lot lower, or more precisely that there is a large amount of uncertainty for these strategies to be worthwhile. In which case you're actively betting on volatility rather than actually reducing your risk.

The single best way to reduce risk, is to reduce all your positions proportionally.

fundamentals......

2011-03-16T15:32:00.000Z

Just two very simple points to make;

1) Before there is a bear market, generally, there have been positive fundamentals in place, ie. good corporate earnings that have been reflected in rising stock prices. Appealing to positive fundamentals is akin to pointing to the rear view mirror and exclaiming that there's straight road behind you, irrelevant if you're driving off the edge of a cliff.

2) Soros is right, the market and economy are reflexive. A fall in stock prices and a rise in credit spreads, will generally be followed by contraction in the economy for three reasons;

prices are a good forecast of future results.
prices reflect current sentiment, which in turn reflects future marginal economic activity.
prices effect the cost of capital which in turn effects spending decisions in the future.

Violent prices moves are only really "irrelevant" if they are corrected quickly.

$WDC risk managing the position

2011-03-11T12:59:00.000Z

1) obviously we hedge, but what with? why? how do we calculate hedge ratios.
2) we have a stop, but of time or price? and where?
3) what position size is appropriate relative to the rest of the portfolio?
4) is there a good option trade to structure this better?

The most important thing is to be robust. Be roughly right rather than precisely wrong.

1)
The natural hedge would be Seagate. We're betting on improving pricing in the hdd industry, shorting Seagate would remove that factor so a broad sector or index hedge is a better idea.

Calculating beta, ie the correlation between the stock and an index, has plenty of academic page space, the Raven uses his own special sauce, but it doesn't make that much of a difference.

Computer says... 1.5.

The nasdaq is a poor index to use as a hedging tool as it is very concentrated in AAPL.

We hedge to remove systematic risk, not add idiosyncratic risk, so a better choice would actually be a blend of indices, half spoo half nasdaq, looks robust enough, calculating a new beta to this... computer says..2.4raw 1.95net, the main driver of this high beta is the high volatility of WDC and relatively low volatility of the spoo. This suggests selling $0.97 of spoo and $0.97 of nasdaq for each $1 of wdc.

2)
To be logically consistent we should have a look at the residual chart for $WDC, we at least have a history of the pnl of the trade that we are putting on rather than just looking at an outright chart, or using some rule that we don't have any feeling for.

It also allows us to at least estimate the risk in our hedged trade, as such for a $1 of wdc, we can expect daily moves of $0.04, with the worst daily move of -$0.38. These numbers are meaningless. A dollar of wdc is a dollar that could be lost. Theoretically it is possible to lose more, if the stock dropped to zero and the hedge rallied, but assuming risk of greater than $1 is over cautious and unrealistic. What it means to us is that we need to be cautious and not leverage the position, although many people would say that $1 of wdc and $1.95 of hedges is already leveraged. A reasonable stop would be a loss of 20% in price performance, and a reasonable stop in time would be 3 months.

3) Obviously this depends on what other positions are in the book, risk tolerance etc. What can be said absolutely is an upper limit on the position size, and that placing anything bigger would be a mistake. quarter Kelly betting criterion would suggest nothing greater than 5%. That is an upper bound.

4) Given that this isn't an event driven trade, ie. we are not anticipating a takeover, spinoff, rights issue, etc, then the value of using options is that they give us leverage and the ability to limit our downside. Without even looking at the vol surface, it doesn't make sense that we'd pay a dynamic hedger to take risk for us, when we actively want to take risk in the stock.

However, that might be worth a look later.

an awesome HIT..........$WDC reaction

2011-03-09T00:17:00.001Z

Huge news monday morning, and would have had more to say here if there wasn't the need to trade it. WDC are buying Hitatchi's storage business, the ominous "third player". The stock moved from $30 on Friday to $36 a pretty huge move. Having been short the stock and spent the last two days first buying back the small short and putting on a proper sized long its fair to say this is a game changer.

Removing this pricing pressure from the market has an enormous impact on the multiple that one should value wdc and seagate on. Without the deal the pricing situation was bleak. A large number of units overhanging that didn't seem to get cleared a siutation getting worse because Hitatchi was looking for an exit, and in so doing was trying to push up sales at the expense of margin for a potential IPO.

It was quite plausible that the selling prices could have been knocked down a further 5%. Just using the trailing 12 months, that would have reduced sales from $9.9bn to $9.4bn, and net profit to $0.58bn from $1.09bn. Putting that on a conservative multiple of 8x (which is justified for such a cyclical business) and adding in the $2bn of cash and you were looking at a price of ~ $28, but obviously with a lot more downside if the economy got worse or Hitatchi really started to blow out stock.

Whereas if we put on our rose tinted spectacles and dream, then WDCHIT looks pretty sweet; the combined group would have about $19bn of sales, on an 21% operating margin and all the synergies, and then a move up to a better multiple of lets say 10x and we're looking at $2.6bn net profit a year and a stock price of $100. yes triple.

Being very conservative, lets say a 50% leak, half synergies, 18% margin and the same old multiple 8x and we're at $36. Mid case and we're talking $55.

Lets make it even more simple, there are essentially three cases;
1) deal gets kaboshed - stock drops, $27
2) deal goes through, no synergies, high leak, no multiple expansion $36
3) deal goes through, land of milk and honey, $55

You can play around with probabilities and try to be really smart and work out a finer detail on this, however in the short term one has to recognize that the future has radically changed, and that historically markets don't digest that information quickly.

The same human nature that allows momentum to be a profitable strategy is at work, its hard to buy a stock that has gone up a large amount in a short period of time. Here we see the reason why and that there is a lot more upside potential.

The Raven has bought his position already, but will continue to add if the price action confirms this view.

Tomorrow some more thoughts as to those relative probabilites and how we're going to risk manage our position.

Simon Fox - HMV's "Guardian"

2011-03-02T23:56:00.000Z

CEO of HMV, joined the firm when the stock was at 130p, its now at 15p.

Not to overstate the case, but sharehoders have been decimated, well actually reverse decimated, as they have about 10% of their original investment left.

During his tenure, there has been a different head of the renumeration committee for different years, and a differing method for calculating performance awards, be that by changing the "peer group", the criteria or the conditions. The Raven is sure though that shareholders must be delighted to know that they had to match another firms offer for this superstar, in order to motivate him in his role?! what is 2mm of shares between "partners"?

When he joined in 2007 he had a total compensation of £333k, for 2008 he earned £992k, for 2009 £579k and for 2010 £874k.

What did shareholders earn?
2007 -33%, ouch and the FTSE did what?
2008 +29% almost back to break even yah, definitely worth a million quid...
2009 +3% still not at break even... hmmmm half a million?
2010 -44% almost a million again?
2011???? -82% and what will be looking at??

Thank goodness ITV didn't land this superstar, the Raven was long ITV, that would have been pretty nasty.

It is "interesting" though that a company losing nearly all of its shareholders' value has a CEO that also find the time to join the board of the Guardian, and the Chairman, to top that decided that joining M&S might be a good idea, only to discover that perhaps he didn't actually have enough time for both roles.

Just to put it into perspective, since he joined the firm shareholders have lost half a billion pounds, and the CEO has made £3mm but feels that he needs to be incentivized to turn the company around rather than jumping ship? Shareholders should have made him walk the plank.

HMV warning

2011-03-01T20:55:00.000Z

Thanks Robert Swannell, are you going to pay HMV shareholders a golden parachute?

trading update

can't believe the guy rocks up and leaves after such a short period of time when the firm was already in a difficult position. Its not even being a mercenary, and the excuse is very poor.

net debt of £130mm is worse than the City was forecasting, its a little worse than the Raven was thinking given their update, and leaves less room for further restructuring costs and makes meeting their bank covenants a little harder.

The news in January that credit insurers were restricting insurance to HMV's suppliers should be in the stock price by now. The point the Raven feels the retail market is not pricing in so clearly is that between October 09 and the release of full year results in April 2010, inventories fell from £319mm to £248mm, a reduction of £70mm of stock, roughly one would expect a similar % move this year, and so inventory should fall to ~£234mm ie £68mm, which should mean that HMV naturally should be able to trim payables to £420mm. So in reality the demand for insurance should have been lower over the half.

Bought a few more shares, however its still a tiny position and should HMV fall to zero it would cost less than 1% for the portfolio, which is the maximum risk. Gut feeling that this is going to come with a rights issue that it should be able to get away if it does it sooner rather than later, the worry is that creditors get to extract the value from this firm.

miliband's mistaken

2011-03-01T12:00:00.000Z

Article in the Times today who's main thrust is that Miliband disagree's with Mandelson that Labour should be comfortable with people getting "filthy rich". That people's income haven't risen in real terms, as real wages are at the same level as they were in 2003. It is unfair that the benefits of growth are accruing to the "filthy rich".

What he doesn't deal with is why the returns accrue to the wealthiest, or in fact why the wealthiest are wealthy. In Miliband's rather simplistic socialist view he neglects how or why wealth is created, it isn't just a process of dumb luck, or inheritence, or just that the wealthiest simply 'own the means of production', its the capital and risk taking create growth, rather than it just being a return on hours of work. Unless there are substantial productivity gains being made by increasing the skill of the labour pool, its logical that a growth generated by investment should increase returns to that capital.

Regardless the figure that is quoted as evidence for his blathering is that real wages will be the same next year as they were in 2003. The Raven has several problems with such a meaningless statistic.
1) wages are only a small part of REAL income for the poorest households, in fact for the poorest 20%, wages only make up a 25% of total consumption. When in real terms government spending has increased massively over that period it makes little sense to point to real wages when arguing about how well the poorest have done
2) "real" wages don't actually capture the benefits of gains from technology. ie. buying a phone in 2003 for the same price as one today would show 0% inflation, where in fact the quality of the product has improved greatly, in which case there is actual deflation.
3) picking two points in time is dishonest, given that real wages increased during the boom and have fallen back in the recession.

Tax Rates and Growth

2011-02-10T11:50:00.000Z

some charts...

factor returns;

2011-01-24T01:01:00.000Z

The Raven runs a small statistical arbitrage portfolio as one his strategies. This week there were some interesting results in terms of factor returns. (ie. a typical "value factor" would be to rank stocks by their cheapness measured by price to book, and to see what a portfolio long the cheapest and short the most expensive would have returned).

Obviously the market factor was a negative;
The average of the universe was down (2.11)%.
Size returned +1.14%
Value +0.86%
Momentum (1.60)%

That is a classical flight to quality and a momentum reversal, with the stocks being punished the hardest, those that don't pay a dividend and have been rallying for months and have reached very high valuations, something like $RAX was off ~10%, whereas something like $GE was up ~7%.

It is also very interesting to note how much popular speculation has occured in US equity markets over the last few months, additionally, how bearish the world has been on European stocks, where we have seen Spain have a monster rally. We haven't reached the end of January and the two most popular trades of the year have been taking out and shot. (If some nutter rocks up with a shotgun and pops off a CEO we've never heard of, my rhetoric wasn't to blame!)

