Tuesday, 26 February 2013

Post game press conferences for everyone . . . and would you want a Guru?

The headline should read: "Fed President unwilling to let markets drop for more than three days." Bernanke did his usual thing and dovishly played down the suggestions contained in the Feds own minutes that the day of reckoning was any closer now than it was a couple of months ago. The S&P500 thanked him and crawled back into the green for the day in what will probably spark a few relief rallies in Asia.

On 21st February when the Fed minutes were released “many” of the 19 officials who attend the rate-setting Federal Open Market Committee “expressed some concerns about potential costs and risks arising from further asset purchases”. So what can I take away from Mr. Bernanke yesterday who said:

“To this point we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more rapid job creation.”

So is this Mr Bernanke "winging it" away from the clubhouse. If this was a sports team we'd be talking about mixed messages and a divided locker room. What a mess!

It's much the same in Italy with many commentators now calling for a Grand Coalition similar to the one in German in the mid 00's. Maybe with the right coach in charge it could happen and of course nothing would get done. Brussels and the IMF might actually prefer a nothing coalition that would be divided and unable to fight the drift to non-representative "technocracy" as represented by Mario Monti?

Central bankers such as Bernanke do not seem to have a problem with the deterioration of risk assessment in these markets, but some agencies and governments still disagree. The European Banking Authority said on Tuesday that it estimates that some banks have up to a 70 percentage point lower risk weighting across their credit books than their peers, and that only half of the difference is due to easily explainable factors. What do we make of this? Well as I've said before, the best place to be in a bank during a crisis is in the room where all the crap assets are held because you can mark things according to an agenda rather than on where they probably are. This works on the way up as well as on the way down. On the way up just because a piece of paper you hold trades at (say) 70cents in the dollar doesn't mean you have to markup your own holdings to that level. Excuses such as: "It was only 250k and this is part of a billion dollar issue of which we hold 100m are commonly used. What this of course means is that no one knows the real book values of banks until they liquidate the questionable paper and sometimes they never do. I'm not surprised that the EBA can't find a consensus on risk adjust valuations.

The Chinese have the same concerns as the EBA. According to UBS China's shadow banking system accounts for no less than Rmb13.6tn ($2tn), or about one quarter of 2012’s GDP, and could be as big as Rmb24.4tn, or nearly 50 per cent of GDP. This means that Chinese regulators have little control of the real leverage in the system. When China Trust Co's sell paper to investors backed by loans to real estate developers or coal miners etc. you start to see a Ponzi-like symmetry to the risk still in markets. Therefore today came news that China would try and slowdown some of the activity of these intermediaries. Of course, like Mr Bernanke they don't wish to panic markets, so there's lots of talk about reigning things in rather than stamping them out. Clearly wiping out 25 - 50% of your yearly economic activity would be akin to a suicide, but doing nothing leaves the system dangerously exposed to a collapse in confidence. Remember that Ponzi schemes work until enough people question the ability to be repaid, Madoff's being the best example recently.

Investors can probably be relieved that Bernanke has said what he said, because the markets will now again discount things. If Italy gets a grand coalition and if China says business as usual then it's game on and we can once again see how many walkers a tight-rope can hold.

I'm riding up this morning for a meeting in Paddington to discuss a charity bike ride. I'm not sure which of the bikes I'll take out, but the clouds here look fairly benign so the Pinarello's carbon wheels are a distinct possibility. One thing I did spot recently that made me green with envy were these Guru branded THM Claviculas cranks:

They come as standard on the new Guru Photon HL. You don't see as many Guru bikes around as you used to and here in Sydney I seem them mainly in their aero TT guise being used by the triathlon crowd that laps Centennial Park ad infinitum. This one looks pretty cool and at under 11lbs it's astonishingly light. I looked up some of the components and lets just say that if your over 80kgs you better find another mount.

That of course doesn't mean that you can't admire one if you see it.


Burning bridges . . .

Up yours baby! . . . Italy has thumbed it's nose at Europe and the people have spoken. The question now is will the President be able to get a coalition together, or will they go to another election at which point surely people will be given the chance to cross the Rubicon back to the north or burn the bridges and prepare for the IMF in the form of Christine Lagarde to come waltzing down the peninsula.

Whatever happens will now start a period of risk in the market meaning that Fridays rally was the nervous shorts covering.

I miss a lot of stuff, but I'm not easily surprised. Here's a thought . . . usually within the financing for an LBO a lot of the lower quality paper is in that 5 - 10 year duration range, which going back to the "silly period" of 2005 - 07 means we're about to see paper maturing that might push a few deals into the courts. Today's example is rump of the TXU deal  (aka Energy Future Holdings Corp.) the then record- setting leveraged buyout by KKR & Co., TPG Capital and other notables including the Goldman Private Equity could become the biggest bankruptcy of a private equity-backed company since the failure of Chrysler Group LLC. Basically the restructuring talks have already started because the likelihood is that if you own some of the bonds etc. linked to this deal you won't be getting back 100cents on the dollar in 2015.

The Energy Future  buyout as it came to be known was essentially a bet on natural gas, the price of which has collapsed and currently sits 77% below the prices at the time of the deal. Readers of my blog will remember me mentioning the situation of a number of hedge funds in relation to the natural gas price. One investor in 2011 told me it was the most compelling commodities bet he'd seen in years and that if the fund I was then setting up made it a core position we were sure to get some investors. There was a rally, but it wasn't the "ball tearer" that many hoped for. Back to the current day and the $40.1 billion of debt that the KKR consortium put together on the back of 8.3bn of their group's equity. It's time now for the first tranche to get repaid. Good luck with that. I suggest investors watch out for senior paper trading at a level where the debt for equity swap into the new entity might make sense. I have no insight on any of the bonds but as usual will make the appropriate calls to see where things are trading.

