Saturday, January 2, 2016

The "Valuation Problem" revisited......

Over the weekend my wife and I went to see the Michael Lewis movie, The Big Short.   The book was outstanding, but the movie was actually even more entertaining.  If you've not seen it, I'll give it a "Three Thumbs Up". This movie would have been an unbelievable, un-watchable, silly, absurd work of fiction and unworthy of any Hollywood blockbuster hype, that is, if it were not for the fact that it actually happened. Star Wars was playing in the theater across the hall and if we hadn't all lived through the financial crisis, seen it with our own eyes and experienced the aftermath through our brokerage accounts, we'd think the Star Wars plot might be a bit more plausible.

I normally don't do movie reviews, but I particularly enjoyed the portrayals of Mark Baum (Steve Carell), Michael Burry (Christian Bale), Jamie Shipley, Charlie Geller and the cast of "Independent thinkers" who dared to bet against the system during the period leading up the 2008/2009 financial crisis.  There were several memorable scenes which apply to today's topic:
  • Michael Burry instructs a new hire to pull the lists of mortgages and data making up a Mortgage Backed Security (MBS) and discovers that, based on the data, most of the mortgages supporting the AAA rated MBS are likely to default.
  • Mark Baum interviews Florida mortgage brokers, a Realtor and their customers, including a stripper who owns five homes and a condo she bought with no money down, using adjustable rate mortgages.  The mortgage brokers bragged about how they "just got people to sign up" for NINJA loans (No Income, No Job or Assets).  Volume was through the roof.  
  • Mark Baum questioning a Standard & Poors official on how she can give a AAA rating to certain bonds?  Her explanation was that "If we don't give the bond a AAA rating they'll go to Moody's".  At the time, AAA ratings were apparently for sale if the price was right.
  • Selena Gomez and Dr. Richard Thaler explaining Synthetic CDOs using Blackjack hands.  "A CDO is like making a leveraged bet on the outcome of another leveraged bet".
  • Mark Baum discovering  “So mortgage bonds are dog shit. CDOs are dog shit wrapped in cat shit.”.
It was clear, at least to those who were looking for it, that the bubble of all bubbles was forming.

Last year, on December 24th, 2014 I had posted "The Valuation Problem...."   At the time I was concerned about the proliferation of non-investment grade (my opinion) securities making their way into mutual funds, pension funds, ETF's, etc.  After a review of the numbers, I'm sad to report, not much has changed since last year, or for that matter, since 2007.

Here are a few summary bullet points about the current valuations of the eight-hundred-and-twenty-six (826) Technology Stocks making up that category in Google Finance.  (Detail Data Below: Send me an e-mail or a comment and I'll be happy to send you the full Excel spreadsheet)

1.) Of the 826 businesses - 396 have no earnings (i.e. losses).

2.)The "Top 20" (sorted by earnings) have a Market Cap of just over $3Trilllion with a P/E of 18.2.

3.)The remaining 806 businesses have virtually no earnings. ($2.3T mkt cap $33 billion in earnings)

4.) The aggregate PE for these 806 businesses is 71.4.  i.e.) The current stock price is equal to 70+ years of current earnings.

5.) 247 of these businesses lost more than $10 million last year.

6.) Three of the businesses posted losses of more than $1 Billion (Sunedison, Sony and JD.com)

7.) JD.com won the prize for futility.....losing nearly $2 billion

8.) Fifty-five (55) of the businesses are ADRs (foreign stocks listed on US exchanges). i.e.) Filed under IFRS accounting rules with offshore management insulated from SEC sanctions and regulation. The market cap of these businesses is currently $628 Billion. (Not including Alibaba) If you include Alibaba the number jumps to $830 Billion.

Suffice it to say, I'm less than enthusiastic about the financial performance of the above described $2.3 Trillion worth of US listed businesses and even less enamored with their valuations.

The "Top 50" and "Bottom 50" are listed below.




Now.....let's see who owns these....