HMV

2011-01-12T22:56:00.000Z

After poor trading and announcing that they are closing 40 stores, the stock dropped to ~25p.
At this price its worth a small punt. DB have highlighted it popping up on their LBO model, and so too it has on the Raven's. Very roughly after knocking the balance sheet around a little there is back of the envelope £200mm of net debt after some restructuring costs and sales, with that restructuring the business should earn approx 50mm of cash a year, which put on an market multiple you get to about 46p a share. That is aggressive and rather rough, but it was worth putting in the book as a marked to have some more work done on it when time allows, seperating out the value of the chain waterstones. (obviously there are some pretty awful long term structual problems in the sector, internet retailing, the iphone, etc which should be depressing the price)

E-bonds

2010-12-07T07:13:00.000Z

http://www.ft.com/cms/s/0/540d41c2-009f-11e0-aa29-00144feab49a.html#axzz17PIFVPam

In yesterday's FT there was an article by JC Junker and G Tremonti outlining a proposal for the EDA (to be created European Debt Agency) to issue "E-bonds" up to 40% of eurozone GDP.

They also suggest that there be a switch option for holders of eurozone member sovereign debt.
"
The conversion rate would be at par but the switch would be made through a discount option, where the discount is likely to be higher the more a bond is undergoing market stress. Knowing in advance the evolution of such spreads, member states would have a strong incentive to reduce their deficits. E-bonds would halt the disruption of sovereign bond markets and stop negative spillovers across national markets.

"
For some reason they believe that Eurozone countries would treat the EDA in a superior way to the private market creditor, even though the EDA wouldn't have the bark of refusing to buy more debt, or politically the teeth of being a local voter when it came to a default.

"The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design" Hayek, could not seem more appropriate.

The "cure" to reckless sovereign borrowing, buyers ignoring risks and moral hazard is obviously to create another EU body, with a more complex system, with even less market discipline?

"Seagate Technology Terminates Private Equity Discussions And Announces Share Repurchase Authorization"

2010-11-30T11:53:00.000Z

http://www.seagate.com/ww/v/index.jsp?locale=en-US&name=private-equity-termination-repurchase-seagate-pr&vgnextoid=6692a92cf699c210VgnVCM1000001a48090aRCRD

Interesting the company instantly announced a share buyback, however the Raven is skeptical as to much many share will actually get bought back and when given that they intend to do it out of future cashflow. $2bn would be ~154mm shares, approx a third of the company!

Leverage?
Just for giggles where would that take the leverage of the firm? The Raven thinks its quite possible for their margins to fall to 15% then using 4yr average revenue and SGA, we're talking EBITDA of $1.3bn. Current assets cover long term debt and current liabilities currently, so leverage would be 1.5x still investment grade. but 10% margin and its 2.7 and we're getting to the covenant zone. Its not clear that its a lock either, there are strategic hurdles and a cash rich competitor, maybe levering up isn't the smartest trade.

So what are historical returns for announced huge buybacks?
Ok there aren't many companies that announce they're going to buy back a third of the company. Interpolating the stats isn't too easy, as two factors tend to drive returns, size of announcement and completion rates, which in this case are contradictory, top decile announcement size and probably lower quartile completion rate. Looks like about a 3% pop on the announcement, and another 5% over the year.

How much fat was on this puppy?
Punters are going to compare it to where WDC has traded, however its very clear that WDC priced in its own possible LBO on the back of the STX news, because taking a historical ratio of where they traded would indicate that STX was already at fair value to WDC before last nights announcement. Perhaps the trade on th open for the Raven will be to cover his very small STX short and sell some WDC, we shall as always check the price action at the time.

$STX call

2010-10-21T08:34:00.000+01:00

Company said they couldn't give future guidance or comment on PE approach given legality, which made for a short (if late and bland) call.

Interestingly they didn't participate in the "13th week", which $WDC had said was at twice the average rate of the prceding 12weeks. They think that the 13th week was busier because of pulled forward demand because of China's golden week, and quarter end dates.

$0.31 EPS and missed revenue.
49.2mm units (backs out ASP of $55) they said approx 8% q/q price decline. gross margin of 20.4%
'competitors more tenacious than years past'

long discussion on SSD's and hybrids in relation to notebooks, netbooks and MacBook Air.

general thoughts;
STX had popped up on the Raven's LBO candidates screen just based on historical numbers, however he'd excluded it because of the margin pressure and "third competitor" issue. To him it doesn't make sense for a PE firm to take such a big punt on storage when there are so many issues which management of the firm really don't have so much control over. Its also not apparent that higher financial leverage is either appropriate or adds value to equity holders. As the stories appeared in the WSJ its not to be written off lightly, there's a pretty good chance that a bid does materialize, and the rumoured price range is anything from $15 to $25. Anything above the 52w should be heavily mentally discounted.

FT article on Hitatchi Global Storage

Hitatchi is looking to sell its storage business, interestinly its lower margins and agressive attempts to take market share aren't helping the supply-demand imbalance. Strategically wouldn't it make more sense to buy the lowest margin competitor, accept market share and work on the cost base? the $1bn price tag for ~ $2.5bn of sales would value $STX and $WDC at $4.32bn and $3.84bn, or $9.15 and $16.76+$8.7=$25.5

$WDC earnings call

2010-10-20T00:50:00.002+01:00

As the Raven has noted on the blog a few times, the sector will face margin pressure going forward. That's clear that this is happening from their current results. Yes sales hit estimates, net income was there, however that doesn't disguise what's happening with the MARGIN.

average selling price $46, -$3 lower than last year, -$1 q/q.
historical seasonality suggests this should be the best quarter for demand
gross margin adjusted for SGA was 15.8% last year 20.8%, unajusted 18.2% v 23.2%
margin decline driven by lower average selling prices, which is being driven by an excess of ~10mm units (Raven estimate), "6-8mm units need to get burnt off" ~ 5% capacity
management correctly say that Seagate's ownership structure won't matter to industry pricing
margin errosion is WITH them giving up market share to our ominous 3rd party

next quarter's guidance appeared to be 50-60c although the line was terrible and the accent heavy, so when the replays up it needs to be checked. Seasonally the coming quarters will be weak historically and there doesn't look like too much to get excited about buying this stock. Two interesting side points from the call; 1) company see increased demand for sea shipped product rather than by air, which can pull demand from back to school next year into the preceding quarter and 2) China's demand may change seasonality going forward, although hard to tell given economic volatility.

very roughly its got about $12 of cash, so its run rate p/e on next quarter is ~ 7.5, however;

The Raven wasn't so clear as to what effect the ipad is having for solid state devices, or just how much the company held back from shifting product to protect prices. The company is going to look at strategy and investment decisions and implied that some products didn't make sense at these prices...

Anyway its interesting and is definitely a better looking from the perch than Seagate, but if anything it and $STX are a short tomorrow and perhaps for the next few months depending on price action. Longer term though, enterprise does look a good bet, and of course it could be LBO'd. So its definitely a high risk position either way.

UK income distribution, FAIRNESS

2010-10-08T03:41:00.001+01:00

We've heard much in the UK over the last few years about the inequality and unfairness in soceity. The Raven decided to look at some numbers because the political rhetoric as is often the case didn't match reality. Just looking at back of the envelope calculations some things didn't make sense. There has been much "taxpayer" outrage over bank bailouts (the fact that UKFI is actually breaking even on the bailouts is material for another post).

Wages; this is all earnt or income for a household, whether its derived from savings, self employment, salary, etc
Cash benefits; all cash payments directly from the government to the household
BIK; Benefits in kind; NHS, housing subsidy and travel subsidy
Other services; are the cost of the police force, army, government etc. The Raven's decided to allocate that evenly by household as its not obvious to him that any segment of soceity benefits more from it that one another, its clearly a cost so we must all be "enjoying" the benefit, even if it appears the ONS value this as zero.
Direct Taxes; VAT, fuel, etc
Vice Taxes; Tobacco, Alcohol and Gambling
Capital Taxes; Inheritence tax, Capital gains tax, dividend taxes, etc.

There are a few broad points to be made;
1) INEQUALITY, is nowhere near the levels thrown around by left wing commentators. They deliberatley exclude the value of services that soceity consumes and assume that these costs are magically absorbed by the tooth fairy. It seems contrived to be measuring income or household consumption to be only disposable income, when if one is even slightly unblinkered, it is very obious that households all enjoy police protection, the fire service the security of the army, etc. The Raven finds it outrageous that the ONS deliberately excludes these, but does include the NHS and housing benefits? by the ONS measure the lowest income household would have £18k and the highest income household £106k, whereas taking into account ALL services its £39k and £127k respectively. This is only half the story as obviously the government takes payments for these services so we should look at net income; in this case the numbers are £35k and £53k. How there is any uproar over inequality is amazing really. Especially when one cosiders the earned incomes were £5k and £101k.

2) As described before the majority of the population believes they are tax payers, and by this they believe net contributors, however looking at our numbers its pretty clear that only 25% of the population actually are net payers into the pot. The most disturbing indicator of the unsustainability of the system is looking at the middle of the distribution. A middle income house actually takes £15k more than it pays in tax, or to put that into budgetary numbers; £29bn. In fact subsidies of the middle half of the distribution total £117bn. A number not a million miles away from the current deficit of £150bn. To actually be a taxpaying household then one needs a household income of £48k.

It is very interesting that if one calculate the GINI index on earnings its 0.35, on ONS incomes 0.24, whereas taking into account services and actual tax paid its 0.05.

$EURUSD loss this month.

2010-10-01T10:37:00.001+01:00

Its always cathartic to analyse a trading loss, and hopefully consign it to the box of expensive lessons rather than repeating it. With this being a rookie mistake and knowing what he did wrong before the event its not going to add much to knowledge box, but certainley requires some public self flagellation because he has clearly forgotten some basics.

The Raven shorted $EURUSD quite agressively on the 21st Sep, then got stopped out pretty quickly, then bought some downside puts, lost that premium and repeated it again. All in a loss of 10% of trading capital, even for a high return and volatility account definitely needs some serious thought.

The first short was at 1.3128 stopped out at 1.3160 on the same day, 21st Sep.

The put buys were on the 23rd Sep when spot was ~ 1.3333, where the Raven bought a lot of 1 week 1.32 puts, and the second lot 28th Sep spot ~ 1.3450 buying the 1.33 put, and on the 30th Sep spot ~ 1.36.

The first thing to do is rather similar to what one would imagine an AA meeting is like, admit your errors and sins, owned up to the actual errorS. Now time to understand the flaws personally.

There are several rods with which to beat his own back;
1) The cardinal sin; The first trade was very wrong on one level and right on another. Trading before the market has started moving in your direction is a mugs game, really that is unforgiveable, bad discipline and senseless. The small redeaming feature is that a moment of rationality dawned and the trade was cut because of sensible risk management.
2) The compounding error; Looking at the actual bond auction data and what was being reported was obviously too good a bait for the Raven's ego and it enticed him to make a classic error. He believed that the market was reacting to headlines, when he knew the headlines were wrong, which is the incorrect assumption to make. Similarly if you know an idiot is buying a stock and its going up, it doesn't mean that the stock should go down, however its very tempting to use this data point to falsely bolster one's confidence in the trade idea.
3) repeat step 1. correct to buy options to limit risk, bloody stupid to ignore your own first principles and trade against the market.
4) repeat step 2. further headlines, except now one has to be honest and admit that a degree of loss aversion and ego were kicking in, as well as a sense of frustration for making the error of step 1.