A sour deal like the TXU one could impact financing rates for the current M&A mania. If that happens my theory of a yield led M&A boom is going to take a hit. Please be careful in these markets.

I managed a short ride today to help my wife with her training for this weekends NSW cycling event . She rides a white and pink Pinarello FP7 made with Toray's 46t carbon. It's a nice machine with a minor drawback that it uses SRAM Force as a groupset. I'm promising to swap that to Campagnolo if she gets into daily biking . . . . but it's a chicken and egg thing. So that we matched I took my Pinarello out and it was a pleasure. I'm thinking of putting the Fulcrum Racing Zeros in order to go further afield without the tubular tyre puncture risk that I have on the Boras. A great morning for me.


Monday, 25 February 2013

They'll always be an England . . . so gear up and ride

Mondays are always a bit disconnected in Australia. There's lots of weekend news, but without the big boys the local market takes some time to get up a head of steam. In the spirit of that I suggest listening to this week's BBC History Extra Podcast (21st February). Why you ask? Well the podcast in question starts with a piece on government investigations of the Bank of England in the 18th Century.

I guess point is that the more things change, the more they stay the same. I also thought it was particularly apt given the Moody's downgrade of the UK. My own feeling is that the UK has disappointed itself. It defies conventional thinking that Sterling can be as weak as it has been and it still hasn't had the export led bounce that many including myself have expected.  Here's a chart of GBP against various currencies. It looks to me that the 20% advantage that the devaluation has given the UK has been wasted.

What is it about an economy rich in engineering and technical prowess that is producing so little that the rest of the world wants? I want to believe the UK will get out of this, but I fear that Osborne could be jettisoned on the fires of a Keynesian solution.

Mario Monti the illegitimate Italian Prime Minister is having a few problems getting re-elected,or should that just be "elected". You see the funny thing about democracy is that when people have it taken away from them they get a bit upset. Brussels and the IMF can do as much cheerleading for Italy's ultimate "grey man"as they like and it will count for absolutely nothing if Monti falls. The protest vote therefore is the key and people look likely to use it.

Of course the Italian situation is similar to that of the UK. The export side of the economy is just not working. Combine this with the straight-jacket that is the Euro and you can see that getting out of the current malaise looks difficult at best.

Japan and Italy are two sides to the same coin. Having said that the Japanese at least have their own currency to debase and don't have to rely on others to help. It looks like ADB President Haruhiko Kuroda is likely to be the next head of the BoJ. The JPY as I write this is back over 94 after the leaks came thick and fast. The commitment to weaken the JPY is truly of samurai (or should that be Kamikaze) proportions. Japan struggled through much of the 90's and 2000's with a weaker JPY then they have now and they still remained mired in de-leveraging from their hubris of the 80's. Perhaps Japan should have done this earlier . . . . or maybe the west should have learnt from Japan and avoided this disaster in the first place.

A mate of mine sent me a new app suggestion for my iPhone. Bicycle Blue Book is a site that gives you a valuation on your bike in case you want to trade it in for a new model. My thought is that this is likely to be used for insurance valuations and I'm not overly in favour of it. I don't need my bikes constantly valued. For example I looked at an old Colnago that was for sale on the local bike trading website.

I'm not going to buy that bike for anything but pleasure, for me it's similar to my wine collection . . . I own these wines because I intend to drink them myself. It's a good idea . . . but please don't get obsessed by it as car dealers have with a similar app. Thanks Si.

I got out on the rainy Sydney weekend for a Sunday ride around the beaches. This coming Sunday I've volunteered to be road crew for my wife and sister-in-law at the girls only event at Sydney's Olympic Park. I've dusted off the stop watch and whistle and expect big things from the girls. If you're also taking a person of the female variety to Gear up Girl then stop by at my mobile workshop to compare torque wrenches and Strava data.


Friday, 22 February 2013

Petulant children . . . minor adjustments

The Federal Open Market Committee’s Jan. 29-30 meeting said the central bank " . . . should be ready to vary the pace . . . " of its $85 billion in monthly bond purchases. The market hated this and I didn't blog yesterday because I wanted to see today's reaction. The equities world wants to see this as profit taking day with no particular significance. That of course ignores the trend in the bond markets where big picture economic soothsaying is somewhat more prized.

High Yield Bond ETF v. SP500
The divergence of the high yield bonds and equities probably indicated that we were due some rethinking. The assumption has been that people would sell their bonds to buy equities when the risk reward equation in bonds no longer made sense. To degree that looks right and probably caused the divergence. But what happens when the Fed takes away the very factor that was decreasing the equity risk (i.e. cheap money) and instead tells you the investor that you're on you're own. This is what we had two days ago. The first time the Fed cuts the monthly repurchases we're not going to be in Kansas anymore.

