CORPORATE GOVERNANCE
Satyam Chief Admits Huge Fraud
NYT, 7-Jan-09
Mr. Raju said Wednesday that 50.4 billion rupees, or $1.04 billion, of the 53.6 billion rupees in cash and bank loans the company listed as assets for its second quarter, which ended in September, were nonexistent... In the four-and-a-half page letter distributed by the Bombay stock exchange, Mr. Raju described a small discrepancy that grew beyond his control.
Satyam Computer Services, a leading Indian outsourcing company that serves more than a third of the Fortune 500 companies, significantly inflated its earnings and assets for years, the chairman and co-founder said Wednesday, roiling Indian stock markets and throwing the industry into turmoil ...
REAL ESTATE
Commercial Property Loses Shelter
WSJ, 8-Jan-08
New data from Deutsche Bank show that delinquencies on commercial mortgages packaged and sold as bonds nearly doubled during the past three months, to about 1.2%. The delinquency rate will likely hit 3% by the end of 2009... An unusually high number of the underlying CMBS loans that are going bad were made and securitized in the past three years... a $125 million mortgage secured by a shopping center in Corona, Calif. called Promenade Shops had cash flow of $6.3 million when J.P. Morgan underwrote the loan in July 2007 but the loan was based on the assumption that the cash flow would rise to about $10.5 million.
Delinquencies on mortgages for hotels, shopping malls and office buildings were sharply higher in the fourth quarter, as the weaker economy hit landlords and threatens to cause losses for investors in the $3.4 trillion market ...
VALUATION IMPAIRMENT
Timely Warning on Cable Values
WSJ, 8-Jan-08
A key determinant of asset impairment, in addition to market prices, is the long-term cash-flow generation potential of a business... By resetting the level of shareholders' equity through write-off they enhance future returns on shareholders equity.
Shareholders in cable-TV companies might have forgotten in recent weeks -- as they have congratulated themselves on their foresight in owning relatively recession-proof stocks -- that the industry isn't without its competitive challenges from phone companies and the Internet ...
TECHNOLOGY
Intel Outlook Pared Again; Rivals Unveil New Products
WSJ, 8-Jan-09
Intel said Wednesday it now expects to report $8.2 billion in revenue for the fourth quarter and the company had projected in mid-October that sales would rise 3% from the third period...The company also said that its gross profit margins will be at the bottom of the lowered estimate it issued in November of 55%, plus or minus a couple of percentage points. In mid-October, the company had said the range would center around 59%.
Intel Corp. issued a second warning about deteriorating business conditions, signaling further weakness in the computer sector ...
OIL
Bahrain Credit Outlook Is Downgraded
WSJ, 7-Jan-09
"Break even" oil prices for Iran ($90), Oman ($77), Bahrain ($75), Saudia Arabia ($49), Kuwait ($33), Qatar ($24), UAE ($23)... Bahrain holds fewer liquid assets -- such as foreign-exchange reserves or investments by government-controlled funds -- than other regional oil exporters... Last month, Saudi Arabia said it expects to run its first budget deficit in years, committing itself to spending heavily despite an expected fall in oil revenue.
Moody's Investors Service downgraded the credit outlook for the Kingdom of Bahrain on Tuesday, marking the first sovereign-rating hit to the oil-rich Persian Gulf amid tumbling crude prices and the global financial crisis ...
COMMODITIES
Steelmakers Move Cautiously To Raise Prices, Reopen Mills
WSJ, 7-Jan-09
Troubled auto makers, contractors, appliance and equipment makers have cut back on their steel purchases. The majority of mills closed over the last few months remain shuttered and many around the world are operating below 50% of their capacity... In China, several steel mills have announced price increases ranging from 5% to 25% for a variety of products.
In an early sign that some steel prices may have bottomed out, steelmakers in the U.S., China and some other countries are attempting limited price increases and reopening a handful of mills that were closed because of weak demand a few months ago ...
CREDIT
Defaults Pose a Reckoning for Stock Rally
WSJ, 7-Jan-09
U.S. investment-grade corporate-bond issuance jumped to $108 billion in December, according to Dealogic, near the record $111 billion set in May, and up from a nadir of $15 billion in September... In the U.S. alone, some $758 billion in corporate debt is coming due in 2009, according to Standard & Poor's.