 ....wonderful, under-performing, overpriced creations of the Wall Street Marketing Machine.  As an exercise, I've picked "every 100th" business and I've listed a few of their largest shareholders.  Let me know if you see a pattern.  I'll describe what I see shortly.



Again, these stocks were picked at random.  After sorting the population by earnings, I've selected "every 100th" business.  So, do you notice any patterns in the above, statistically invalid analysis of the eight (8) tech stocks?  Vanguard has a significant position in all but one (7 of 8) of these potentially "dog shit wrapped in cat shit" businesses.  Blackrock funds are listed seven times as well.  Many of the others are household names (Fidelity, Janus, T Rowe Price, Morgan Stanley, State Street, Wells Fargo, etc.) You might just have some money invested with these funds/managers. I know we do/did.  Remember the "Third Avenue" Fine Print.... post I did a few weeks ago?  How about the post on "Why Genius is about to fail....again...."  Liquidity is king.  A lack of same can be financially fatal.  

If you go through the complete list you'll find hundreds of businesses like INUVO, SGOCO, NCR, Synacor, Marin, JD.com, etc. where the IPO share price was much higher than (2x to 10x) the current quoted price. Most of these businesses have never made any money and unfortunately, they probably never will.  Investors in these pipe dreams have been, or will be, wiped out.  

Mecox Lane, a Chinese mail order catalog house is a poster child for this type of misrepresentation and hype.  Mecox Lane threw up a website and got UBS & Credit Suisse to underwrite them as "the next big thing" in Chinese eCommerce.  Tell me again how/why Swiss Banks are putting Chinese IPO's on the NASDAQ?  It would be really nice if we had some sort of "regulator", perhaps a "Commission", that regulates "Securities" and "Exchanges"?  That would be really nice.  One of their responsibilities might be to make sure that IPO's are not flaming frauds, but I digress.

Anyway, Mecox Lane went public in October of 2010 at $86 a share. ($130 Million)  .  Management recently announced that they were "taking the company private" for $4 a share ($6 million).  As usual, UBS and Credit Suisse pocketed huge fees and the insiders ran off with the IPO money. This fraud, make no mistake about it, that's exactly what this is, perpetrated by Investment Banks, has been repeated hundreds of times over the last few years. 

So how does this happen?  


"It's not a lie if you believe it to be true...."
                                    George Costanza

Most of us, follow the tried and true, Jeremy Siegel Stocks for the Long Run methodology.  Whereby we've been conditioned to invest in Index Funds, Mutual Funds and ETF's to take advantage of the supposed diversification, momentum and "long term" returns of the equity markets.   Unfortunately, we don't actually know what we own. When we invest with Vanguard or Blackrock through our 401k's, Mutual Funds and ETF's, we trust the money managers to make good decisions in our best interest.  We don't understand that we are actually buying shares in INUVO, SGOCO, NCR, Synacor, Marin, JD.com, or derivatives representing the behavior of these securities, et al.  (i.e. dog shit wrapped in cat shit).  These funds have to invest in something. They don't get paid to hold cash. (You can do that yourself.) They don't add value or produce returns unless they take on risk, so the above is what they've come up with.   As you might suspect, they also get paid a pretty penny through underwriting discounts/allotments, sweetheart pricing and, I'm sure, other interesting incentives for their efforts.  For the most part, we've all been been lucky enough to ride the rising tide back up.  We buy the dips, dollar-cost-average and just like what we used to believe about real-estate, stock prices "never" go down in the long run.   Everyone makes money.  Life is good.  This obviously works just fine, until, of course, it doesn't.  At some point, we are destined to become like Margaret in my "Fine print...." post.  We can't get our money back.  It's our fault.  We screwed up.  We trusted....but we didn't verify.