Of course I remain somewhat sceptical that a real bear market is around the corner because of the M&A factor. More evidence came from that space comes in the form of the $1.2-billion all-stock deal for OfficeMax, where shareholders will receive 2.69 Office Depot shares for each OfficeMax share, valued at $13.50 each. This is a deal that has been 10 years in the making and only in a time of super liquidity do the two CEO's see the need to get together. The numbers are not compelling and much of Wall St had given up on this. It's a deal all about synergy and lacks the transformational dimension . . . but it got done and will be unlikely to suffer any competition regulation disruption.  M&A does rely on financing, both by banks and by companies. If you want to leverage an asset you have to be able to borrow against it. If the banks have the money, which is what Bernanke has been pumping in a very low rates of interest, then they can do the deals. If not . . . 
Any notion that the US regulators would step in and require more restraints on the off-balance sheet side of the US majors would have me worried. The Bloomberg piece that came out yesterday mentioned that: "U.S. accounting rules allow banks to record a smaller portion of their derivatives than European peers and keep most mortgage-linked bonds off their books. That can underestimate the risks firms face and affect how much capital they need." No great surprise here, unless of course you're a legislator who doesn't understand risk. The bottom-line for me is that you need to watch the regulators. 
I got my new Fulcrum Racing Zero wheels yesterday and managed to get them out to test things. A couple of interesting things occurred in the process: The hubs on my Mavic Cosmic Carbone SLRs are spaced slightly differently than that on the Fulcums and for that matter my Campy Boras and Easton's. This means that you have to recalibrate you're front and rear derailleurs.
For me that's a problem as I'm yet to master the dark art of bike tuning. I have small problem from yesterday in that my chain is touching the front derailleur on the lowest gear (small ring on crankset / big sprocket on rear cassette). To change this it should require a very minor adjustment using the limiter screws. Having said that, it's not always that simple. If I get this wrong I'll be off to the local bike shop to see if they can fix it . . . if I get it right I've just saved myself some cash. The main thing to do is be very deliberate when you tune your bike. The manual talks about doing things in 1/8 turns of a tiny screw, but the margins we're talking about are so fine. In the case of the adjustment I'm trying to make I need to aim for 0.5mm between the chain and the inside of the front derailleur cage. I reckon that's closer to a 1/16 of a turn of a screw, but if you go too far you'll get your high gears out of sync. Honestly I wish I had electronic, because from what I understand the yaw control makes this process much less testing.

The price difference between Campagnolo Super Record  Mech and the same in electronic is approximately $1800, which is a lot trips to the LBS. 

Wednesday, 20 February 2013

How do you spell colour / color? It depends . . .

On this blog I'm always running into the problem that I have a large readership in the US and non-Commonwealth who don't always like the spelling vagaries of the English language. We all know that our American cousins hate "u" and "s" where no letter or "Zee" seems more appropriate to the spoken word. And don't get me started on tyre / tire! I have no hard and fast rules, so I'm going to mix it up as a lesson in confusion . . . sorry.

As predicted on this blog nearly a year ago Marius Kloppers is stepping down from BHP. I bring this up because of my recent posts on M&A being the new driver in markets. Kloppers failed twice when attempting significant deals with Rio Tinto and Canadian company Potash, additionally he'd over paid for shale oil assets in the US. Jac Nasser the Chairman had lost confidence in Kloppers who failed to understand local sensibilities and competition regulations when attempting the two big deals. BHP is now a lower growth cash-cow restricted by infrastructure costs when building new projects such as the mothballed Olympic Damn expansion in South Australia and by regulators when trying to grow by acquisition. One wonders if it might be best for shareholders if the company was split into its various divisions so as to cast a smaller shadow on the world stage. Obviously Iron Ore is the loser in that scenario as it remains a behemoth unlikely to be given much room, while still needing to raise significant capital for new projects. I am also guessing  that the board would argue that the company offers a smoother revenue profile by being diverse, but honestly without the accounting magic is it really? I expect Kloppers to pop-up on a couple of boards . . . at least he offers experience on how not to get things done.

I heard an interesting interview on the BBC yesterday concerning Latin America. Without going into the details I thought the comments in respect to Chinese expansion of commodity holdings were interesting. No surprise then when the FT is running with a story on the expansion of Chinese oil interests to a level where they will produce 3m barrels a day abroad in 2015, almost double their 2011 overseas output of just over 1.5m b/d and equivalent to Kuwait’s annual output. China is a bit like BHP, too big and rich to ignore.

Given the pollution situation in China it seems unlikely that the old 10% per annum growth rates can be sustained. There's a limit to everything and sure if you're an auto executive you might not worry given how few cars per head there currently is, but you should. People maybe be dumb sometimes, but they're not completely stupid.

I've said it before and I'll keep saying it, hybrid bonds should be in your portfolio, but then again there could be exceptions. The Co-Contingency bonds or "CoCo's" recently issued by KBC at 8% and Barclays at 7.625% each feature write down to zero once the bank’s common equity tier 1 ratio falls below 7%. Now this is a very strange phenomenon in the bond world because traditionally within corporate capital structures bonds rank above equities in the case of a bankruptcy. Even in the case of CoCo's the tradition has been that the bonds are exchanged for equity when the barrier is breached. But in the case of these bonds you get wiped out! So the bonds are worthless even though the bank remains a going concern. I do not like this structure and only the most sophisticated investors should have these in a portfolio. This is far worse than the Japanese resettable convertible preference shares I have written about previously and I would go so far as to say that this structure is a direct consequence of QE and general central bank put option theory now in the market. This is the ultimate evidence that risk no longer seems to be a factor.

To prove that I'm not completely out of touch I decided to go through the motions of how to price the barrier option embeded in the above CoCo bonds. The first thing I did was pull out historical information as to what Barclays tier 1 capital has been. Then I mapped it against the share price. Why? Well because I wanted to work out the correlation between tier 1 capital and the shares, because I need to judge the bonds worth daily as opposed to quarterly when the official tier 1 is published. Also you want to know at what point it's worth shorting shares against your bonds. For example say Barclays Tier 1 moved down from 9% to 7.5% in a quarter? You need to ask what effect that has on the shares historically and does it stabilise as management retain earnings etc and take restructuring action or is there a propensity for it to fall further. Does shorting the shares help if you can't sell your bonds? Then of course you have to know what happens to volatility at this stage, so you could use a jump diffusion model that is essentially a modified Monte Carlo simulator. Look without going into it this is very complex and just by me writing down this small number of factors should tell you that without the proper quant analysis you should avoid CoCo with the death cliff feature.