Its only now after getting a bloody nose and having portfolio level hard risk limits kick in that its really possible to step back properly and analyse the mistakes made. Additionally one can analyse the initial premise for the trade with less baggage.

Its not automatic that we should repeat the $EURUSD meltdown at the beggining of the year if we see a further melt up in European sovereign spreads. Perhaps we could see what we saw with the dollar in late 2008, a squeeze in the currency due to large losses being taken in that currency? similar to the squeeze in the Yen that Hugh Hendry thinks may happen.
On a similar thought to the Yen, HH points out that politicians and central banks need the political capital to act. Although he was talking about a different central bank and set of politicians one could apply the same logic to the EUR. Trichet is not going to trash the currency unless there is some real economic hardship, reaching as far as Germany, and for that to happen we'd have to actually see the $EURUSD a lot higher to slaughter their exports. Trichet is very arrogant (the irony isn't lost in this comment), so the pain level will have to be enormous.

The other side that really has to be mentioned is the sell dollar buy anything for the end of year trade, (which fits really well with long term trend following alpha patterns, ie. its about this time in 2004 they swung around after being down a similar amount).
Anyway just a thought, which is rather pleasant to have without the burden of the idiotic mistakes of September. At least trading stocks has been profitable.

1. I will not trade against the trend
2. I will not trade against the trend
3. I will not trade against the trend..........

with implied correlation

2010-09-13T14:21:00.003+01:00

correlation chart

2010-09-13T14:11:00.000+01:00

despite the recent commentary on how correlation is, and how this MUST be caused by high frequency trading its quite interesting to look at correlation on a longer term basis. The Raven created a pseudoDow (which is subject to survivor bias, but much quicker to do calculatons on) and calculated a rolling two year "correlation" on the monthly returns. Instead of taking an average of the correlation matrix coefficients he used an approximation from the calculation of the dispersion. The difference is a couple of point of correlation at most, so the general shape of the chart shouldn't be missing too much.

The key takeaway from this is though, that while correlation may be high, its certainley not freakish or out of historical norms, and the panic in the media with respect to HFT overdone and ill informed to say the least.

BskyB and NewsCorp

2010-09-13T09:36:00.000+01:00

http://ftalphaville.ft.com/blog/2010/09/13/340871/news-corps-little-bundle-of-joy/
FT alphaville today highlights the 'competition commission concerns', which unsurprisingly a competitor supports. To take the liberty of summarizing the concerns; Sky + Times + The Sun = unstoppable control of the UK media, however the article says this is because of the ability to cross market titles and spend on marketing, neglecting more crucially the importance of how NewsCorp have really won the content war. The fact that the Times has a paywall when no other main stream newspaper does, or that Sky's pay TV model is dominant is the key issue, not spend on marketing or cross selling. These products are superior. Arguing against the deal because of competition concerns seems weak and definitely not as solid ground as the real reason that shareholders should be voting against the NewsCorp bid for BskyB, VALUATION. Taking 700p for an asset worth at least 1000p on a standalone basis would be absurd.

bits and Bob

2010-09-08T10:11:00.004+01:00

"The UK Royal Mail's £26bn pension fund made a 29% return on its money last year, helped by a sophisticated derivatives strategy, reducing the company's £10.2bn deficit and potentially helping along its possible privatization"

well it turns out that the "strategy" was buying equity futures, aka taking a leveraged bet on the market, very uhmm sophisticated.

The story that has been hogging the headlines in the UK has been the appointment of Bob Diamond as the new CEO of Barclays. Today Vince Cable (who now apparently prefers to be called Dr. Cable) has been calling for the breaking up of the large 'universal banks'.

This as a measure to reduce risk makes absolutely zero sense. Utility banks will still have to invest their depositors cash, any belief that making loans on commercial property or residential mortgages is not risky really should have been destroyed in the credit crunch. The financial world would merely have more firms with more linkages, and as such there would be no amelioration of counterparty credit risk, nor the removal of the moral hazard of 'too big to fail'. It is the systemic nature of financial intermediation and the lack of penalties on bondholders and creditors of financial institutions that propogate poor investments. There is only one logical solution and that is a pigovian tax on all creditors.

Krugman and the Wolf.

2010-09-03T10:55:00.003+01:00

Its interesting to see a high brow rehash of Krugman's appaulingly weak argument in the FT today by Martin Wolf.

http://www.ft.com/cms/s/0/119c59ac-b6c3-11df-b3dd-00144feabdc0.html

Essentially the argument is that because long term bond yields are low, we should not worry about government debt. Economically and logically it makes no sense. A proponent of this view would logically conclude that only now should Greece begin fiscal consolidation, rather than years ago. The whole point that fiscal conservatives are trying to make is that trying to cut a deficit when long term yields have exploded is almost impossible, needless to say, cutting government spending when private firms are finding it difficult to borrow makes even less sense that the gloomy scenario Wolf and Krugman paint.

It is intellectual dishonesty in its most repulsive form, and unsurprisingly partisan support of Balls by Wolf. Even if one were to swallow Krugman's prescription that fiscal responsibility should only be practiced when one is forced to do so by the market, the notion that bond yields are signalling a lack of concern isn't clear cut at all, especially in the UK given the government's commitment to cut the budget deficit over the term of the parliament.

If as the Raven believes, bond markets are signalling a lower growth, lower inflation future, then it makes it even more imperitive that governments show fiscal responsibility as their ability to shrink debts in the future through a growth in their tax base is diminishing.

$BP, life after the spill?

2010-08-10T03:17:00.000+01:00

Now there appears to be some relief in the stock the Raven thought it would be worth having a look at his revised estimates on $BP.

assumptions;
86 days of spill at 60k flow rate = 5.16mm barrels of oil
cost to $BP of clean up $30mm per day, and cleanup lasting another 172days = $8bn
litigation cost = $28bn from Exon Valdez figures inflation adjusted
aditional fines of $22bn from Water agencies etc.
so $58bn all in.
valuing the stock on its historic multiples that would make it worth 425p a share, $40.8 an adr. pretty much bang on where its trading now...

(the Raven does note, that he thinks those cost estimates are too low, especially the litigation cost, given that most estimates are based on the Exxon Valdez figures, which had less human impact than the BP spill, given that its not impossible that the litigation could be more like 3x that figure (but who knows??) in which case the Raven thinks its more like ~ 215p and $20.65, on the other hand there could be m&a as JPM have indicated that could get built into the stock? the one thing the Raven does know, is that there is more action in the name going forward)

An interesting point from Zecco on $WDC and $STX

2010-08-05T11:40:00.003+01:00

The Raven read this and thought it was interesting;

http://pulse.zecco.com/2010/07/data-storage-valuation-versus-earnings-stx-wdc/

Basically it points out that data storage is cheap ie. $100 for a terabyte now. It doesn't explicitly say it, but the argument is then that 1Terabyte is enough space for you to store everything you could want and therefore that you'd just buy the cheaper version of the 1TB. Now it would be easy to dismiss this argument by regurgitating a quote about a desktop PC being everything you could need in the 90s. The Raven thinks it more interesting to wonder where the actual limit might be using a bit of imagination. As we're only really looking at personal data storage what items do people like to store? (and a point he's going to dig some more into offline)
photos, music, films, books? software? personal documents

photos, music and films all have the potential to upgrade again to higher resolution formats requiring more storage space, books less so, but software and the personal documents they produce if anything produce larger and larger files. Without even looking at the massive increase in commercial data that will be stored in the future its easy to make an argument that the size of files will expand to fill the space available to store them.

The other point that really should be thought about is what percentage of the population actually store this kind of data on their pc's, and if there is a potential generational effect, as stupid as this sounds the Raven would have a rather good punt that penetration of these sorts of products is much lower with consumers the older they are. ie. Your average 50yr old isn't going to have as many digital photos as your 30 something, or as many photos as that 30 something will have in 20yrs. Just to make the maths easier, lets say people only buy storage when they get to 20, and that penetration really only goes up to 40, thats 20yrs of the population that could be 40yrs in 20yrs time. Not a huge growth rate, but certainley not a stagnating industry at 3.5% p.a. growth for 20yrs.

It still looks like a situation to sit on one's hands. Especially given his other previous thoughts on WDC and STX...

http://blackraven999.blogspot.com/2010/08/wdc.html

http://blackraven999.blogspot.com/2010/08/stx-translation-of-wdc-comments.html

share buybacks

2010-08-04T15:18:00.002+01:00

IT REALLY IRRITATES THE RAVEN WHEN SELL SIDE COMMENTATORS SAY THAT SHARE BUYBACKS ARE A WASTE OF MONEY BECAUSE OF THE PRICE THAT IS PAID ON THE SHARES. IT IS JUST STUPID.

Imagine there are two shares in a listed company, the intrinsic value of the company is $400 lets say made up of $250 of hard assets and $150 of cash, the company has no liabilities. So the intrinsic value of one share is $200.

Lets say the company decides to buy back 1 share, ie. 50% of the shares issued. if they pay $x for that share to you as a shareholder. If they pay $100 for the share, you as a shareholder then have $100 of cash, and 1 share left in the company, which then has an intrinsic value of ... $50 of left over cash+$250 of hard assets = $300. So as a shareholder you're left with $400. If they pay $1 for the share, then you have $1 cash + 1 share worth $250+$149 = $400.

WOW its the same.

STX translation of WDC comments

2010-08-04T01:48:00.003+01:00

Given the view the Raven has as to where $WDC should trade (in yesterdays post), then its relatively simple to make the same sort of read across in valuation terms to $STX given the belief that the "third party" drives margins down to 15% for these two players.

(the Raven is thinking that would be a great name for an activist hedge fund, you wouldn't need to be writing caustic letters with such an ominous name)

Reducing STX margins to 15%, then applying the same prop. adjusted EV/ebitda multiple then a stock price of $7.50 compares to $23. ($28.73 -> $10.67) a lot lower than its current price. Keeping its 3% margin premium that it had to $WDC then you have $9 and $13, so that tells you that the market is expecting them to be able to keep that premium, whether that's wise or not is a much more difficult call to make.

If the Raven is going to be buying anything in the near term future its going to be $WDC rather than $STX.

a bit of playful thinking;

2010-08-04T00:14:00.004+01:00

ok just some left field thoughts from the Raven on things as crazy as the gold dow ratio...

just looking at spx vs $GLD back to 1975 some stats using the following ratios you get an SPX based on current gold prices;

min 154

25% 682

50% 1217

75% 2716

max 6505

average 1833

we currently stand at 45th percentile, so not extreme at all.

if we look at the price of gold, fixing the SPX and using the lowest SPX/GLD ratio from the last gold bubble, we see a SPX inflation adjusted price of $8,353. whooooah indeed.

WDC

2010-08-01T23:14:00.006+01:00

This is a stock that the Raven has been keeping quite a close eye on the last couple of weeks (he's traded around a small punter sized position). The company makes hard drives, the Raven actually uses one of their external hard drives to back up all his data.

VALUATION
This stock is cheap, by whatever metric you'd look at it classically, if you're using historic data it looks cheap. EV/ebitda(ttm) its 1.84x, p/e(ttm) 4.5, p/s 0.6, p/b 1.32, forward p/e 5.7.