Credit-worthy companies have recently found a healthy appetite for their new debt. It is the older stuff that could cause trouble, both for corporate borrowers and stock investors ...
Wednesday, January 07, 2009
The “Basic Speed Law” for Capital Markets Returns
The “Basic Speed Law” for Capital Markets Returns
CFA Magazine
November/December 2008, Vol. 19, No. 6
The return of stock prices to levels more consistent with economic growth is mean reversion at work
Recent stock market behavior has been astonishing—down 22 percent in the first half of October, down more than 40 percent in the past 12 months. Much of this drop has been blamed on the current financial crisis, but there are deeper—and yet simpler—economic forces at work. Three truisms are too easily overlooked.
The first truism is that over the long-run real per capita economic growth in the United States, over and above inflation, has been remarkably steady at 1–2 percent, as the top line in Figure 1 shows. Growth over the past 25, 50, and 100 years has averaged 1.4 percent, 1.7 percent, and 1.9 percent, respectively. This real growth rate reflects improving productivity, which over periods of decades varies little. Share prices (the middle line) and per-share earnings for the broad market (the bottom line) exhibit much the same growth, albeit with much more variability. One nuance is often overlooked: Just as the economy is the shared production of a growing population, a growing roster of companies drives that economic growth. Entrepreneurial capitalism—new enterprise creation— is an important driver of economic growth, contributing roughly half of real GDP growth, on average, over time. The other half of overall real GDP growth is contributed by the growth of existing enterprises. This means that share prices and per-share earnings for broad indexes, such as the S&P 500, should match the growth of existing enterprises, roughly half of total GDP growth. As it happens, this growth closely mirrors per capita GDP growth.
The second truism is that if the aggregate real per capita growth rate in the economy is a bit under 2 percent, the broadest sectors of the economy, such as the corporate sector, have to deliver about the same per capita growth rate in the long run. If the growth rate were greater, that sector would eventually become larger than the entire economy, an outcome that is constrained by both economic and political forces.
Over the past several decades, Americans at all levels in business, government, and private life have behaved as if these first two truisms were no longer relevant. Implicitly, and in some cases explicitly, decisions were made, including investment decisions, that were based on the assumption of far greater growth. A common refrain was that even if real per capita growth in the aggregate economy is limited to about 2 percent, that does not apply to us or to our investments, whether our domain is housing, technology stocks, hedge fund investments, or the stock market.
The third truism is that valuation of long-lived assets, such as common stocks, are highly sensitive to the assumed rate of growth. The experience of Google is an obvious example; the stock price has plummeted to $330 from $750, despite continued impressive growth in earnings, because the earnings growth has not been fast enough to justify an initially lofty multiple and expectations for future growth have been continuously revised downward.
Applying these three facts to the market as a whole leads to several stark conclusions. First, as with any broad sector of the economy, corporate earnings are constrained by the same long-run 2 percent speed limit. This means that unless P/Es change, stock prices will also grow, on average, at no more than 2 percent in real terms for the truly long-term investor.
History supports this view. In the past 25, 50, and 100 years, real growth in S&P 500 per-share real earnings has averaged 3.2 percent, 2.0 percent, and 1.5 percent, respectively. Meanwhile, the S&P 500 price index has risen by 5.1 percent, 2.7 percent, and 1.9 percent, respectively, over and above inflation. The earnings have grown faster than per capita GDP growth in recent years, in large measure because of recent earnings that have subsequently proven illusory. Meanwhile, share prices have grown faster still, largely on the back of rising valuation multiples, which we dare not rely on in the future. This recent outsized growth in real per-share earnings and share prices, over and above the per capita real growth of the economy, may be helping to foment the populist backlash we’re now seeing.
In this historical light, the current crisis is seen as more than simply the result of a housing bubble or an overstressed financial system. It is based on a widespread hubris that somehow the laws of economic growth do not apply, that share prices and earnings can grow faster than the overall economy. That hubris was reinforced by organizational structures that allowed executives, insurers, derivatives traders, bankers, and many others to take large amounts of cash home as long as the euphoria continued and as long as customers were willing to set aside logic in favor of a promised nirvana.
The ultimate return of stock prices to levels more consistent with economic growth is nothing more than another example of mean reversion at work. The good news is that, from current levels, mean reversion need not exact as severe a future toll as it has imposed on us in the past 12 months. This too shall pass.
