Short Sellers, Mark-to-Market, and Mark Cuban’s Nonsense

It’s been a while since I have last posted. The markets have indeed kept me busy. I will try to get back to a normal posting schedule.

I did want to spend a couple of minutes discussing a few topics that I have been thinking about lately.

1) IT’S A BAD IDEA TO BAN SHORT SELLERS
While I admit that as a long-only manager, shorts can be very painful to my holdings. But I still think they play a very critical role in our trading. Very good short sellers will expose bad business models and force them to improve themselves or go out of business. They play an important part in our market ecosystem and to ban them can artificially inflate valuations. Beware when they come back…it could get ugly.

2) MARK-TO-MARKET IS EXACTLY WHAT WE NEED
Recently I have heard politicians discuss the possibility of modifying the mark-to-market accounting rules. Rather, they say we should potentially value these securities as if they were to be “held to maturity.” Therein lies the problem.

Investment banks and prop desks trade the securities. They are not in the business to holding them to maturity. Showing these assets as being “held to maturity” will only further inflate asset values and create an even larger bubble burst.

3) RECENT MARK CUBAN BLOG POST = GARBAGE
I have always been a fan of Cubes. He thinks outside the box and is a superb entrepreneur. I am a huge Maverick fan and I really believe he’s one of the best owners in sports, but check out this senseless post from his blog :

Tax the Hell Out of Wall Street; Give it to Main Street

Sep 30th 2008 9:02AM

Tax every single share of stock that is bought and sold 10 cents per transaction. One dime. If you buy a share of stock, your brokerage pays a 10c tax. If you sell a share, your brokerage pays a 10c tax. 1 share, 100 million shares. Its 10 cents per share.

Of course the tax will be paid for by those of us who are buying and selling stocks. So what. Here is the reality. If you are a true investor. Someone who wants to own a share of stock in a company you believe in, then its an amount that is not going to impact your investment decision making process.

If you are a professional trader or an institutional trader that trades continuously, then it may impact your decision making process, but only to the point of reducing your returns by a minimal amount. Its not going to change your inclination to trade. If you make 9.9pct instead of 10pct, you aren’t going to stop trading.

Whats the economic impact ?

If the NYSE, Nasdaq, Amex and OTC are trading 2 Billion shares a day, thats $ 200 Million Dollars PER DAY. If there are 260 trading days a year. Thats about 52 Billion dollars a year.

Thats real money.

Wow…where do I start. To make it easier, let me bullet point my thoughts:

1. So he wants to tax each share. Does does he not realize that if we begin to tax traded shares then we will see volume dry up? Low volume would create serious volatility in the market. Most traders know that light volume days mean more volatility thus lower liquidity for assets and a very inefficient market. Honestly, do we really want more volatility right now? I vote no.

2. I am sorry Cubes but your math is overly-simplistic. By taxing traded shares, then you would see much lower volume. Your tax revenue projections would, at best, be maybe 25% of your guesstimate.

3. There are so many arguments I could make on this post. I think the two above are enough for now…..however how about I propose the following:

TAX THE HELL OUT OF SPORTS OWNERS, GIVE IT TO MAIN STREET

1. Put a 15% tax on sporting event tickets and concessions. Not only would Main Street collect money on tax receipts, but it will force the consumer to save for retirement and not waste $200 for a family of 5 to see a football game.

Isn’t part of the credit crisis the fact that the consumer is “tapped out.” This should help cure part of the that problem.

2. Make the owners finance their own sports venues rather than pushing it on “Main Street.” They sell us on the idea of “perceived” economic benefits from having a sports venue. That’s the oldest trick in the book.

(I actually don’t believe we should “tax the hell out of sports owners”…rather, I want to point out how silly it is for a billionaire to tell others how to run their business when they themselves have been subsidized with taxpayer money.)

Go Mavs!

AIG Downgraded, Faces Cash Crunch.

UPDATE: AIG Ratings Cut by S&P and Moody's. Firms moves to raise capital otherwise they may be forced to file for bankruptcy later this week.

AIG is suffering a severe cash crunch as rating agencies cut the firm's credit ratings, forcing the firm to raise $14.5 billion to cover its obligations.