CHART
This looks like a three legged dog with fleas. a blind three legged dog. Its fallen 41% since its high towards the end of April. Its done 40% more volume than one would have expected in that period as well. The 200dsma is 44% higher, basically its ugly, and looks oversold, but thats not a reason for it turn tomorrow.

WHO OWNS IT?
Index funds, mutual funds and relatively passive money, so who's been selling??
4.3% of the float is short, 1.8 as a SR. (as of the middle of the month - so not very informative), not particularly high.

WHAT's THE GOSSIP/FEAR?
Going through some of the fears;
1) SSD tech becomes cheap enough to shut out HDD
2) inventory build up and volatile ASP (normal hardware producer risk really)
3) the "cloud"
4) areal growth rates too high or too slow (too high drives down the margin, too slow and SSD becomes cheaper relatively)

There is a lot of uniformed speculation as to what the fear is in the stock, the Raven doesn't claim to be any wiser than the street on this one, so its best to go through the obvious angles and see if it makes a bit more sense. SSD technically just isn't cheap enough to be competition just yet, the Raven also knows enough about the street to realize that this isn't a risk that has suddenly been priced in since April!! Neither is the cloud, or projected areal growth rates. So clearly by process of ellimination, investors are worried about inventory build up, pricing, etc. A "normal" fear in this sort of stock.

Listening to $STX and $WDC's earnings calls, its pretty clear that they both saw the same thing, the rather ominous sounding "third player" in their space producing an excess of 5mm units. They both speculate whether this is because the TP doesn't have as much control as they do, ie. aren't able to dial down their production as quickly, OR whether this is a deliberate shot at trying to gain market share with a limited number of OEM (original equipment manufacturers) that the TP is particularly close with. To the Raven the latter makes sense. In which case one should go and give the margins and balance sheet a good kicking to check how cheap the stock really is?

Ok, so looking at the suspected TP's driving down prices, the Raven thinks 'they' are running on a gross margin of ~15%, but also with higher r&d costs, and probably lower net margins than either STX or WDC. It does mean however that pricing could be quite weak, with bloody noses all round (although quite STX and WDC management seem quite aware of the danger of chasing market share thankfully). The Raven does think that the most conservative level is a 15% drop in ASP (average selling price). In which case WDC becomes break even, and worth ~ $11 of the cash its got on the balance sheet.

Realistically its easy to see WDC's margins get compressed down to 15% in the short term to match our TP's lower margins. That would mean EPS ttm of $1.95 ish. Putting that on a "value" p/e of 10x and you've got $19.50+$11cash = $30.50. So its only 16% higher than Friday's close. Certainley not bargain basement valuation in this scenario, putting a margin of saftey of 25% on that and you're at $23. (if you're a real punter though you could argue that you should use a market multiple of 14x and a 25% discount then you're looking at $28.73)

The other general trading point the Raven would make is that there seems little point being a hero, or draw a line in the sand, its much easier to trade the right hand side of a U than the left hand side, or "don't catch a falling knife", or "monkey's don't pick bottoms", etc, etc. Basically IF the Raven thought this was a screaming buy from a valuation standpoint, he's nimble and small enough to wait until the stock starts to move up before starting to buy. He's had a quick run of some quantitative screens and he'd only buy this stock when it broke throught its five day moving average on the shortest time frame.

So to sum up;
Looking in the rear view mirror, WDC is cheap. However the stock is telling traders and investors that there are worries about the future, by process of elimination it is 'clear' that market level inventory build up and weak margins going forward are a big risk given other market participants increasing supply and being less responsive to demand. The Raven believes that as a worst case scenario the stock trades at $11, at a realistic downside the stock is worth $30.50, so the Raven would look to buy a meaningful portfolio sized position if the stock went below $23 with the condition that the stock broke above its 5dma after that.

2010-07-22T16:25:00.003+01:00

http://online.wsj.com/article/SB10001424052748703467304575382810481110230.html?mod=WSJEUROPE_hps_LEFTTopWhatNews
The Raven saw this story and has to say that he wasn't that surprised, but he does wonder why the media isn't making a bigger deal of it, and why GM isn't being castigated. GM is going to pay $3.5bn for AmeriCredit, a subprime car loan business. You'd have thought it might have learnt its lesson with GMAC? or that it would be paying cash back to the government, but no, it appears it intends to use the taxpayer as a back stop and to agressively go after market share and unit volume, again you'd have thought it would have learnt its lesson, but apparently not. Heads the unions win, tails the taxpayer gets shafted, brilliant.

$CAT numbers were good, and the Raven feels that should and is driving a lot of the market action, however it does feel like there is speculation that China is going to be easing policy, just from the action of commodities, stocks and $AUDUSD (which has broken out from its recent range). The Raven sees absolutely no point in fighting this sort of a rally, he stopped out most of his shorts overnight and this morning. He'll probably put them on later in the day if we start to fade, but not before.

The Raven really would like to emphasize one point; you absolutely have to own your book everyday. A lot of investors fall into a very alluring trap, they care about the price they paid for a stock and not what the current price is. Focusing on your cost basis is suicide, it makes you sell winners too quickly and hold onto losers, as you're putting your pnl as an input into your trading decisions. It is much better to mentally at least start yourself off everyday at $0 pnl, and construct the book you'd want to own.

WDC

2010-07-22T00:40:00.004+01:00

$WDC results were worse than "expected". One would imagine that the market's expectations were lower than the consensus analyst expectations (given the pounding its taken this quarter), he's picked up a little stock given the beating it took today and after hours once reported.

Just to highlight some of the widely quoted stats that the Raven looks at before running his own prop models;
from FINVIZ http://finviz.com/quote.ashx?t=wdc
5y sales growth; ~20%
5y EPS; ~17%
Forward p/e 5.1
Trailing p/e 5.3
p/sales ~0.8
EV/ebitda ~ 2.56
Short ratio 2.2
% of float short 5.8%
52w change -(0.2)%
52w residual -(19.2)%
current ratio>1
cash>debt
mkt cap $6.92bn
from market watch;
8 buys, 3 overweights, 6 holds, 1 underweight, 0 sell

or with a touch more brevity;
growth CHECK
balance sheet health CHECK
valuation CHECK
beaten up CHECK
reason for being cheap ?? The Raven would guess that the sector has always traded at a lower multiple, but that there is softer demand and some reports of much lower pricing in June.
The Raven doesn't like the insider selling over the last year.

There also isn't a catalyst, and in this sort of environment its not a smart idea to have "value" trades on, or trades that are based on the market coming to its senses and deciding to reprice an asset upwards in your favour. Especially when the chart looks so ugly.

HOWEVER, the Raven does think it is a touch oversold technically and just can't resist a tiny punt that it recovers some of the ground its lost. This is not a position that he's going to add to if it goes against him as his stop is going to be pretty far away.

Bernanke was a big yawn today.

More interesting to the Raven's eye was the $EURUSD continuing to move lower, that really is a bullish sign for Bunds. He heard a great comment today, "if Greek banks pass the stress test, then the test has failed" or something to that effect. Not a bad line.

$AMR (3.4)%, $NFLX (0.6)%, $WDC (5.2)% (and off another 3.5% in AH trading), $WFC +0.6% yesterdays view of the results would have produced about +1.5% delta neutral at the close.

tomorrow we should see $AXP, $CAT and $SNDK that the Raven cares about. The Raven is short some $AXP, but thats more of a hedge for some of his longs.

some commentary on numbers today and the Bund& EUR

2010-07-21T02:27:00.004+01:00

$AAPL, what a surprise, it beat. stock up ~2-3% after.

$YHOO, one legged, blind dog with flees and partial sight. The Raven was itching to short this but took his eye off the ball, or lacked the stones to make another earnings call as his portfolio has been quite concentrated. (his toothless wonder was doing his best to reduce the range of his hearing) A lame excuse he knows, self flagellation in process...

$GS numbers a little disappointing to the Raven, he was actually expecting it to beat, and it didn't fit with what he thought the revenue would be (in terms of prop desk/fees split). The Raven covered his short just after the open as the tape and orderbook just didn't smell right.

$UAUA he cut his position in half, its had a great move from where he picked it up on Monday when it tracked $DAL falling out of bed.

tomorrow; $AMR, $NFLX, $WFC and $WDC of interest for the Raven.

He's not got trades on any of them, however for choice (gun to your head kind of choice) he'd be short, long, long, long those names.

He's traded around a lot over the last week, but has kept himself 100-200% short, if anything he'd want to increase that position right now, with a very tight stop, but that would just be too crowded and obvious.

The Raven has been scratching his head recently, trying to understand the underperformance of Germany 10yr government bonds, the Bund, which has lagged Gilts and US Treasuries. The only thing the Raven can think of is that the market is expecting more QE from the UK and US, whereas Germany won't participate, whereas looking at the chart above its perhaps more clear that the $EURUSD is the leading indicator for the Bund's relative performance, and that the $EURUSD's return has been linked more Greek headline risk. It would be interesting to see how things moved if there was a return to QE though!

where are the shareholders' yatchts??

2010-07-20T01:00:00.005+01:00

Its another investment banks results tomorrow, perhaps the most notorious investment bank's results, aka the face sucking vampire squid, or Goldman Sachs. The Raven doesn't have too much commentary to give on this particular firm, he's got a very small short in the name, however he does want to make a wider point about investment banks.

It is a famous saying, particularly on the buyside, "where are the customers' yatchts?". The question comes from a buyside fund manager being shown a fancy new corporate toy by a Wall Street broker, and the question is to highlight that in general given the level of risk, "intermediation" is far more profitable than investing, or allocating capital correctly, its the brokers with the fancy yatchts and not the customers.

The Raven would like to refine and distill another gem of truth from this scene. In our story (pre 1999) the firm's yatcht, is ultimately owned by the partners, as it is their firm. Updating the story today, it wouldn't be the firm's yatcht on display it would be a senior MD's yatch or a pan-galactic-global-head-of european exotic volatility derivatives trading. Just to illustrate here are some numbers from Barclays;

2009: Staff costs £9.95bn, gross profit £4.56bn

2008: £7.2bn, £5.09bn

2007: £8.4bn, £7.1bn

2006: £8.2bn, £7.2bn

2005: £6.32bn, £5.3bn

So for 5yrs employees have received £40bn and shareholders £29bn, representing a split of 58%, 42%. This is not atypical.

The vast amount of the Raven's time in the markets has been in the buyside space, specifically HFs. There is next to no chance of an investor giving you 58% performance fee, especially for trades that have so much systematic risk and require so much leverage. The other key point is that no hedgefund could in any way have a balance sheet that looked anything like a bank's, its creditors just wouldn't allow that much leverage, 5% equity, borrowing 20x your equity?? The Raven can imagine his PB's face; "I'd like 20:1 leverage and I'll pay libor+50bps", "ha ha ha, you're 'aving a giraffe mate"...

This poses two important questions; How do banks borrow on such competitive terms, both in the absolute amount borrowed and the low interest rate? and why do shareholders reward staff with such a high split of the profit when they essentially wear all of the real risk?

This chart is a gross oversimplification of the situation, however it does illustrate the point which he feels lies at the heart of the answers to our questions.