Brad Cornell is a visiting professor of finance at the California Institute of Technology and a senior consultant to Charles River Associates. Rob Arnott is chairman of Research Affiliates, LLC, and former editor of the Financial Analysts Journal.
CFA Magazine
November/December 2008, Vol. 19, No. 6
The return of stock prices to levels more consistent with economic growth is mean reversion at work
Recent stock market behavior has been astonishing—down 22 percent in the first half of October, down more than 40 percent in the past 12 months. Much of this drop has been blamed on the current financial crisis, but there are deeper—and yet simpler—economic forces at work. Three truisms are too easily overlooked.
The first truism is that over the long-run real per capita economic growth in the United States, over and above inflation, has been remarkably steady at 1–2 percent, as the top line in Figure 1 shows. Growth over the past 25, 50, and 100 years has averaged 1.4 percent, 1.7 percent, and 1.9 percent, respectively. This real growth rate reflects improving productivity, which over periods of decades varies little. Share prices (the middle line) and per-share earnings for the broad market (the bottom line) exhibit much the same growth, albeit with much more variability. One nuance is often overlooked: Just as the economy is the shared production of a growing population, a growing roster of companies drives that economic growth. Entrepreneurial capitalism—new enterprise creation— is an important driver of economic growth, contributing roughly half of real GDP growth, on average, over time. The other half of overall real GDP growth is contributed by the growth of existing enterprises. This means that share prices and per-share earnings for broad indexes, such as the S&P 500, should match the growth of existing enterprises, roughly half of total GDP growth. As it happens, this growth closely mirrors per capita GDP growth.
The second truism is that if the aggregate real per capita growth rate in the economy is a bit under 2 percent, the broadest sectors of the economy, such as the corporate sector, have to deliver about the same per capita growth rate in the long run. If the growth rate were greater, that sector would eventually become larger than the entire economy, an outcome that is constrained by both economic and political forces.Over the past several decades, Americans at all levels in business, government, and private life have behaved as if these first two truisms were no longer relevant. Implicitly, and in some cases explicitly, decisions were made, including investment decisions, that were based on the assumption of far greater growth. A common refrain was that even if real per capita growth in the aggregate economy is limited to about 2 percent, that does not apply to us or to our investments, whether our domain is housing, technology stocks, hedge fund investments, or the stock market.
The third truism is that valuation of long-lived assets, such as common stocks, are highly sensitive to the assumed rate of growth. The experience of Google is an obvious example; the stock price has plummeted to $330 from $750, despite continued impressive growth in earnings, because the earnings growth has not been fast enough to justify an initially lofty multiple and expectations for future growth have been continuously revised downward.
Applying these three facts to the market as a whole leads to several stark conclusions. First, as with any broad sector of the economy, corporate earnings are constrained by the same long-run 2 percent speed limit. This means that unless P/Es change, stock prices will also grow, on average, at no more than 2 percent in real terms for the truly long-term investor.
History supports this view. In the past 25, 50, and 100 years, real growth in S&P 500 per-share real earnings has averaged 3.2 percent, 2.0 percent, and 1.5 percent, respectively. Meanwhile, the S&P 500 price index has risen by 5.1 percent, 2.7 percent, and 1.9 percent, respectively, over and above inflation. The earnings have grown faster than per capita GDP growth in recent years, in large measure because of recent earnings that have subsequently proven illusory. Meanwhile, share prices have grown faster still, largely on the back of rising valuation multiples, which we dare not rely on in the future. This recent outsized growth in real per-share earnings and share prices, over and above the per capita real growth of the economy, may be helping to foment the populist backlash we’re now seeing.
In this historical light, the current crisis is seen as more than simply the result of a housing bubble or an overstressed financial system. It is based on a widespread hubris that somehow the laws of economic growth do not apply, that share prices and earnings can grow faster than the overall economy. That hubris was reinforced by organizational structures that allowed executives, insurers, derivatives traders, bankers, and many others to take large amounts of cash home as long as the euphoria continued and as long as customers were willing to set aside logic in favor of a promised nirvana.
The ultimate return of stock prices to levels more consistent with economic growth is nothing more than another example of mean reversion at work. The good news is that, from current levels, mean reversion need not exact as severe a future toll as it has imposed on us in the past 12 months. This too shall pass.
Brad Cornell is a visiting professor of finance at the California Institute of Technology and a senior consultant to Charles River Associates. Rob Arnott is chairman of Research Affiliates, LLC, and former editor of the Financial Analysts Journal.