From the Wall Street Journal: With AIG now tottering, a crisis that began with falling home prices and went on to engulf Wall Street has reached one of the world's largest insurance companies, threatening to intensify the financial storm and greatly complicate the government's efforts to contain it. The company, whose stock fell 61% yesterday, is such a big player in insuring risk for institutions around the world that its failure could shake the global financial system.

AIG has been scrambling to raise as much as $75 billion to weather the crisis, and people close to the situation said that if the insurer doesn't secure fresh funding by Wednesday, it may have no choice but to opt for a bankruptcy-court filing.

The Fed is currently trying to have Goldman Sachs and JP Morgan Chase extend a $70 billion credit facility to help prop up AIG according to people familiar with the situation. This comes on the heels of AIG's stock sliding more than 60% on Monday.

WSJ: AIG Faces Cash Crisis As Stock Dives 61%

Tomorrow will be a big day for the market. Not only is AIG under the gun but traders fear that a domino effect could take place.

AIG was seeking help from the Fed but one problem that arises is that the Fed is really only to supposed to assist banks and not insurers therefore there are limitations as to what kind of help can be offered. At this point, Goldman and JP Morgan may have to come to the rescue.

From Bloomberg, with respect to the actual downgrades...

AIG Ratings Cut

S&P lowered AIG's long-term counterparty rating three grades to A- from AA-, citing a ``combination of reduced flexibility in meeting additional collateral needs and concerns over increasing residential mortgage-related losses.''

The ratings assessor also lowered AIG's short-term counterparty credit rating by two levels to A-2 from the top A-1+ rating, and cut its counterparty credit and financial strength ratings on most of AIG's insurance operating subsidiaries by three notches to A+ from AA+. The ratings remain on watch for a possible further downgrade, S&P said.

AIG's senior unsecured debt rating was downgraded by Moody's to A2 from Aa3. Moody's said in a statement that its decision was made ``in light of the continuing deterioration in the U.S. housing market and the consequent impact on the group's liquidity and capital position due to its related investment and derivative exposures.'' Moody's placed AIG's long-term and Prime-1 short- term ratings on review for possible downgrades.

Bank of America to buy Merrill while Lehman running out of options

Merrill to be bought out by Bank of America? Sure looks like it.

UPDATE (Sunday 3:57PM CST)
NY Times dealbook saying BofA and Merrill in talks.
Having personally started my financial career at Merrill, I am honestly shocked by this headline. Tough to believe that Mother Merrill will no longer be an independent entity.

From the New York Times: Bank of America is in advanced talks to buy Merrill Lynch for at least $38.25 billion in stock, people briefed on the negotiations said on Sunday, as a means to preserve that investment bank while Lehman Brothers looks likely to collapse.

The move suggests a desperate effort at triage on Wall Street, as Bank of America works to shore up the likely next victim of the credit crunch. A deal, valued at between $25 a share to $30 a share, could be announced as soon as Sunday night, these people said. Merrill shares closed at $17.05 on Friday.

Bank of America, the nation’s second largest bank by asset size, had been mulling buying Lehman, perhaps in a consortium with other financial players. But with financial aid from the government looking unlikely, Bank of America has moved on to Merrill, these people said.

As Lehman began to totter in recent weeks, investors feared that Merrill would be the next victim of the credit squeeze. Shares in Merrill, which has already reported tens of billions of dollars in losses, have plunged more than 68 percent over the past year.

Lehman continues to fight for its life after Barclays deal falls apart this afternoon. As I pointed out in my suitors list, Barclays has the capital but the problem was that any deal from Barclays would have required shareholder approval. Needless to say, that won't work.

Wall Street prepares for worst as Lehman deal stalls

Related Articles
Lehman Brothers basically done today
Lehman Brothers: New Plan but Same Problems
Lehman's credit at risk with Moody's

(Friday 2:05PM CST):
Fitch close to cutting Lehman credit rating
Fitch says Lehman rating will be cut without a deal

Lehman firesale looks likely says USNews
Lehman's Long Weekend

NYTimes talks Lehman Family Ties
The Family Ties in the Lehman Drama

There's continues to be lots of speculation today on which firms might be interested in taking on Lehman. And it’s no mystery now that Lehman is looking for a buyer. The firm confirmed that Dick Fuld is actively seeking the white knight scenario.

I am leaning towards a BofA - Lehman deal.