I managed to do some riding in the Mt Wilson area about 3 hours from Sydney over the weekend. Cycling in the Australian countryside is rather different from the Swiss and French Alps. Here I managed to miss running over a black snake by less than a metre and a Wallaby by less than 10 metres. I can't remember ever seeing such exotica on a ride in France, though I was once chased by a guy near a gypsy camp who decided that I shouldn't have been witness to whatever they were packing into the boot of their car. I still have the strava track of that ride somewhere I should look it up and look at the reading from the heart rate monitor . . I bet it jumped into the high 180's!.

I decided enough was enough for the Mavic tyres I had been using on the Cannondale, they were just too soft and the ride on a debris strewn road in the Blue Mountains only served to confirm this.

I changed over to the Vittoria Open Corsa Evo CX II's that I got on sale last week. I took them out yesterday and immediately got the impression of a more solid road feel. I doubt whether there was much of a speed difference and that suits me fine.

My new Fulcrum Racing Zero's have finally arrived at Attelier de Velo. It took 3 weeks and I honestly don't blame the guys, but once again you have an example where the Australian importer is slack and probably hasn't improved shipment times since the 90's. As with many things "down-under" the consumer has always been told take it or leave it. The problem is that the consumer now has a choice. Items that have a value of less than a $1000 can be sent in tax free because the government has said it costs more to collect the tax than the tax itself. I'm sure that they could work out a more efficient system like they have in Switzerland where they make it the responsibility of the courier companies, but they haven't so the winner is the online retailer. I want to support my local bike shop because of the service I get. I know I could have saved around 25% buying these wheels online, but because I'm a bigger rider and things can go wrong on even the most solid wheels I decided to pay up so I could have an iron-clad warranty. Mind you if I lived in the UK and bought these on Wiggle I'd have a very good warranty and still save the 25%.

In case you're wondering bikes imported from abroad into Australia attract a 10% GST on the bike cost and for some stupid reason on the portage. There is no large bike building industry in Australia. Sure there are a few guys doing custom steel frames, but even the locals have worked out it's cheaper to design here and manufacture in China or Taiwan than actually set up a factory in the country.


Friday, 15 February 2013

Fear and the unknown . . . mitigating equity risks via pref shares

A quick note today to catch up after I rode Akuna Bay yesterday. A nice day in the northern fringes of Sydney and it put me in a good mood for weekend ahead. I'm heading up with my bike kit to the Blue Mountains to get some hill climbing efforts in.

Yesterday I took my sister in law for her second hill climbing session and as you'd expect the improvement was significant. It put me in mind of the adage about fear coming from the unknown. If you remember Andy Schleck's face before the start of the final time trial for the 2011 TdF you'll know what I mean. The Schlecks had failed to ride on the course during spring and therefore for all their efficiencies as pro's they still had lots of questions about the course as the electronic clock ticked down for the start of the ride. Cadel Evans had ridden the course and on the platform looked calm and determined. The rest is history.

It's the same for all riders and that's why it's often good to revisit hills soon after a first ride to see what extra you can get out of it. Once the fear goes you're free to ride. This weekend I'm hoping to set some new PB's on the Mt Irvine to Bells Line of Road ride for these very reasons.

Fear is a strange thing and the market has lost it. The familiarity with how the central banks of the world behave has left the market with expectations of continual bailouts when things get tough. Bernanke has clearly got what he wants, but a note of caution that riders familiar with a particular course disrespect it at their own peril. 

Finally, continuing my theme of the past week or so comes yet another M&A deal. This time the chief benefactor of the US governments bailout of AIG Mr. Warren Buffett teams up with  3G Capital, a private equity firm backed by Brazilian billionaire Jorge Paulo Lemann to take Heinz private. The bid values Heinz at $28bn, including $5.1bn of net debt, with Buffett (Berkshire) and 3G will contributing $4bn of equity each, and Berkshire buying another $8bn to $9bn of preferred stock paying a 9 per cent coupon. Buffett loves prefs and especially those that pay him an above market rate of return. He did the same on numerous occasions. His only risk is that Heinz is too geared to pay back the leverage on it's balance sheet. He's now first in line in the case of a bankruptcy and he's smart enough to know that the equity value of some of the Heinz brands far exceeds the risk he has taken on. Good for him. 

The lesson you should get out of Buffett's actions is you can buy equity if you like, but if you get the chance always have preference shares or convertible bonds in your portfolio.


Wednesday, 13 February 2013

Thanks Lloyd for agreeing with me . . .

Thanks Lloyd for agreeing with me. Even the king of traders can see old school M&A leading the US now that money is free. More evidence regarding this fact comes from today's news that Comcast is buying out GE’s 49% in NBCUniversal for $16.7 billion, more than a year ahead of the date planned when GE and Vivendi sold the US cable operator a majority stake in December 2009. OK, so it's old M&A, but they're completing it early which shows confidence in things. It's also good news for GE which will now use the 18bn on their balance sheet to accelerate the buyback and invest in their industrial businesses. And it's that investment portion that will drive the M&A because GE will probably acquire bolt-on businesses which will in turn predicate the trickle down of what Mr. Blankfein is saying.