The red curve is a modified distribution of returns. In simple terms, the IB (investment bank), chooses to win a slightly higher amount, 4.39% instead of 3%, but when they lose are prepared to lose 10% more. This is attractive to shareholders because they effectively have a call option on the return of the assets. They typically have put up $5 of capital, borrowed $95 and bought $100 of assets. If the value of those assets drops $50, $15, or any number greater than their initial stake $5 they still lose the same amount, $5, however if the assets rise in value they get all of the upside, so $4.39 rather than $3 in our example. How much is this option worth? in the normal case $7.9, in the modified case $11.8. That would imply a fair book value of 1.58 and 1.78 respectively.

It should be very clear even to the casual observer that as a shareholder you become far more sensitive to the distribution on the right. Shareholders are MADE to care about the left hand distribution by their CREDITORS. As a lender to the IB, the potential for the assets to fall 15% means having lent $95 you would be facing a loss of $10, whereas in the unmodified distribution you wouldn't expect to make a loss!

However creditors appear not to have been sensitive to the risk of these potentially large losses, and that is because they believed these institutions where TBTF (too big to fail), so they correctly believed that the $10 loss would be underwritten by the government. To the Raven this perfectly explains why investment banks were allowed to borrow so much by the market, and our example shows clearly why they would chose to do so maximize this.

As we said before shareholders only have sensitivity to the majority of the time when they are making money if creditors do not impose a cost for leverage. Thus shareholders are willing to give up 60% of the revenue to the most aggressive traders and prolific deal makers, because these employees maximize returns in the right hand side of the distribution, even if their risk adjusted performance is no better.

So where are the shareholders' yatchts?

earnings commentary

2010-07-19T22:59:00.003+01:00

The Raven listened to the 57min or conf call replay for Delta ($DAL), interesting to see the market reaction given the numbers they posted with commentary, a couple of things did stand out to the Raven from his notes;

1) they lost quite a bit of money on "ineffective hedges", which they blamed on FASB rules, ahem excuse me chaps, but hedging jet fuel prices with crude oil is ineffective.

2) merger looks on track

3) they seem to have a lid on capacity

4) margins seem ok, even in Europe given the pricing pressures from FX

5) valuation isn't cracking right now, but, if they continue to pay down debt, it'll look substantially better, especially if they manage to keep a lid on labour costs and capacity issues.

$UAUA (United) numbers tomorrow, the Raven is more bullish this name as he's been trading its credit for years, the valuation looks a lot better and the tie up with $CAL should be "transformative". The way it traded today makes him slightly nervous tomorrow as it managed to close the gap it opened up today, so could easily have some room on the downside.

$GS numbers tomorrow, they will beat for sure, probably by something insane like a $1, however the Raven is still bearish on this stock, in fact on all investment banks as a proposition for shareholders. The Raven has a bone of contention that was raised today over at the motley fool. The Raven would like to expand a little bit on the idea that shareholders don't get enough of a share of the gross operating profits.

GS vs XLF residual chart update

2010-07-16T13:06:00.004+01:00

just a quick chart for the $GS residual, updated to where its trading pre-market after the SEC news. Certainley is an interesting level given that its still got numbers to come next Tuesday?

The Raven is going to fade this pop, in VERY small size.

It seems like a lot of people are getting short at theses levels, the Raven got short very early this morning, he's watching it with a very tight rolling stop as this is getting crowded, he wants the cheap seats right next to the fire exit, the ones covered in chewing gum next to the teenagers throwing popcorn at eachother who can't understand a Nicolas Cage film's plot, with an obscured view of the actual screen, yes thats how close he wants to sit to the fire escape..

turning Japanese?

2010-07-16T00:53:00.003+01:00

The Raven is really quite confused.

He's going to shoot out his thoughts as they pop up; maybe they'll make more sense tomorrow morning...

Just looking at the newsflow;
$AA beats, $INTC beats, $JPM beats, $CSX beats, and what does the market do to these stocks? FADES them.
$BP fits a cap, $GS get off with a $500mm fine, Fin Bill passes, etc.

You'd think we'd see the market a lot higher, or at least a bit more volume going through. The price action is terrible on the very short time horizon. Stepping back a little and it looks like we're right at the top of a decending channel, the Raven would have thought this newsflow would have squeezed out the shorts and we'd break hard out of the channel, but that doesn't appear to be the case, so he's a bit confused here.

$AMD up small in after market, another small hit for the Raven, however he got $GOOG wrong, but not all wrong as he'd not put capital on it.

WTI crude was all over the place today.

FX looks like the USD is still getting sold and EUR and GBP are still on fire.

VIX doesn't seem to care either way at 29

The one thing that does seem to care however is 10yr yields, which are <3%.

Interesting commentary from TeamMacroMan saying that it felt like summer last year and that we were starting a bear trap, the Raven was short then and he's short now and had been thinking the same thing for a couple of days.

$GS news probably not that good actually, given SEC had sod all $GS still had to pony up and the Raven guesses that it only covers this one series of trades, or apply to other banks. You'd have to think that they'll look at the other guys in the business, still its chump change. The Raven did laugh at a comment he heard that GS probably made more today trading their own stock, obvious joke.

Stocks are not expensive on Raven p/e, or on an equity risk premium model, both of which are backwards looking and take account of low interest rates. The Raven is tempted to look at Japan again, but its just not comparable, the stock market certainley wasn't at bubble valuations like the Nikkei and the policy response has been quite different (although not as dynamic as governments would like to pretend).

The Raven really disagrees however with some commentary he's been hearing; "either a depression is coming or stocks are screamingly cheap". Perhaps the stopped clock that is Bill Gross is telling the right time? perhaps this is the "new normal" (he had to swallow a bit of sick in his mouth just thinking about repeating that phrase). If the Raven is rolling out cliches that are wrong, maybe this time is different; maybe we've moved into a new regime where earnings grow at ~ less than half the old rate, so something like 2% not 6.2%, which would give a ERP based valuation of 950. Not inconsistent with where we are now, or the very low interest rates. what if growth went to zero? then we're really ugly and at 700. So a big enough spread to take these sorts of numbers with a lot of salt!

He can't resist looking at what the numbers would be like if we went back to the old normal; 2400. In which case, stocks are screamingly cheap.

fade the numbers

2010-07-14T15:44:00.002+01:00

some quick comments on numbers we have already seen and the market reaction;
$AA hit, positive outlook, however stock fell 50bps (on residual basis).
$CSX slight beat to the Raven's expectations, down 300bps (resid).
$INTC good beat, opened up so the Raven sold his long even though the stock might have broken out, if yesterdays action is anything to go by the stock will fade into the close regardless of its earnings news.

$AMD looks ok, however the Raven imagines that most of the good read across from other results is in the stock today, so he's going to leave it alone for the moment, especially as he thinks (still needs to do some more work on it) that $AMR, $GOOG and $JPM will be more interesting.

£ITV catching a beating today, interesting commentary in the FT that they'd perhaps try and change their strategy to a pay-TV model. The Raven's still long, although has traded around the position quite a bit.

In general he's been looking to increase shorts here and has been selling off longs.

the start to earnings season

2010-07-12T11:37:00.005+01:00

first a quick comment on $BP, interesting to see where the stock has retraced to, its knifed through the first fib retracement, next target technically would be 435p. The rumour today is that $XOM is going to be interested after talk that Apache would buy some Alaskan assets over the weekend. Overall though it does appear that the market is focusing on the "value" of the underlying assets, rather than liabilities. The question is whether the market comes back and has another look at the liabilities?

The Raven has spent a little time looking at upcoming earnings announcements, after the close we have Alcoa and CSX, which should be interesting. In general the Raven believes that stocks that trade generally strongly into earnings tend to beat estimates, however there doesn't tend to be much follow through, whereas a stock that is weak into earnings, and misses tends to see some punishment after the event. Again one has to pay attention to the volume profile running into earnings.

$AA, the whisper is that they are going to miss, however retail punter sentiment seems bullish it doesn't appear that the stock has taken too much punishment before the earnings, its residual returns are negative, on a weekly, monthly and quarterly basis, usually a negative sign for earnings. The Raven doesn't have a strong view where the EPS will actually come in, however he is biased to think that the stock will trade lower over the next week. EV/ebitda is ~15x, fwd p/e its cheap, but its not a pretty balance sheet, especially as capex seems to have outstripped cashflow over this cycle.

The stock is clearly going to be trading on earnings 2yrs out to the Raven, and it'll be interesting to see how the market reacts to any commentary from the company and how it guides.

Option implied breakeven move is approx ~6%. He's going to look to get short at $11 or better today in small size, and hopefully will be covering his short tomorrow morning at $9 (more likely if he's in the black it'll be 10.40ish, however he'll be sized to cover at $12.25 and it not destroy his July.

$CSX on the other hand looks like it should beat earnings and that the market is expecting that. That doesn't mean that it can't trade up on it. implied breakeven move ~4%. He'll look to pick up stock at $51-$50, depending on the tape. Again small size.

Its not pleasing to note that £BT have caved into the unions and given them a 9% pay rise for 3yrs, it seems the public are determined to live in a parrallel universe. Even though the stock is cheap (if you close your eyes to the disasterous pension liabilities, in which case its more like fair value, you really do have to wonder what is going through management's head? Is the firm going to be run for the benefit of its staff or perhaps for shareholders? novel thought. What % of revenue ends up as profit and what % goes to staff directly as comp, and what as pension? or £20.7bn of revenue;
profit of 1.7bn (8.2%) and £5bn to staff (25.1%)

2010-07-07T09:42:00.002+01:00

South Africa's trial by World Cup, by Gideon Rachman in the FT;
"While China has bent over backwards to attract foreign investors, South Africa has adopted investment laws that impose heavy costs on investors in the name of 'black economic empowerment'. That seems to have enriched a small group of well-connected black insiders, while discouraging job creation for the poor."
http://www.ft.com/cms/s/0/e97d29e6-8865-11df-aade-00144feabdc0.html

An interesting comparison made by Mr Rachman.

The Raven does wonder whether Australia's "Miners Tax" which cost Kevid Rudd his job could be translated to SA, if anything the case is easier to make politically. SA stocks are priced generally to include a big chunk of political risk offsetting the potential for growth, so its not clear even if such a measure was taken how much it would knock prices.

the end of the road for the 'cheap' FCUK ?

2010-07-07T09:07:00.003+01:00

The Raven had a quick look at French Connection the UK retailer last night;
£FCCN
Well the conclusion is that its a very unappealing stock, even at its low valuation. (nb. low not cheap valuation!) on Revenue of 214mm, CoS 104mm, but other operating expenses of 117mm and the firm's running at an operating loss, which it has really since 2007. Its been restructuring and hence has some restructuring costs which kick the average loss for the last two years at 20mm p.a. Just to put that in context the firm has ~ 130mm in balance sheet assets and ~57mm of liabilities.