With that said, I decided to put a small list together of firms that could be involved in potentially buying Lehman. In no specific order…

Bank of America – represents the best chance of a US-based bank to take on Lehman. Of course, BAC struck a bad deal earlier this year (Countrywide acquisition) which leads me to believe that they probably still have a “bad taste in the their mouth” at the moment. However, they do have the resources to make it happen and coupling LEH with BAC might even make sense from a “net positive synergy” standpoint.

LEH would provide their strong equity underwriting platform to BAC’s extensive roster of heavyweight banking clients. BAC would also be able to leverage LEH’s oil and gas group to gain more market share in investment banking.

And finally, BAC would be able to step into the prime brokerage business (actually step back into it after they recently sold their platform to BNP Paribas). Although, I am not sure they want to get back into prime brokerage considering how bad the hedge fund market is right now with respect to the industry-wide deleveraging.

Plus BAC still has a few other problems which includes $5 billion settlement for the auction-rate securities debacle.

While I would say “spending” is a bit tight at BAC right now, they do have the balance sheet to put a deal together. They are definitely in the mix - the question is "how much?"

Probability: BAC is the most likely of all US firms to do a deal. But I am not sure any US firms are comfortable enough to take the risk.

Goldman Sachs – the match of Goldman and Lehman hit blogs this morning and, of course, CNBC’s Charlie Gasparino put an end to that rumor with his “sources.”

GS might be somewhat interested in doing this deal but I believe under two conditions: (1) at a price of about $1.5-$2.00 per share (“takeunder” price where its bought cheaper than its current market price) which most certainly Dick Fuld will push away and (2) assurances that the Fed would provide a liquidity backstop of-sorts as they did for the JP Morgan-Bear deal.

And let’s suppose hypothetically those conditions were to be met, it might still be asking a lot. GS, who steps up to earnings plate next week, might be facing their own host of debt-related problems at the moment. One of the largest holders of Level 3 assets on Wall Street, GS would be reluctant to take on the responsibility of trading more toxic debt into this beleaguered market environment.

Probability: Unlikely that it would happen with Goldman. They are probably too busy putting out their own fires and need to make sure that they don’t compromise the strength of their balance sheet. They probably figure they can win in the situation by simply eating up investment banking market share once Lehman gets swallowed up by another firm.

JP Morgan – after digesting Bear it would be a lot to ask from Dimon and his army of executives. No way they could do this kind of deal. The firm is stretched right now. Just wouldn’t make sense.

Citigroup – one word: impossible! The firm is too busy shedding non-core assets and dumping bad business units. Not only did they lose huge on Pandit’s hedge funds but are also suffering from writedowns in Fannie and Freddie Mac.

Probability: JPM and C are nowhere in the game - too many battles to fight on various other fronts. You have better odds on a Vegas table then betting that one of these two firms plays White Knight.

Korea Development Bank – might be the dark horse in all of the speculation. Up until about late last week, LEH and KDB were in close negotiations. KDB was said to have offered six trillion won (4.3-5.2 billion dollars) for a 25% stake. Think about what that sum of money could buy them now – the whole thing? Maybe so.

South Korean regulators would be the enemy to this deal. The chairman of the South Korean Financial Services Commission explicitly told KDB that such a transaction would be highly scrutinized.

Probability: At this new “discounted” price, I wouldn’t be surprised to see KDB roll the dice. In KDB's eyes, the "cheap just got cheaper."

Other firms to watch: HSBC and Barclays. Barclays intrigues me slightly to the extent that they enjoy about a $40 billion market cap and have plentiful resources to do a deal.

SUBPRIME WRITEDOWNS: BLAME IT ON FAS 157!

In case your not sure what FAS 157 is, here’s a quick primer:

The US Financial Accounting Standards Board Rule 157, which became effective for fiscal years that began after November 15, 2007, makes it harder for companies that must assign pricing to those securities considered the hardest to value – Level 3 assets. Essentially, firms are now forced to “mark-to-market” and determine a current fair value rather than use historical cost figures to value assets on the their books.

In the fair value hierarchy, Level 1 assets are simply “mark-to-market” whereby an asset’s value is determined with quoted prices for identical instruments in an active market (ie., an equity security traded on the NYSE).