Europe is still well behind the US on the road to recovery and news yesterday is that the number of new vehicles sold in European this year is expected to shrink to 12.3 million, a 20-year low. Goodyear and Michelin cut their outlook for their European businesses. The cycle of cash for clunkers has run it's course and Draghi's low credit terms haven't trickled down to the retail customer in enough volume yet.

During the 18th century the UK government consolidated its debt into a single perpetual bond that has been restructured, but never cancelled or repurchased. You can buy these bonds and they currently pay a coupon of 2.75%. The point is that governments now have to think about doing the same. In addition they have a huge bubble for the retiring baby boomer generation who could use some guaranteed annuities right now. I expect that governments will and should look at this again given the absolute rates. Would I buy them . . . no, but if I was well into retirement I might.

Following on from yesterdays comments about Canada and the great Canadian short trade I happened upon the news in the local Sydney newspaper that the number of people living in the state of New South Wales (capital: Sydney) looking to buy their first home fell to its lowest level in 21 years in December. Governments in Australia are obsessed with voters buying homes and pander to this in various vote buying schemes. The fall coincides with changes to first-home buyer incentives, which was withdrawn on October 1 for purchasers of existing homes. It was replaced with a $15,000 grant to buy a new house or apartment priced below $650,000. Senior economist at Australian Property Monitors, Dr Andrew Wilson, said:

"It's the lowest number of first-home-buyer home loans approved in a month since January 1992,"  . . . "And the proportion of first-home-buyer loans to total loans is 8.1% in NSW, the lowest proportion ever recorded. The average over the 20 or so years is 18.7%. We've seen a significant collapse . . . this shows that first-home buyers have not been activated to buy new homes."

Of course Master Builders Australia chief economist, Peter Jones, urged the Reserve Bank to cut interest rates at its March board meeting.

I guess this is good news for many of the bears on the commodity countries who believe things are way over heated. The trouble is that once again without employment collapsing there's not much of a trigger.  The best you can hope for is that the Australian dollar slides back into the 90's as the RBA cuts rates and the value of the Yen carry trade takes a hit.

I spent some time today cleaning my Pinarello and am looking forward to taking her out this afternoon. I last rode the Pinarello in the rain last week and it was surprisingly dirty. When you start cleaning a bike it's always hard to stop. It's amazing what over use of lubricant can do in terms of attracting dirt and road debris. I had to get into the rear derailleur with an old toothbrush to clean things out. I tend to use Rock 'n' Roll Gold chain lube as it's a dry lube.

Maybe last week I should have used a wet lube. For readers not familiar with the various lube types the heavier wet lube repels water, where the dry lube can be washed off in the rain. I only ever used wet lube in the winter in Switzerland as I'm a fair weather rider at best and prefer dry lube when possible. It's always worth trying a few different types so as to decide which best works for your training.


Tuesday, 12 February 2013

Triggers . . . .

It's become popular on line through social media for crackpots and tin hat wearers to jibber on about all sorts of crazy conspiracy theories. My first thought yesterday when I saw tweets about Pope Benedict XVI resigning was to think that the usual nuts were at work. But how does a staunch conservative skip 600 years of history and decide to abdicate? Who knows? Maybe, just maybe this is the start of one of those cycles of crazy things and maybe it's not. We shall see . . .

The S&P is pushing new highs this year and so to are valuations. The index now trades at 14.4x trailing PE and needs some new catalyst to really take it higher. The M&A is in my mind the biggest reason the market can go higher,  . . . oh that and Bernanke buying 85bn in MBS etc. every month.

There are number of stale shorts still in the market, one them is Canada. Like Australia Canada has largely sidestepped the GFC. Also like Australia they have ridden the commodity boom, or more specifically the oil sands and energy boom to safety. Their American cousins though have long believed that the Canadian consumer is as vulnerable as they were as credit levels peaked in 2007. Bloomberg today printed the following:

"Canada’s major banks have more than tripled their lending to car buyers since 2007, the year before the global credit crisis struck, and automakers are increasing dealer financing. The appetite for cars may undermine the Bank of Canada’s forecast that consumer debt will stabilize around a record 165 percent of disposable income, one reason policy makers cited last month for delaying plans to raise interest rates."

Reading the full piece it felt like some guy at a hedge fund had written the story. The problem is that merely citing a fact such as non-mortgage debt per person reached a record average C$27,485 in the fourth quarter of 2012, up 5.9 percent from a year earlier, gives you nothing without a trigger. In the beginning of the GFC that trigger was a whole raft of resettable mortgages that started the ball rolling. A lot of the consumer loans that get cited in articles like this one are fixed and unless people lose their jobs it's not likely that they will go into stress en-masse.

A quick word on those hoping an iWatch could be a trigger to get the stock and margins growing again at Apple. Maybe it can, but by definition it seems less likely to me given the consumer's preference for quality jewellery on their wrists rather than small computers. I have a Garmin 210 GPS watch that links to my heart rate monitor and a foot pod that measures my running cadence. The point is that I don't wear it when I'm going out to dinner or to meetings because it just doesn't look serious enough. I can pull an iPhone out at a meeting and people don't think anything about me other than I have a smart phone. I doubt an iWatch will replace a Rolex as most desired time piece in Asia anytime soon.

I got some Elite Custom Race Bottle Cages today to replace the ultra expensive Cannondale carbon fibre ones I had on the Evo. I lost faith in the carbon fibre model after I cracked my second one and at 60 bucks and limited availability I just can't be bothered. I had intended on going with the Arundel Mandible, but honestly given the pro's race with the 10buck Elites I felt that was good enough for a Clydesdale like me. One of the things I found with the Cannondale cages was they were almost too tight for a standard water bottle. Maybe I just needed to get smaller bottles.