The Raven got excited when looking at the balance sheet that this could be a good liquidation story as its assets really are a healthy dollop of cash 36mm , some receivables and inventory which should cover the current liabilities and it appears to have no long term debt at first glance. However there is the relatively ugly uncapitalized leases, of which;
7.3mm <1yr
35.3mm 2-5yrs
222.9mm >5yrs.
Now the Raven isn't familiar with how these get treated in UK bankruptcy, in the US he believes they could be treated as unsercured creditors, with a cap on the liabilities of max of 1yr or 15%, globally capped at 3yrs of the lease. Using that it would be ~ 7.3+35.3+34 = 77mm. Which wipes out any upside for shareholders. The only hope there could be is that these leases are below market rents, in which case the landlords would be keen to terminate the deals if the company weren't able to assign the leases for a fee.
In that rosy best case scenario which the Raven doesn't believe in then he thinks there is approx of 42.4mm of shareholder value in a liquidation scenario, approx 44p as a share price (last nights close of 35.25p), indicating a 20% discount.

The other exit for shareholders would be a sale to a competitor, however the Raven doesn't have a good feeling as to which of their competitors would actually want to take on these stores, as it would appear to be a bit of duplication for major competitors. This is pie in the sky talk however given the large stake held by Stephen Marks the founder and 42% shareholder. The Raven doesn't know the chap, but given his reluctance to see the problems facing the brand as it started making losses in 2007 it would be a surprise to see him liquidate or sell the brand to a competitor.

Pass, there are easier trades and fatter pitches to look at...

AXPchart

2010-07-06T17:44:00.004+01:00

the Raven thought its not a bad idea to show the $AXP vs the $XLF chart as he's looked at the $GS version, certainley some things to think about out there...

a couple of long weekend thoughts

2010-07-06T16:07:00.006+01:00

$LZ
Lubrizol popped up on a screen over the weekend, it looks ok from a valuation perspective, its been touted as a aquisition target. The Raven remains rather skeptical of that potential outcome, for sure speciality chems is a consolidating sector, however its not clear to the Raven whether Lubrizol really fits as 'bolt on aquisitiong' for the diversified big players. It does look relatively cheap given the recent operating improvements. Chart looks fine, but its more of a case of waiting for the right entry point rather than just buying a "cheap" lottery ticket at the moment. From a valuation perspective it appears to be >30% cheap, however as with all companies in this sector its very hard to strip out the cyclicality in the earnings and cashflow, so a lot more work to do on this puppy..

$BP

Interesting to watch it squeezing higher at the moment as the Raven thought it might, but before he crows, its interesting to look at the current newsflow and how that might change. Currently it appears that the market is reacting to small positive stories, such as the story yesterday that Libya basically thinks its an interesting investment, other stories have focused on SWF's buying more stock. At the same time there have been pieces highlighting that the actual costs have already hit $3bn, the stock is UP, so it does say which way the market is positioned perhaps? The Raven gets the feeling that the market would react far more positively to news that the well is capped than it would on news of additional liabilities.

As much as he would castigate himself for his dog leg forecast, but it does appear that the short term trend is up and that longer term it could be much lower.

$MDT $DD

The Raven is lagging behind in these longs to their hedges at the moment, he's not too concerned although he's keeping a close eye on things. It does appear that tech and financials are driving a lot of the index volatility at the moment, but that is the nature of the beast in a low volume summer period with lots of macro tid bits.

$EURUSD

"Interesting" that Trichet was making comments on fiscal responsibility this weekend. The Raven has to admit that he has thought that budget cuts in the UK were positive, however the implicit support of these budget cuts from Merve the Swerve and Tichet have really made him question their wisdom, the case that belief in these measures restoring confidence was shown to be hollow in the Great Depression seems a lot more compelling now. It is however interesting to see the EUR's reaction over the last week to a good liquidity auction, a good Spanish bond auction, Trichets comment... but in reality is it anything more than a well flagged short squeeze? and more of a USD sell off, given the weak data coming out of the US and perhaps a realization that the US isn't that much ahead of the curve. Especially when one looks at the way some of the other crosses have traded.

$GS vs $XLF

Without too much of a view this is a chart the Raven likes to look at, the residual performance of GS versus the financial sector ETF. Its interesting to see the GS seems to be losing its rerated premium that it earned during the financial crisis. Perhaps part of that is the unwelcome government attention (certainley not all of the derating as the process had already started before the SEC came out with anything), or perhaps the interpretation of the effects of the Volker Rule (which seems very unlikely given how watered down it has become). Just something to think about.

euro pop

2010-07-01T13:38:00.003+01:00

$EURUSD $EURGBP;
Yesterday had some interesting news that he feels slipped under his radar, that is perhaps playing out a little today. The ECB auction for funding went well and the commentary is that there still is some "excess liquidity" in the sytem. This positive sentiment and the fact the demand fell within the expected range is perhaps the reason that the bund has failed to rally on the equities sell off, which would also go some way to explaining the $EURUSD rally. Interesting to note however that initially this morning it wasn't a USD move, it was a EUR move, however with the employment numbers perhaps the read is going to be that the US really isn't that much ahead of the rest of the world on the road to recovery, and Europe's problems really are going to be the world's problems. It certainley feels like that in the UK, even though its not a member of the euro.

The other point to note is that the this month the euro area is going to be doing its stress tests. This will be run a very different manner to the successful US stress tests. The central authority will outline the broad details of the stress scenario, leaving the details and stress testing to local regulators. Obviously they will have zero meaningful data if they don't properly stress government bond markets in their scenarios, especially looking at the price of Greek bonds! but that isn't really the point of these stress tests, they're just an attempt to make the market feel like there is a finger on the pulse. They may well work, even if they have are meaningless, stranger things have happened.

The Raven particularly enjoyed listening to Greenspan's interview on CNBC, a rather balanced and an apolitical point of view regardless of whether you think he's right or wrong. Much better than listening to senators barking at eachother.

€DB1
Deutsche Boerse looks like a very interesting stock to the Raven. Its cheap from a valuation perspective, and certainley trades at a large discount to its US peers. The Raven believes it should face less competition within this home market, it also has much more exposure to derivatives. Ordinarily this statement would be not be positive in this environment, however its not hard to believe that exchanges will benefit from proposals to have all OTC transactions cleared through independent clearing houses, it certainley isn't a wild idea to make CDS trade on exchanges.

He remembers in 2006 (maybe 2007), the launch of the European Xover Index trading on exchange, funnily enough the HF community and a lot of users of the CDS market thought this was a good idea, however the dealers for some mysterious reason thought it was a bad idea and conspired to kill this listed contract. It might have something to do with their large trading margin, superior capital margining requirements, and the massive benefit of asymettric transparency they had in this OTC market. It certainley will be interesting to see how this develops over the next couple of years.

The stock hasn't been doing that much recently and looks a bit like a value trap to the Raven, so he's not doing anything with it, but its definitely on the watch list!

Medtronic

2010-06-30T23:29:00.004+01:00

The Raven had a very good day, and pretty much all of his net short on the close. He does have to however admonish himself for not sticking to some risk limits and targets, although his decision to overide them was profitable, it was perhaps not the wisest decision, hopefully he'll learn from it.

It is rather interesting to watch the way that $BP traded today, it looks to the Raven as if it traded with a negative beta today, however thats just his optics, rather than a proper analysis, but it would confirm his suspicion that the short interest is now rather significant and with weaker players who'll get squeezed sooner or later.

The Raven noted a comment yesterday from MarketFolly that $MDT had seen some insider buying, having a look at the stock its rather 'boring' but at a not too unreasonable valuation, on a BREVE valuation its got ~25% upside. It also passes his proprietary earnings manipulation test rather well. The residual charts look quite interesting to the Raven as well;

His current thinking is to divide his maximum position size into 5 clips, and add them progressively as we approach where the residual low is, putting one clip on tommorrow morning, another clip with the residual down a further 3.5%, then 3clips at the low, leaving a soft stop 5% below the residual level low. Getting to that point would be a loss of 7%+5% on the first clip, 3.5%+5% on the next clip and 5% on the remaining three, so a total loss of 35.5% on a risk unit, therefore for each 1% of total portfolio loss he is prepared to accept he should be willing to risk 2.8% of his portfolio as per unit position size, giving a maximum position size of 14%.

He'd also like to give a little explanantion of his thinking as to how many % of the total portfolio he would be prepared to lose; as a very rough and ready back of the envelope calculation to highlight the process. He expects to win with this strategy 80% of the time, winning 21% and losing 35%, giving him a net of ~10%. Now the Kelly Criterion would imply that one should bet the "expectation"/"odds" as a percentage of your bank roll; for $1 of risk, one would make a return of $1.86 (using american odds ie. including your stake in the return), your expectation would be $1.29 so that would imply betting ~ 70% of your capital, which is WAY too high. Suffice to say though that he is comfortable that risking 2% of his capital in this trade is below the KC limit, and within his other portfolio limits.

It could be quite quiet tomorrow so the Raven thinks it might be a good time for him to do some deep research on the name, perhaps it'll be an even bigger trade.

some initial thoughts on a busy day..

2010-06-30T13:27:00.006+01:00

Its a relatively busy trading day today, given its the end to a rather eventful month and quarter, so BR only has a few comments to make and note, even if it may be slight repetition;

$BP - the Raven has been looking at where he'd want to short this stock again today as he's now flat. News flow on capping the spill and its potential cost seems to be a little quieter, and there is now more speculation on how much its assets are worth. With bullish case EV's of around $200bn you get to a price of 345p or $31.05 (for the US ADR = 6 UK shares *1.5055). He's not a chicken entrail reader, sorry, chartist, but he thinks a pull back up to 382p could happen in the short term, depending on what the short interest is in the stock. So from 365-385p range the Raven will be looking to scale into a short again.

The Raven read quite a good speculative piece today about China by TeamMacroMan; it highlights how hard it is to make any sense of the any of the official numbers, but that if you look at sentiment for financial conditions, its a pretty ugly picture, and that fits with the Hugh Hendry, Chanos type hypothesis that China is a rather large bubble on the cusp of bursting, or perhaps it has already and we're just waiting to hear the pop in the West.

$MU
just a quick look at the stocks residual chart pattern is interesting (ie. a chart of the stock performance adjusted for a beta hedge).

Its interesting to the Raven because it appears to have missed out on the rerating that $SNDK has been given over the last few months, conference call yesterday was apparently weak, and the seem pretty cautious about their outlook. It does have an absolutely cheap motivation, but doesn't appear to be going anywhere in a hurry.
$GBPUSD
The Raven will have a little review of the UK macro position tomorrow when things are quiet, however if one doesn't wish to boil one's blood then perhaps not reading the Guardian is a good idea. Given this "newspaper" supported the LibDems in the election and is "left-wing" it feels justified in running a headline claiming that the Budget is set to destroy over 1 MILLION JOBS! SECRET TREASURY INFORMATION... PANIC, PANIC, THATCHER DUN IT, CUTS, PAIN, HYSTERIA.

All that headline articles such as this show is a distinct amount of prejudice, poor journalism and a lack of understanding of the underlying economics. Several facts that are neglected;
1) nominal cash terms there will be an increase in government spending over the period of the parliament
2) the same report that said that 1.3mm jobs will be lost, also said that it will CREATE 2.5mm jobs, so if the Guardian had chosen it could have reported 1.2mm jobs CREATED BY NEW BUDGET.
Ironic that the last government justified wild economic forecasts with the response that they "didn't want to talk the country down", yet in opposition they use half the facts to create a deliberately misleading picture and use that to undermine consumer confidence.

http://www.guardian.co.uk/uk/2010/jun/29/budget-job-losses-unemployment-austerity

a short update.

