In markets such as this one, where investors are reacting to events and rationality takes a back seat, we should not be surprised when we see anomalies... And that is where I would put what happened to Volkswagen's stock price this week. For a brief period on Tuesday, Volkswagen's market cap jumped four-fold to briefly become the largest market cap company in the world (in excess of $ 350 billion). In the process, hedge funds who had shorted the stock lost almost $ 20 billion. It was a classic "short squeeze", sometimes seen with small, market cap companies that are lightly traded, but seldom...
What is the message the market is sending?
The interesting theme that emerged from last week's market mayhem is how the story driving market movements has suddenly shifted from banking problems to the overall economy. Until last week, every market move was traced back to banks or investment banks in trouble and the governments' attempts to bail them out. Last week, the collapse of the markets was almost entirely attributed to the recession that investors/economists see looming for next year.While I am not dismissing the notion, it is worth looking at history to see how good or bad a predictor the market is, when it comes to the real economy....
The New World Order: How this crisis affects valuation
Given how much this market crisis has shaken our faith in systems and numbers, it is no surprise to me that the most common question that I have faced these last few weeks is about how this crisis has changed the way I do valuation. Before I answer, let me specify what has not changed for me. The intrinsic value of a business is still a function of its capacity to generate cash flows in the future. In other words, I am not going to create new paradigms for valuation just because we are in turmoil. In terms of estimates, though, here is what I believe has changed in these last 6 weeks:1. The...
What is going on with the inflation indexed treasuries?
Strange things are happening in markets, but one development that I have seen little comment on is what is happening in the US treasury market. The Treasury has been issuing traditional bonds (where the coupon is set at the time of the issue) and inflation-indexed bonds (where a real return of return is guaranteed at the time of the issue) for more than a decade now. On September 12, 2008, the nominal 10-year treasury bond rate was about 3.8% and the interest rate on the inflation-indexed treasury was about 1.7%. In fact, the difference can be viewed as a market expectation of inflation over the...
Is preferred stock equity?
In the last few days, we have seen announcement by both the UK and US governments of their intent to invest hundreds of billions into their biggest banks. In both plans, the investment will be in preferred stock in the banks, and the announcements have described them as investments in equity. But is preferred stock equity? That is a question that is not new but acquires fresh urgency, with these infusions. Preferred stock is a hybrid security, sharing some characteristics with equity and some with debt. Like equity, it has a perpetual life and the dividends can be skipped, if a firm is in financial...
Black, blue and white swans: Comments on Taleb
I want to steer clear of critiquing the work of others but my comments on long odds seem to have evoked a torrent of emails about Nassim Taleb and his work on randomness and black swans. Let me start off by sketching the points on which we agree. I think that Taleb is absolutely right that we (in academic finance and model building) have become enamored with normal distributions when building models. The real world delivers far more jumps, surprises and asymmetric movements than can be justified by a normal distribution. I also believe that what Taleb is saying was said much better by Benoit...
Markets for sports outcomes- The long odds bias!
Since it is Sunday, it is time for sports, at least in the United States, I thought it would be an appropriate time to talk about markets based upon sports outcomes. People have been betting on sports for as long as there have been sports - I am sure that the ancient Romans had side-bets going on the gladiators. Today, sports betting is a multi-billion dollar business, though a big chunk of it is underground. In addition, we have markets like Tradesports.com (an online betting market), where you can bet on just about anything in the world, As with other markets, the question is whether the odds/prices...
Gold, fine art and collectibles...
I have always been deeply skeptical of investments in non-cashflow generating assets (gold, fine art, collectibles), where value is almost entirely driven by perception. However, a crisis like the current one illustrates why these types of assets continue to have a hold on investors. When investors lose faith in financial assets (and the authorities and entities that back up those financial assets), they look for physical and tangible investments to buy that they can hold on to. Real estate used to be the investment of choice, but as my last posting indicates, real estate is behaving more...
Diversification: Why is it not working?
It is a core belief in finance that investors should diversify. Whether they should diversify across all stocks or a few is what is debated, and what you think about the efficiency of markets or lack thereof determines which side of the debate you will come down on. If you are a believer in efficient markets, you would have spread your money across index funds investing globally. If you believe that markets systematically misprice classes of securities (and realize their mistakes later), you would still diversify across these securities (low PE stocks, beaten down stocks etc.) This market...
Is it time to make the move?
Yesterday was a momentous day in many ways. The market meltdown was global and there were moments during the day when the first 1000 point drop day seemed possible for the Dow. However, there was something about yesterday that seemed different (at least to me) from the market tumult over much of the last 3 weeks:1. The drop in the market, at least in the US, was caused more by concerns about economic growth than by fear. Put another way, while much the volatility in the markets of the last 3 weeks could be attributed to shifting equity risk premiums, yesterday's drop was caused more by more conventional...
Explaining the Market....
The last three weeks have been a boon for financial reporters. All of a sudden, they get the front page stories in their newspapers, a little akin to being the weather forecasters in the middle of a hurricane. At the end of each day, after another violent market move, they go to the experts (academics, practitioners) and ask them for reasons. They get the obligatory: "The market went up (down) because...." I have always been skeptical of this Monday-morning quarterbacking, and last week illustrates why. On Monday, the market was down 778 points and the culprit was so obvious that experts were...
The Buffett Gambit: Buying (Selling) Credibility
In the last two weeks, Warren Buffett has made news by taking multi-billion dollar positions at Goldman Sachs and GE, two companies that would have topped the list of most admired firms a couple of years ago (and perhaps still). The fact that he is getting a good deal from both companies has been well publicized. In effect, both companies have given him a discount on his investment, thus giving him the potential for higher returns in the future. While part of those higher returns can be attributed to the fact that he is providing liquidity in a market where it is in short supply, that alone cannot...
Mark to Market or Not to Mark to Market?
The latest issue that has emerged in the talks on the bailout is whether the practice of marking to market, required of financial service institutions under FASB rules, should be suspended or even ended. Financial service firms currently are required to revalue the securities they hold as assets on their books at market value each period. As the markets for many mortgage-backed securities have dried up, their values have plummeted, which in turn have put the limited capital that banks and investment banks at risk. I have mixed feelings about the rule. I am a believer that investors should be...