Don't get me wrong, I have no quarrel with any one of these individual businesses.  There is at least some chance any one or two of them could become the next Apple or Intel.  Conversely, I could understand it if a few of these businesses lost money and/or failed every year.  I can rationalize it as an underwriting mistake, an aberration or simply unexpected head winds.  My concern is that when the entire market is a misrepresentation and priced as if all of these stocks are all going to be the next big thing, there's a problem. At best it's systemic blindness and a breach of fiduciary responsibility, at worst, it's a criminal enterprise.  

So to get back to the original question:  Who owns all of this "dog shit wrapped in cat shit"?.....the unfortunate, probable answer is:

You do.

So what do the pros say about where we are today?

What do our bankers say?......why....everything is fine!...of course...

In their defense, they couldn't very well say that "we're in big trouble and there's a chance we'll be out of business next year"....that might ding their stock price a bit........here's a great CNBC clip of the world's best bankers describing what's going on right now:

http://finance.yahoo.com/video/best-bank-chiefs-talks-global-141329675.html

Now, looking through the lens of "The Big Short", let's run some of the above commentary through our official Dick Fuld - Banker-Speak-Translator (BST) - 2008 version.

Jamie Dimon: Because of the complexity and the structural rigidity, the EU will experience lower growth, but there are still great investment opportunities out there.
BST: Based on the current valuations, there are lots of stock-haystacks out there with numerous stock-needles that will withstand a global recession.  For the love of god please don't take your money out of the stock market.

Brian Moynihan: China will continue to grow by about 6% and that growth will be good for the world.
BST: We're dumping our China assets as fast as we can.

John Mack: There's been a hiccup in China but I'm long term bullish.  Would I invest in China now?...YES!
BST: Since the've started putting people in jail for "malicious selling" the markets can't possibly go down!

Tidjane Thiam: Switzerland is the richest economy per capita in the world.  We are underweight emerging markets and see tremendous opportunity in Asia.
BST: Thank goodness we have this opportunity! The global-economy simply wouldn't function properly if it wasn't for a bank like Credit Suisse, willing to jump in and purchase the seats in the burning theater.

John Stumph:  The economy is strong but the strength is regional.  Take San Francisco for example, Housing, Commercial Real Estate and Tech is booming.  But 150 miles South or West...not so much.
BST:  We are only writing mortgages in San Francisco.

John Mack: "Regulators are putting pressure on the system, causing staff and compensation reductions.
BST:  Yes....those damned regulators.  Why can't they just leave us alone?  They don't understand our business.  If everything goes in the dumper again, they'll just have to bail us out anyway.  So what's the big deal?

John Mack:  I love businesses like Lending Club (LC)...which I'm involved in...they are going to take business away from the banks.
BST: There will always be a surplus of "dumb money" and people willing to spend it for them.  As a banker, it's my job to match them up in a most effective manner, while, of course, pushing my risk along to some unsuspecting sucker and charging usurious fees along the way.

In the midst of all of this "everything is fine" rhetoric there is no question that the industry is pulling in its horns. Deutsche Bank is laying off 35,000 people, HSBC 50,000, Barclay's 30,000, etc.  I've cut/pasted URL's below re: bank cutbacks, compensation reductions,  asset sales, earnings "misses" and other leading indicators.  Again, this is just a sampling of  recent press releases.  There's a lot more out there, and I'm relatively sure, more to come. Simply put, banks don't make cuts of this magnitude because everything is rosy.   They don't cut compensation and sell assets because they expect blue skies and sunny days ahead. They cut payroll, bonuses, jobs and overhead because they are in trouble.

Just for fun, here's a November 26th, 2007 clip from the CNBC talking heads.  To me, it's astounding how similar the discussion is to today's "don't worry, everything is fine" rhetoric.  The analysts are wondering how big the upcoming (2008) Citibank layoffs might be.  Charlie Gasparino was reporting that analysts were concerned that Citi had previously cut 17,000 employees and that if they continue to reduce staff, they might cut too deep "to the bone", hurting the long term prospects of the business once the mortgage markets recover.  They also wondered whether there might be layoffs coming from the other banks or if this was a uniquely "Citi" problem.  They speculated that perhaps Bear Stearns and Merrill Lynch might also be looking at layoffs in the near future since they have some mortgage exposure as well.  They also reported that Citibank could be looking at mortgage associated write-downs of "up to $11 Billion dollars on the upper end of the range".