2010-06-29T23:03:00.003+01:00

The Raven has had a pretty decent week back in the saddle, generally being bearish has paid off. He's also made some good single stock calls, his longs like £BSY, $DD have outperformed their hedges, shorts like $AXP look like they are starting to breakdown.

The Raven believes that there are a lot of endowment type investors ie. investors that are using a 10-12month moving average to time their investment in the SPX500 and other equity indices; those averages were at the 1085-1100 level and he's been expecting selling to accelerate as we came closer to month end if we were below these levels. Tomorrow being quarter end could be pretty ugly as there doesn't seem to be much buying interest in the market out there. He's going to stay short and look to cover at most half of his position tomorrow over the day - but that depends on the volume profile and what the price action is like. He'll be a liquidity provider at the right price and odds.

He also noted some interesting comments by Team Macro Man, noting that fixed income markets and gold appear to be giving very different signals. Fixed income markets have seen longer term interest rates falling, this being a response to "European headwinds" one would imagine, and the belief that austerity measures and weak growth will neccessitate lower interest rates for longer. On the other side of the sovereign (what a great pun), it appears that investors in gold believe that ulitmately the action of keeping interest rates lower for longer will be more loose money hence real assets should rally. The Raven has lost enough money shorting gold this year to just leave this one alone for the moment, he thinks its a bubble, and the best way to trade this is going to be after it pops. He's seen enough adverts advertising how retail investors can get 30x leverage on their gold investments to know that its frothy. He's not going to short it again unless it crosses the 100d ma, increasing at the 200d ma and the 250d ma.

Returns from trendfollowing alpha's have been a bit of mixed bag, partly because of the squeeze and reversals in some trends earlier in the month, however they appear to be back on track. The Raven has looked at adding some better filters and money management to the system to try and improve the risk reward, however he doesn't want to compromise on robustness.

He took a good chunk out of $MU on the short side today, it had been pumped into earnings and looked pretty frothy given the market and how aggressive the whispered numbers were. He covered at the 8.73 level. If it does a lot more volume and breaks its resistance it'll be interesting to see where it ends up, its got a relatively cheap valuation versus the sector and improving fundamentals, so it may well become a good buy.

He had a quick scan over his M&A universe, really nothing to be done in that space at the moment by the classical look of things. He does however remain relatively bullish on UAUA post merger, he's keeping an eye on it; its not quite there yet.

It was quite interesting today to see the reaction to BP rumours. The JPM analyst put out a bullish "note", well actually it was literally a fictional piece, based on the idea that XOM would look to aquire BP at some point next year. He does point out more seriously that XOM could buy BP and potentially detoxify the situation if they can get a handle on the liabilities, and that they'd be buying a much lower rated asset. He notes that the company could pay up to 700p without the aquisition being earnings dilutive.

It certainley is interesting to hear valuations on the stock that are not talking about $400bn of liabilities. The Raven has done his own work, he thinks the size of the liabilities are likely to be more like $75bn.

Now today the dicussion has switched as to how much BP's assets are really worth. The Raven would argue that its all very well for JPM to look at different measures, but it seems strange that the market wouldn't apply some sort of uncertainty discount. using BP's old BR's EV to cashflow multiple we get to a stock price of;

BP currently has debt a BR debt measure of $47bn. It has operating cashflow-capex ~$10.6bn, putting that on a very high mutliple of ~20.7 = EV of $219, take off $75bn for the spill, $47bn of debt and you'd be looking at a stock price of ~345p. About 15% above where we are trading, hardly a screaming buy, or a decend margin of safety. Even if you take the better spill estimates JPM were coming out with at the beginning of the spill and put it on the old multiple you're talking about 507p, you're looking at a 40% discount to perhaps the most bullish possible scenario. Alternatively if you look at the fact that the credit market is pricing a high likelihood of default then we're talking about -100%. The Raven has been short, which he covered most of this morning when it appeared that the XOM rumours were gaining traction. He'll probably look to put on more shorts if it squeezes up.

Where would he buy it for a long though? well actually he'd buy the credit instead at this sort of relative pricing. As stupid as this sounds, but he thinks it'd be a buy more at the 130p level, but if its trading there, then for sure the market and media are going to be coming out with a lot more aggressive estimates for the spill costs, so obviously that value would probably be lower. As arrogant as this sounds, it does appear to the Raven that T2 and Whitney Tilson have got in way too early, especially as he doesn't feel that many pension funds have dropped the stock, or those div yield players have kicked it out of their funds, that would be significant selling pressure of a size that wouldn't be able to be absorbed by traditional short term liquidity providers, or hedgefunds, so it should produce a relatively high risk adjusted return just because of the size.

a non-EUR rant

2010-06-23T00:06:00.004+01:00

Well the Raven thought that he would feel the need to rant about the EUR, but that's not such a big urge today, Mrs. Raven has been bored by it several times already this month.

However, the Raven did read an 'interesting' interview with Vic Niederhoffer today (VN as he won't be able to spell it correctly twice) based on the premise of interviewing people that have been spectacularly wrong. Indeed VN has been wrong, in huge size twice, blowing up his fund in 1997 and 2007 after some huge gains. One might speculate that he'd have learnt or been in denial, however he instead had some strange analogies to make and basically wished he'd taken less risk.

Traditionally the Raven would mention the Kelly Criterion at this point and may well do as an appendix, but his main point is in conjunction with another lame article (whose title he has already forgotten) that was essentially a collection of 'good trader habits'.

This article certainly didn't deviate from the well trodden and essentially useless path of stock phrases and ideas. "let your winners run, cut your losers quicker, don't get emotional and bet the right size". These sorts of articles frustrate the Raven as they portray investing and speculating as a simple rule based skill that is applicable across lots of asset classes, time frames and regimes, which it just isn't, as anyone that is going to be successful for a long period of time should recognize. Now the Raven dislikes empty criticism that doesn't replace or better that being criticised, so in that vein;

1) Sound risk management is key

Now that doesn't mean having fancy systems or whizz bang models necessarily. That means the hard non-formulaic work of making sure you don't bet too much of your capital, that you realize what you're betting on and how much you can lose, how quickly and in what scenarios. Also kicking the portfolio with random ideas, historical ideas, likely scenarios, the kitchen sink, anything you can throw at it and making sure that you can live to fight another day. Now for the ironic glib formulaic statement; correlation is ephemeral, and if a hedge can hurt you when you need it help you, it probably will. As is a realization that other people are thinking exactly as you are, so don't rely on liquidity to get you out of your book, that my friends is a recipe for an offer only market, Oshkosh truck size spreads when you do find a bid and a PB that has a penchant for s&m.

2) Don't bleed to death

This second point is really point one again, however its for those investors who are "smart", i.e., skeptical of the market, who predict 9 out of 2 crashes. The Raven once heard a very glib quote, 'we don't believe in VaR or any of those statistical risk metrics, we realize how flawed they are, we understand what risk is, and the amount of money you can lose". You may think this is precisely right, especially in absolute space terms, however risk is more like not being able to play the game again, and in a roaring bull market as an absolute fund returning L+100bps will rapidly lose the firm capital and your ability to bet, heaven forbid you really loaded up on protection and lost money, well then you can guarantee that you'll have your capital pulled before your cheap options pay off to make you the next Paulson.

Its interesting that VN says in his interview that in general people are too skeptical or too gullible and that he believes he is the latter. One would have to agree given the fact that he's blown up spectacularly twice after huge performance. The Raven agrees, however both of these problem characteristics tend to cause blow ups and bleed outs because of not paying enough attention in just making sure that you're still around to trade tomorrow, and next week, and next year, etc, etc.

back in the saddle;

2010-06-21T22:45:00.003+01:00

Today was the first day back on the perch for the Raven since the LO arrived 10 weeks ago; perhaps a chronic lack of sleep and circadian rythm will be positives for a skeptical trading style? or maybe not so much.

He would review his position notes if he was feeling ultra disciplined, he's not, that and the fact that the world has changed rather drastically in 10weeks mean that his portfolio has radically changed twice. Currently he's long a few UK stocks, a long and short a couple of US stocks, long some bund, short the CAC40 and Eurostoxx, with no volatility, fx or commodity positions.

in no particular order;

Bsky B; Newscorp has made a bid of 700p for the stock, its trading at 705p, management have said they'd look at offers above 800p, its 100d ma pre-bid was 563p and closed at 600p.

Now the Raven had a quick look at this, ok Newscorp have a big stake already so there aren't going to be any other buyers coming out of the woodwork, (however that didn't stop Pepsi recently having to bump its bid for its bottling groups), so its not going to get silly. BUT even at 800p the Raven thinks Murdoch is being a wiley old croc, the cashflow on this asset has been rock solid, its blown its competition out of the water so that it only has the government to fear rather than competitors. The Raven as a Virgin Media customer because he's not aloud a satellite at his flat really can say there is a massive difference and that he'd switch back in an instant based on service, content and value for money. In terms of valuation, well the Raven doesn't think 800p is out of the order (in fact he thinks 900p is more like it).

Dupont; now he doesn't feel as comfortable with this long as it doesn't have a near term catalyst, but it is relatively cheap and he thinks its turned the corner for earnings last quarter. He thinks that it should be well over $50 a share and closed at $38.41. Its next earnings are towards the end of July, so he's just put this on really small, looking to increase over the next couple of months. He does however want to avoid buying too much of this if it starts to tank into earnings, firepower for the day before and enough rope to hang himself will probably be essential in doing a SNDK.

Nedbank; the Raven has no position currently, because he sold it when it was bid up on rumours that Standard Chartered would buy it from Old Mutual. Its still an attractive business in a growing market, however it really doesn't fit with his skeptiscm for financial at the moment, or more precisely doesn't fit enough at this price.

Next; its just recently popped up on the Raven's radar (primarily because he was looking at ASOS). Now this has no catalysts at present BUT it does look pretty decent in terms of valuation, the Raven would like to kick the tyres and have a look at some of the stores as he hasn't really been clothes shopping for years. Its priced with almost no growth and the Raven really doesn't think the UK consumer is going to be that badly hurt. Once we get past the budget and the bluster, people will begin to realize that its not all doom and gloom, the government is taking the tough actions and there will be growth in the future. Ok some public sector jobs will be lost, and government spending will be lower, but for most households this IS positive. It will provide a large deflationary or disinflationary force in the UK, which will the Raven believes keep UK interest rates lower for longer, and stop the BoE from unwinding its QE. As such a large proportion of UK households are on floating rates, this really does make a difference to their disposable income, and he doesn't believe that the fundamental spending nature of the UK consumer has been bludgeoned to death just yet. Its trading at a BEVE (a Raven proxy for EV/ebitda) of 7, Marks and Sparks is trading at 8.5, Tesco at 8, Sainsbury at 8 and HnM at 19. The balance sheet looks pretty good, margins seem healthy, management seem fine. The Raven thinks there is at least 20% upside on discount valuation to start, and probably another 20% if his macro scenario plays out. So he's got a good clip on.

PUB; he's still got a position in this, although he's hesitant using the word still as he's sold 70s and bought 60s a few times in the last few weeks. Viz-a-viz is aforementioned UK consumer punt, PUB looks like pretty good value against book value. It appears Einhorn agrees, who's the Raven to argue (he hit his own hubris alarm bell there).