Rain in Sydney has me off the bike. I was hoping to try out my new Vittoria Open Corsa CX II's that I've chosen to replace the Mavic tyres I currently have on the Cosmic Carbone SLR's. They have a 320 tpi thread count, so essentially they should be about as close to a tubular as you can expect. I ad thought about trying latex tubes with them, but Sydney streets seem littered with glass and latex is nowhere near as resilient as butyl tubes when treated badly.


Monday, 11 February 2013

Educating yourself. . .

Readers of this blog know well my interest in the spiralling costs associated with education and health. In the past I've mentioned the bubble in US student debt and alluded to other countries which have a similar cost spiral. I thought the NY Times on weekend had a typically good piece on education in the US. To give you an idea of the inflation in the US tertiary system the Times gave the example of Appalachian State University (NC), where a degree can easily cost $80,000 for a state resident, including tuition, room, board and other costs. 40 years ago the total was about $550 a year. With inflation, that would translate to just over $4,000 for each year it takes to earn a degree. The problem with tertiary education is that governments of all colours have effectively bribed the middle classes with cheap education loans and it is this cheap money that has caused the spiral in costs.

Think about it this way, if you print money and hand it out for free you flood the system with worthless cash. At the same time if you lower admission standards as has been the case noticeably in the UK and NZ then you create the environment where the universities have very little incentive to do anything but expand into areas that used to be covered by trade schools and polytechnics. If governments cut back quickly on this free money they risk a) a voter backlash and b) bursting a bubble (effectively now a ponzi scheme) that would carry the US middle class back into recession.

It's taken a while but as I said last week the pension industry is fast getting its' own education in the securities lending or stock banking business. First it was Blackrock, now comes the news that State Street is getting sued for similar reasons. The FT says that State Street now has $2.1tn of assets under management and $23.4tn under custody and administration, so even though the lawsuit in question comes from a tiny pension fund (assets less than 100k) the ramifications could be significant. Apparently State Street has received a 50% fee for revenues generated for stock lending from the fund's holdings. I know the State Street will argue this has more to do with the size of the portfolio (i.e. it's more like a minimum charge than a commission at this level) than with the actual fee charged in this case. My own thinking with the electronic management of custody the actual costs to managers should be decreasing and what we're now seeing is the death of the old fat margins business; it's as though Henry Ford was able to convince the world that Model T's were hand built by artisans rather than mass produced . . . eventually someone gets into the factory and works out the real cost of production and either copies it and charges less or exposes it and forces them to pass on the benefits to the consumer.

Are investors educating themselves on the risks in the bond markets? If you believe like Neil Dutta, head U.S. economist at Renaissance Macro Research LLC, that U.S. economic growth will be three percent "or more" this year, than you probably also believe that QE must start to cool. Mr. Dutta is no uber-bull, but if his J-curve effect comes into play and we see a switch into risk assets then how can you sit in bonds? Last week comes the news that investors pulled $1.2bn from US junk bond funds in the week that ending Wednesday, and the money was redirected to funds that invest in loans, which pay a floating rate of interest.

High Yield (blue) v. Investment Grade (purple) Bonds 1 year returns

This of course provides some insurance as to the turn in interest rates and says to me that at least part of the investing world has woken up to the risks of sitting in lower credit grades. Add to this the pick-up in M&A I wrote about last week and you'll soon be seeing lots of new paper hitting the street with higher coupons and perhaps better seniority.

I'm educating myself more on my cycling training. If you're like me you'll probably go through the following training progression:
  1. Time - ride for longer
  2. Distance - ride further
  3. Speed - ride further
  4. Heart Rate and Calories- ride to try and measure your effort
  5. Power - ride scientifically
I've progressed through the first four of these and now use measures such as the Strava suffer score to approximate my riding effort. This is far from scientific and lacks in it's ability to zero in on effort and improvement. Until now I haven't wanted to commit to a power meter system because of cost and weight. For those not familiar with power measurement you traditionally have two ways of getting a measurement: a) a specially made wheel with hub based measurement or b) a crankset with a similar instrument. Either system is going to cost at least $1500 and for my bikes probably closed to $2500, so it's not a no-brainer for the amateur gentlemen rider. There's been a couple of lights at the end of the tunnel, the first has been pedal based systems which Polar and Garmin have been associated with, but are still around $1000, the other is the CycleOps PowerCal heart rate estimation system. It's the CycleOps PowerCal system I'm more interested in as it is close to $100 depending on what extras you want. 

The main thing to know is that it's an estimation, so in short bursts reviewers are saying it won't give you an accurate read-out, but over a longer ride within the limitations of the algorithms inputs you'll get better numbers. As I'm no Mark Cavendish my wattage under a 300m sprint for gold is really not of any great interest to me, rather I just want to see my efforts and where I can improve consistency on my rides. For 100 bucks I'm going to give it a go and see what it comes up with as I could use some education.

No ride for me today as my legs have had enough. I managed about 215k's last week, which is pretty good when you consider I rode with newbies on 4 days out of 7. Don't get me wrong it's nice to share my love of cycling with people as it brings a whole new level of satisfaction to the effort you put in. I know for example that I was a horrible partner to ski with in my 20's when I took up the sport, so I feel I better understand the frustration of people taking up a sport latter in life . . . at least I think I do?