Monday, January 05, 2009
Today's Reading List
RISK MANAGEMENT
Risk Mismanagement
NYT, 4-Jan-09
By JOE NOCERA
VaR isn’t one model but rather a group of related models that share a mathematical framework. In its most common form, it measures the boundaries of risk in a portfolio over short durations, assuming a “normal” market. For instance, if you have $50 million of weekly VaR, that means that over the course of the next week, there is a 99 percent chance that your portfolio won’t lose more than $50 million... one of VaR’s flaws, which only became obvious in this crisis, is that it didn’t measure liquidity risk... the big problem was that it turned out that VaR could be gamed... It (the risk of CDS) was outside the 99 percent probability, so it didn’t show up in the VaR number. People didn’t see the size of those hidden positions lurking in that 1 percent that VaR didn’t measure.
THERE AREN’T MANY widely told anecdotes about the current financial crisis, at least not yet, but there’s one that made the rounds in 2007, back when the big investment banks were first starting to write down billions of dollars in mortgage-backed derivatives and other so-called toxic securities ...
REAL ESTATE
U.S. commercial property in a downward spiral
NYT, 5-Jan-09
By Charles V. Bagli
The Urban Land Institute predicts 2009 will be the worst year for the U.S. commercial real estate market "since the wrenching 1991-1992 industry depression"... Regional banks may be an even bigger concern. Over the past decade, they barreled their way into commercial real estate lending after being elbowed out of the credit card and consumer mortgage business by national players. Their weighting in commercial real estate has nearly doubled in the past six years, according to government data... In 2006 and 2007, nearly 60 percent of commercial property loans were turned into securities... Effective rents, which have already started to fall, are expected to decline 30 percent or more across the country from the euphoric days of the real estate boom, according to real estate brokers and analysts... The Real Estate Roundtable sees a rising risk of default and foreclosure on an estimated $400 billion in commercial mortgages that come due this year... Already, $107 billion worth of office towers, shopping centers and hotels are in some form of distress.
Vacancy rates in office buildings exceed 10 percent in virtually every major city across the United States and are rising rapidly, a sign of economic distress that could lead to yet another wave of problems for the beleaguered financial sector ...
Risk Mismanagement
NYT, 4-Jan-09
By JOE NOCERA
VaR isn’t one model but rather a group of related models that share a mathematical framework. In its most common form, it measures the boundaries of risk in a portfolio over short durations, assuming a “normal” market. For instance, if you have $50 million of weekly VaR, that means that over the course of the next week, there is a 99 percent chance that your portfolio won’t lose more than $50 million... one of VaR’s flaws, which only became obvious in this crisis, is that it didn’t measure liquidity risk... the big problem was that it turned out that VaR could be gamed... It (the risk of CDS) was outside the 99 percent probability, so it didn’t show up in the VaR number. People didn’t see the size of those hidden positions lurking in that 1 percent that VaR didn’t measure.
THERE AREN’T MANY widely told anecdotes about the current financial crisis, at least not yet, but there’s one that made the rounds in 2007, back when the big investment banks were first starting to write down billions of dollars in mortgage-backed derivatives and other so-called toxic securities ...
REAL ESTATE
U.S. commercial property in a downward spiral
NYT, 5-Jan-09
By Charles V. Bagli
The Urban Land Institute predicts 2009 will be the worst year for the U.S. commercial real estate market "since the wrenching 1991-1992 industry depression"... Regional banks may be an even bigger concern. Over the past decade, they barreled their way into commercial real estate lending after being elbowed out of the credit card and consumer mortgage business by national players. Their weighting in commercial real estate has nearly doubled in the past six years, according to government data... In 2006 and 2007, nearly 60 percent of commercial property loans were turned into securities... Effective rents, which have already started to fall, are expected to decline 30 percent or more across the country from the euphoric days of the real estate boom, according to real estate brokers and analysts... The Real Estate Roundtable sees a rising risk of default and foreclosure on an estimated $400 billion in commercial mortgages that come due this year... Already, $107 billion worth of office towers, shopping centers and hotels are in some form of distress.
Vacancy rates in office buildings exceed 10 percent in virtually every major city across the United States and are rising rapidly, a sign of economic distress that could lead to yet another wave of problems for the beleaguered financial sector ...
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