Obviously, Merrill Lynch and Bear Stearns collapsed.  Citibank MBS losses eventually came in at $39 Billion (well above the $11 Billion consensus at the time).  The seventeen-thousand (17,000) lay-offs were insignificant compared to those announced so far in 2015 and tantamount to a rounding error when compared to the more than 250,000 bank employees who eventually lost their jobs in 2008/2009.  

Well....there it is.  We're just connecting the dots.  Here's the math:

MBS = ADS = Dog Shit
CDO = ETF  + Derivatives/Leverage = Cat Shit

ADS + ETF + Derivatives/Leverage = Dog Shit wrapped in Cat Shit

Again, the more things change, the more they stay the same.

HAPPY 2016!


Deutsche Bank to sell Chinese Bank
http://in.reuters.com/article/us-hua-xia-bank-m-a-deutsche-bank-idINKBN0UB17V20151229

Deutsche Bank to cut 35,000 jobs
http://www.cnbc.com/2015/10/29/

HSBC to cut 50,000 Jobs
http://www.wsj.com/articles/hsbc-unveils-overhaul-of-global-operations-1433824955

Morgan Stanley Plans Large Layoffs
http://fortune.com/2015/11/30/morgan-stanley-job-cuts/

Goldman, JPM, MS Cut Compensation - Layoffs planned
http://www.usatoday.com/story/money/2015/10/21/wall-street-bonuses-headed-down-layoffs-predicted/74235368/

Deutsche Bank CEO just went wild with the Axe
http://fortune.com/2015/10/29/deutsche-bank-layoffs/

Barklay's plans to cut 30,000 Jobs
http://www.businessinsider.com/r-barclays-plans-to-cut-more-than-30000-jobs-the-times-2015-7

State Street to Cut Jobs, Misses Expectations
http://www.wsj.com/articles/state-street-to-cut-jobs-misses-third-quarter-expectations-1445601119

Bank of America Results Fall Short
http://www.wsj.com/articles/bank-of-america-to-lay-off-more-than-100-employees-in-banking-markets-1443536677

Deja Vu - Here's a clip from November 26th, 2007 discussing bank layoffs in general - NOT AWARE OF THE GRAVITY OF WHAT WAS ON THE HORIZON
http://www.nbcnews.com/video/cnbc/21976981#21976981

Mecox Lane - Going private at 5% of IPO price per share.
http://seekingalpha.com/a,rticle/3778256-mecox-lane-will-go-private-at-95-percent-below-its-ipo-price?ifp=1








4 comments:

  1. Would love it if you could send the spreadsheet to me @ cooler241@hotmail.Com

    Thanks! Love your work!

    ReplyDelete
    Replies
    1. Ubriferum, is this you? https://plus.google.com/100727599451014586014/videos

      If so, you are an wonderfully talented pianist. Where are you located? My concern is that, my work is not "well received" in the Peoples Republic. I can e-mail my work to you, but if you are "in country" please be careful. I would not want to cause you any inconvenience because you follow this blog. Agreed?

      Delete
  2. Well, that was a sobering way to start off the New Year:-) I have a question...... How systemic do you think this could be? Is it something that would have across the board implications like 2007 or would it be confined mostly to the financial industry? If the problem is as large as you are hypothesizing it sure doesn't look good!

    ReplyDelete
    Replies
    1. It's really too soon to tell, but the signs are popping up everywhere....starting to rear their ugly little heads. I began to suspect problems in the fall of 2014 when I reviewed the Alibaba IPO...thinking I was actually going to buy some. This should have been a benign, buy or no- buy decision. Today SZSE & SHA are limit down & locked. My friends "in country" are trying to get to the bottom of it. Funny where the trail sometimes leads. Stay tuned & thanks for the kind words.

      Delete