BP; well he's spent a lot of time looking at this and following the situation. In short, given the size of the liability, risks, etc, etc the Raven wouldn't pay more than 150p a share on a punt in small size. Its not at that level yet.

r-a-n-t...
Firstly Obama has been a total tool for trying to turn a ecological disaster into positive PR. There was absolutely no need to compare it 9/11, that was both disrespectful and weak, as was his attempt to turn the issue into a childish and divisive international spat with one of the US's closest allies, only today the UK has seen its 300th casualty in Afghanistan.

Hayward has made the situation no better, his apparent lack of concern, lack of media savvy and insensitive comments are naive at best, reckless for a CEO earning a fortune from shareholders who've lost billions more than the estimated cost of the disaster thanks to piss poor managment. He doesn't appear to have had a clue as to what happened, hardly appropriate for someone supposedly tech savvy. Of course BP should pay for damage that it has caused, but the Raven is very skeptical of a firm putting money into an indepent escrow account for government to hand out as compensation, its hardly as if you're handing over the cheque book to an institution know for its fiscal responsibility.

But at least both guys got their lives back this weekend, time for baseball, golf and a spot of sailing, its not like they have well paid powerful jobs. Mere mortals work weekends, especially when they are under pressure.

the Raven will be moaning about the EUR tomorrow.. and probably the day after that..

and the day after that..

and the day after that..

EU bailout part deux

2010-04-12T09:05:00.002+01:00

He's just noticed that the last post of his was actually about the EU bailout of 3 weeks ago, and the Raven has a few hypothesesesese;

1) Greece is budgeting using a 3% funding rate, hence the reason they are moaning so much about 6% interest rates. That would mean that with their ~130% net debt to GDP they are going to see an additional budget deficit of ~ (6%-3%)*130% = 4%. Which if the Raven were to be right would be larger than the gains they've made from their "austerity" package. Obviously he's being a bit cynical and speculative with that comment, but its entirely possible.

2) The announcement of a €30bn @ 5% loan today actually includes the IMF funds that have been anticipated (€10bn @ 2.7%), that would mean that ... the EU is actually giving €20bn @ 6.15% which would fit more into line as to what Germany has been asking for.

3) These loans do nothing to change the fact that Greece would appear to be insolvent and is just kicking the can down the road. The Raven can't really see a point where they will start to run a surplus, or that staying with the EUR they will suddenly become competitive enough to grow their way out of the hole they're in.

4) That this still appears to be a backstop facility and that the EU haven't actually fired the bazooka, they've just told you how big and how much it cost.

5) The Raven is rather suspicious of France being so insistant that a deal is done, might it have something to do with the fact that its banks have been the biggest lenders to Greece?? non non non of course its just being a good EU neighbour, Sarko would never be so blatantly ridiculously opportunistic.

position notes

2010-04-12T08:28:00.002+01:00

As the Raven is about to take a non market related holiday due to the arrival of a LO, he thought he'd summarize his views so that he's got something akin to position notes when he's back in the land of the living.

$EURUSD; well the Raven spunked some cash on some 1week puts on the EUR and on some put spreads, all pretty low strike and took off his EUR short. The options were certainley cheap as a vol trade and he doesn't doubt that if he'd be delta hedging it he would have made money on today's gap alone. But as he was actively trading his delta and taking a view he's wasted 2% of the fund, ye pays ye money, ye takes ye chances.

$GBPUSD; he's put on a bit of short position this morning (pre-waterfall). The bookmakers now show a fall in the probability of a Conservative majority from ~61% to 58%. Whereas GBP has rallied with the rest of the market. Its also interesting that the polls over the weekend didn't show a marked difference. Longer term he's bullish GBP because of the large event risk priced in.

Nedbank; he's been long and trading this around, selling at 141 and buying in again ~ 136 over the last two days. This still looks like a good longer term thesis, which again has suffered from some country specific news.

$FRX he's been looking at this stock and bought some after its large sell off on Thursday when it didn't get approval for a new drug. He thinks the market is placing an unfair discount on the drugs that have yet to roll off, its a small position and a small trading long.

Gartmore Group, the stock has dropped because of the suspension of one of the directors, its been stated that this is due to him directing trades to certain brokers in conflict to the firms rules, however the Raven thinks the market has mentally linked this to the insider trading that the FSA have been investigating, which the company have denied. At this price relative to other asset managers it looks like a decent punt, especially given that its bite size and he's got about 5% of the portfolio in it currently.

$UAUA yes its an airline, yes its got a unionized workforce, but its also got a lot of potential in the m&a space, the numbers don't look too bad and its definitely had some momentum, as much as he hates to admit it the Raven is bullish on this space and UAUA and BA look the best ways to play it. BA is a different case, because he thinks if Willy Walsh get the best of the UNITE union and introduces the staff savings that could be expected, if they wrap up and integrate iberia well, then the stock could easily be worth 700-800p, so at 240p that looks like a good enough bet. The Raven has been pretty long on its recent small move, but took a few chips off the table last week, partially because he's a chicken and partially because there were other trades to put on.

Pendragon is about 10% of the book as well, it looks like a good story at a good boring price, he's made the thesis before and is bored of it himself.

He's got a small long in oil and gold, oil because if tensions rise with Iran then this will benefit, if the Chinese do a reval then commods will rise as well, and it doesn't look like he's risking too much for both of those plays.

He's short $AA and $AXP as a hedge.

is that a bail out?

2010-03-26T11:09:00.002Z

It appears that the Greeks have been given a deal by the EU, where Germany have agreed to a package rumoured to be up to €25bn of support if the IMF comes in on the deal. Now it appears to the Raven from looking at the IMF website and doing his maths that the IMF will be able to lend €10bn at a blended rate of 2.7% (below where Germany could borrow). One would imagine that the Germans would be canny enough to argue that they (and France) should lend the remaining capital at a higher rate, say 4%? which would give Greece an average cost on €25bn of 3.48%.

The Raven thinks this is a ridiculous plan, which only serves to increase moral hazard and does nothing to either clear up the problem or to really stop the risk of contagion.

First lets but €25bn in context, thats pretty much the debt that Greece needs to roll over in the coming two months, and is ~8% of the total government debt.

Secondly it doesn't solve what really is becoming a solvency issue. Greece has moaned very loudly that is having to pay 6%, one has to wonder really whether they are good for the money they've borrowed already if they can't deal with a 6% interest rate. Its entirely irrelevant what what interest rate other EU governments have to pay on theirs.

The Economist had some numbers this morning that highlighted that the percent of GDP that would be taken up with interest payments will grow from 5% to 8.4% from 2009 tp 2014. They also highlight that government debt will be ~ 350bn which as a % of today's GDP is 147%. As a long term investor the Raven really doesn't think that the Greeks will ever be able to pay that back or grow their economy quickly enough to shrink that number relatively.

http://www.economist.com/business-finance/displaystory.cfm?story_id=15772801&source=hptextfeature

The structure of this "support" from the EU appears to be that they will step in when Greece can't borrow from the market. Surely Sarkozy can see that this encourages speculation? The real question is if this package is big enough and scary enough to make the market feel that Greek paper is safe and that you'll be bailed out if you buy it, in which case Sarko won't be firing his bazooka just yet.

Personally the Raven thinks this announcement will cause a small rally in Greek paper, but the market will come back and push the hand of the EU, either on Greece or another one of the UPIIGS.

the FSA "business plan"

2010-03-18T15:14:00.003Z

Hector Sants has come up with a new business plan for the FSA;

http://www.fsa.gov.uk/pages/Library/Communication/PR/2010/048.shtml

Basically Sants seems to believe that by adding 460 new "high quality staff" to the FSA and increasing their budget overall by 9.9% that they'll magically be able to spot asset bubbles. One would imagine that the "high quality staff" that they intend to hire will be among those made redundant in the credit crunch.

The FSA has only recently found the ability to find and bring mildly punitive action to 3 cases of insider trading. Odd that its been said that approximately 1 in 5 m&a deals are thought to have been traded on before being publicly announced. 3 cases in 9 years, good job guys?

Does £455mm represent good value annually? especially as that money is going to come from consumers of financial services, ultimately the UK public. The UK treasury estimates that the governments assistance in the financial crisis cost ~£10bn, given this crisis was about 1 in 20yrs event then actually the cost of having the FSA is going to be equal to the cost of the crisis, except the Raven would imagine that the chance of the FSA stopping a crisis accurately without predicting 5 out of the last 1 recessions before hand to be rather low.

The Raven thinks that Buffet's maxim that the firm should be simple enough for an idiot to run because one day an idiot will run it should be applicable to a regulator, because clearly and idiot does run it already. Rules should be simple and easy to enforce and should aim to do less harm than good.

UK Household balance sheets and inflation

2010-03-15T18:15:00.004Z

The Raven chose his lunch break yesterday as an opportunity for mastication of the proverbial cud. He chose to reread the weekend's Economist in a state more awake and alert than he had been on Saturday morning, sans coffee. The Economics Focus section had a couple of comments which he disagrees with, but had blithely slipped under his radar;

"Spending in rich countris, such as America and Britain, will flounder as long as householdslook to pay down debts they aquired to buy expensive homes. A burst of inflation would speed up this process by eroding the real value of mortgages".

Well this may well be true in the US, but the Raven takes issue with applying the same logic in the UK. In the US its pretty normal to take out a fixed rate mortgage, whereas in the UK its a small percentage of people that fix and when they do its usually for 2yrs or less. Therefore this glib statement that inflation and the associated higher interest rates would be beneficial to UK household balance sheets is not only wrong, but dangerously lazy in its thinking.

Lets look at the effect on the 'average' or more precisely median household in the UK of inflation of the 1970s style.

HBOS survey "average houseprice" of £160k.

median household income of £30k.

current floating mortgage rate of 5% for a first time buyer with LTV of 90%.

so mortgage payments of £8k a year, approx 26% of gross income. lets say inflation is 10% for one year, and lets say our first time homeowners are especially skilled at wage negociations, they manage a 5% real wage increase so that their household income is £34.5k (+15% gross). But lets also be kill joys and say that perhaps the BoE acts and raises interest rates to 8% (only!), so mortgage rates go to 12%, which would then make the mortgage payments £19k, 55% of gross wages. You don't have to be a genius to see that consumer spending would get shafted and house prices would be smashed by a wave of foreclosures and reposessions. In fact at that point one would imagine that house prices would face a really serious fall, and a proper buyers strike, and unfortunately that would be the same time that a lot of home owners would be locking in their exposure to houseprices, because after they've been forced to sell if prices rise they're not going to be participating.

Its not like the Raven has been dramatic with his assumptions there, what happens if the worker only got inline with inflation wage rises? and if the BoE had to raise rates the same amount? then we're talking £33k, and mortgage payments of £23.5k, so approx 71% of gross income. Now that is negative convexity and something that could destroy households in the UK.

Yet its something that has happened in living memory and very very few households would be prepared for. So perhaps readers can see why the Raven thinks that the commentary from the economist this weekend is a liiiiiiitle dangerous.

at 17% inflation it doesn't matter what a household in the UK does, they are broke. Yet most households would take that risk, and for what gain a 1% or 2% difference in their mortgage payments? speculation indeed...