In Sydney my average ride is about 30k's, whereas in Geneva I averaged 50 - 60. The traffic situation in a city of 4.5m makes the stress and concentration required to ride pleasurably much more difficult. Getting out to Akuna Bay last week was fun even with the fact we were late back onto the road and had to put up with the 3pm Sydney school pick-up and tradesmen dash on the roads. Next time I think I'd prefer to drive out closer to the national park and do the hills twice instead of braving the enormous utility vehicles that ply the roads of Sydney's northern beaches. I feel fine but with a forecast for thunder storms and a multitude of chores to be done I think it's best to take the day off.


Wednesday, 6 February 2013

A little risk and a little reward . . .

I finished yesterday's blog just as more action was hitting the tape in the M&A world. This time Liberty Global has gone after the UK cable TV market via Virgin Media. The deal is worth just under GBP24bn. It's got some kinks in it, not least of which is the part offer of some non-voting shares in exchange for your VM shares. The FT says that the price looks a little low at 7.5x EV. Now I may have at one time traded a few News Corp shares, but I'm no valuation guru. I always thought that unless the target was a dog you wanted to get the price up to around 9x to make it a palatable. This raises the spectre of some proper fun for the risk arb books, or rather the risk arb funds out there because the prop books at the banks are supposed to be insignificant (which I doubt). Risk arb is always attractive and so long as you are happy that the board at VM will roll over and you can short some Liberty Global non-voting shares you should be able to lever up enough to provide some decent returns. This deal prima facie doesn't look as though it will have any problems with the competition regulators as VM is a clear number 2 in the UK market and is being acquired by an entity with minimal UK presence.

This brings me back to my blog on Monday about ETF's. This is a great example how the ETF market generates additional fees. There's probably a lot of Liberty Global shares held by the likes of Blackrock that will now be available to the market via the stock banking desks. It may have been a while since I traded risk arg but I know enough to guess that the first tranche of shares I could borrow from my prime broker in a deal like this wouldn't be coming my way at less than 3%. If the deal gets really hot and if there are already other instruments out there to be hedged (such as convertible bonds or even a voting v. non-voting share arb) then this fee will soar in the next few days. The holder of an ETF gets none of this benefit, whereas if they held the shares they could have pocketed the fees themselves by lending the shares out to the market . . . but that of course requires infrastructure etc. Now do you see why the ETF lawsuit is likely to be very interesting for the banking community in general?

As I said yesterday I expect the LBO world would start to light up like a pinball machine post the Dell announcement. Today the leaks began because any banker not involved probably got marched into a meeting to explain a) why? and b) what they have in their deal books. The first rule of investment banking is where you can't create destroy. Therefore the leaking of the negotiations behind the possible £10bn bids for EE, the UK’s largest mobile phone operator, in what would be the biggest private equity-backed acquisition in Europe since the financial crisis. If you're in the deal it's unlikely you want to leak the details unless you're pretty confident that you're ready to print the deal. Of course you might leak to build more moment to either get the price up or force the hand of recalcitrant debt syndicate members over the financing terms, such as: " . . . this deal is going to get done with or without you. Banks are scrambling for this and you're going to end up watching this debt trade much better in the secondary market and  you will having to source it there where for a lousy 20bps you're in a prime position . . . " etc, etc.

The $/¥ hit 94 last night and the N225 roofed 3.8% in what must be some serious short covering. I wrongly thought the currency would have hit a natural level around the 91'ish mark until we saw some serious economic numbers to support the Abe quest to out-print the rest of the world. What I should have guessed was that I would not be alone in such thinking and the shorts got lifted and the computer algo's in turn hedged by buying the N225. Oh my, if you're leveraged short on a day like today you probably just undid a lot of the good work you put in by buying the N225 at 8 or 9,000 and running it up to this point:

At least you know the correlation is positive . . . 
I have an early'ish meeting today after which I'll be travelling north to ride the Akuna Bay loop with my sister in law.

The blue line shows the approximate course. Normally I'd ride over there, but as this is her first serious hill climbing expedition we'll keep it to a fun 40k's and concentrate on technique. I had to learn a lot about hill climbing by trial and error in the Alps around Geneva. For those looking to avoid my own early attempts try this video from Cannondale man Mike Cotty:


Tuesday, 5 February 2013

Let's do a deal . . . use you elbows

Bankers finally got their Christmas wish. Michael Dell is doing an old fashioned LBO in partnership with Silver Lake. It's a classic for the text books and in my view the only thing that makes it really interesting is Microsofts involvement.
  1. Silver Lake Partners will contribute cash to the deal, the details of which I'm still trying to track down
  2. Microsoft will offer a $2bn loan
  3. Dell will roll over his 15.7 per cent stake in the company
  4. MSD Capital, which Mr Dell controls, will contribute additional cash
According to the FT sector analysts reckon that Dell still gets 70% of revenues from the dying PC sector. The problem is that Dell needs to switch a huge chunk of this over to mobile devices, but may not have the cash to do so once the bankers carve out a huge chunk of interest every year. Thats why Microsoft is crucial. Dell has never been an innovator, instead his always been about the supply chain, he's Tim Cook (of Apple) with a Texas smile. He's going to have to rely on the hit and miss Microsoft "skunk-works" to come up with the product. Surely the end game here from a Seattle point of view is that Microsoft has once again got a little "pregnant" and bought an option to either move further into hardware or to block someone else from doing so. Michael Dell himself will either end up retired watching his Texas Longhorns or become a large shareholder in Microsoft . . . stay tuned for that.

All of this is great news if you're an investment banker in NYC with a big mortgage a couple of kids at private school and a wife/husband/partner who spends like a drunken sailor on leave. The winners so far are:
  1. JPMorgan and Evercore (bankers); Debevoise & Plimpton (legals); acting for Dell’s board 
  2. Goldman Sachs (bankers) and Hogan Lovells (legals) for Dell
  3. Wachtell, Lipton, Rosen & Katz (legals) for Michael
  4. Silver Lake was advised by the same four banks providing financing and Simpson Thacher & Bartlett (legals)
  5. Lazards (bankers) for Microsoft
In my view this will kick-off some serious late nights for investment bankers who missed out on this fee bonanza because what it signals are the loan books are in business again. This is the most bullish thing I have seen for equity markets in quite a while and could start some serious deals that will propel the markets higher.

So that's all the good news, but lets visit the ivory tower that is the US Federal Reserve. If I'm Ben Bernanke I'm seeing this as a sign that what I've done has worked. A couple more deals, hopefully of a similar size may allow me to start withdrawing slowing from the credit markets. You see by virtually wiping out the questionable MBS books run by the banks I've injected them with so much cash that they now have balance sheets capable of taking on risks such as the Dell deal. Of course Mr. Bernanke will be hoping that legislators will give him and his fellow central bankers the power to stop this from becoming a new bubble. The jury is going to be out for a while on this, so grab a spreadsheet and start your engines for a summer of fun.

Do you know what lawyer tabs are on your bike? I certainly had no idea about them until reading Velo News today

I should correct that . . . I have seen this little metal piece nearly every time I take off my wheels, yet had never wondered why it existed. The idea is that this little nob stops your \wheel falling out unless you actually release the skewer and then give it a couple of turns. If you file off this piece you end up in the situation where you just open the skewer and pull the wheels out. This is what the pro teams do, though apparently the French teams are prohibited by law and I bet insurance companies. Not the UCI will enforce the no tampering rule which means a lot of new forks are going to be needed. I don't have a view on this either way, but if you're an amateur like me they really are something you can forget about . . . treat this like a fun fact to bore your non-cyclinng friends with at your next party.

Finally check out the finish from yesterday's Tour of Qatar 2013 Stage 3. This is what happens when you have a nearly dead straight road and some very good sprinters in the peloton:


Monday, 4 February 2013

Some half truths and some racing . . .

A couple pf weeks back I mentioned my concerns about the concentration of "ownership" within the ETF market. Someone out there was watching because today comes the news that Blackrock, the largest player in the market is being sued by a couple of US pension funds who claim the slice of securities lending revenues retained by Blackrock was “disproportionately large”, bore no “reasonable relationship to the services rendered or costs incurred” and was “vastly higher” than the fee that could have been negotiated with an unaffiliated lending agent, amounting to “money for nothing”. I know a lot about this side of the business, but I know nothing about how Blackrock runs it's security lending book. The idea amongst all investment banks was to sell customers so-called "delta one" trackers that saved the individual fund managers the time, money and and effort of putting together baskets of securities and managing the periodic rebalancing that occurs within an index. Now this isn't a problem with the well followed and liquid indicies within well regulated markets like the S&P500, but if we're talking emerging markets and a myriad of access and regulatory rules then it kind of make sense. Of course the other side to this is that the banks selling the products hold the physical shares and therefore so long as they pay the "delta one" buyer the returns promised there shouldn't be a problem, but there is. You see the banks then allow other customers to borrow the shares in order to short trade or hedge other instruments (such as convertible bonds). This "stock banking" business generates a lot of fees, so much in fact that some sophisticated customers have gotten wise to this and demanded a different fee structure in respect of their investment. This is at the heart of the law suit that was filed. Blackrock and all other ETF "manufacturers " will claim that the stock banking business offsets their costs and allows them to give access to investors who otherwise may have had to create specialist offices to trade in many of the markets covered by ETF's. My betting is that when the math hits the whiteboards in courts there's going to be some embarrassment amongst the bankers and the press if they do their homework are going to have a field day. I have some sympathy for Blackrock, but my advice would be to try and settle this now.

Meanwhile the Greeks are back trying to ease the conditions of the bailout. I don't know about you, but I'm still of a mind thatGreece should exit the zone in some way. Their existence in the eurozone seems to be purely as a crutch for the Spanish and Italians. What if they took the view that tax in it's current state was impossible to collect (as Russia did some time ago) and make it so cheap that the revenue will flood in. Why couldn't they just have a Singapore like 20% top bracket making it just too good to avoid. Food for thought? Clearly strawmen lock France's Hollande would hate it.

On to the road and I managed to get in a good 34k's today along Sydney's beaches. I'm hoping to head to the northside on Thursday to do Akuna Bay again. Anyone interested in a ride should just drop me a line. Thursday will be at cafe pace as it's a coming out for one of my students . . . no one gets left behind and the bunch will be stopping at the top of climbs.

On Friday I should be in position to announce a charity ride. I know most of you are not in Australia, but I have three bikes and will be looking to build a team of 5. So if you'd like to make the trip from far away I can assure you some good riding with interesting people. 

A reminder that the Giro d'Italia is getting closer. It begins on May 4th in Naples and need I remind you again that it's the highlight of the year in my view. I'm a big fan of Naples, if you've never been there or to Capri etc. the scenery should be magic.

A reminder of what to look out for:

The Maglia Rosa (pink) is the jersey worn by the leader of the time general classification.
The Maglia Rosso (red) is worn by the leader of the points general classification.
The Maglia Azzurro (blue) is the symbol of the King of the Mountain classification leader.
The Maglia Bianco (white) is worn by the best young rider in the general classification.