Level 2 assets, known as “marked-to-model” instruments, are based on an estimate of observable inputs. In estimating value, firms can use pricing models based on net present value of future cash flows and directly observed prices from exchange traded or OTC derivatives. While Level 2 assets are a bit more complex than Level 1, measurement can be rendered with a fairly high degree of confidence. However, Level 3 assets are not so simple.

Level 3 consists of unobservable inputs, such as those that reflect the reporting entity’s own assumptions about what market participants would use to price the asset or liability. Ultimately, Level 3 inputs, which assist at deriving the underlying asset’s current value, must include information based on extrapolation or interpolation of observable market data.

In the case of Lehman, this sits at the very core of their recent writedown and massive losses. In the last quarter, the firm sold $3.5 billion of Level 3 assets which consisted mostly of mortgage-backed securities. And despite these sales, the firm still has approximately $38 billion in Level 3 assets sitting on the books as of their most recent 10-Q filing. Selling into a weak and uncertain market environment have made matters even worse. And while the firm works to decrease their exposure in Level 3 assets, Lehman makes these sales even more interesting by acknowledging that some of their transactions have taken place with an entity known as R3 Capital Partners.

R3 Capital Partners, launched this past May, is a hedge fund run by an ex-Lehman executive named Rick Rieder. Sounds fishy doesn’t it? I would say so.

Oh and did I mention that Lehman is an investor in this hedge fund. In fact, it currently maintains a "non-voting, minority ownership stake" in the fund.

With that said, I think a few good questions would be:

1. How much did R3 pay for Lehman’s Level 3 assets?

2. Were there any assumptions/conditions built into these deals that actually make these transactions simply a temporary transfer of risk?

3. Could you discuss in further detail the $4.5 billion in assets sold and/or transferred to R3 during Q2?

4. Do any of these executives that run R3 hold Lehman stock? And if so, doesn’t this present a conflict of interest? (The hedge fund’s disclosure documents states that it is possible that R3’s executives “could” be holding restricted stock in Lehman.)

Unfortunately, we probably won’t get the answer to any of those questions. The truth is: they don’t have to.

And so we come back to that darn FAS 157 – it’s forced firms to report market values and not assumed values. Shame on you FAS 157. Look at what you have done to this market.

News for 6 August 2008

Morgan Stanley Freezes home equity credit withdrawals [Bloomberg]
Morgan Stanley told thousands of clients this week that they would not be allowed to withdraw money

UBS strategist Bianco cuts year-end S&P 500 forecast to 1,550 [Bloomberg]
UBS AG cut its year-end forecast by about 3.1% to 1,550 on concern of the slowing U.S. economy

Merrill should slash dividend 64%, Bernstein Says [Bloomberg]
Merrill Lynch's recent woes and capital-raising efforts have diluted shareholders by 87%

Carlyle Group agrees to buy 48% stake in clothes maker Moncler [Bloomberg]
Carlyle Group agreed to buy a 48 percent stake in a sportswear clothes maker

Citigroup may buy back auction rate securities, Journal says [Bloomberg]
Citigroup may buy back 5 billion of illiquid auction rate securities

Lehman likely to sell 20% stake in Neuberger Berman [Bloomberg]
Lehman Brothers looks to sell a 20% stake in Neuberger Berman Inc. money manager

Bear sued for Greenberg, Schwartz pre-buyout comments [Bloomberg]
Bear Stearns is sued for securities fraud over comments allegedly made by executives before the buyout was engaged

Market Recap for 4 August 2008

Equity selloff amid the drop in oil prices...weakness across the financial board.

DJIA   11,284.15  -42.17

NASDAQ   2,285.56   -25.40

S&P   1,249.01   -11.30

GS   177.86   -4.14

MER   26.39   -0.46

LEH   17.94   -0.71

JPM   40.14   -0.62

IAI   32.80   -0.88

IYG   75.11   -1.14

News for 4 Aug 2008

Citigroup to close Tribeca convertible hedge fund after heavy redemptions [Bloomberg]
Turns out that Citigroup closes another hedge fund in less than two months

UBS general counsel David Aufhauser resigns post [Bloomberg]
UBS AG's top U.S. legal official, David Aufhauser, quit as New York Attorney General Andrew Cuomo investigates

Citigroup posts loss on Credit-Card Securitizations [Bloomberg]
Citigroup reports its first loss since at least 2005 on credit-card securitizations

Citadel hires at least six people from Merrill for Asia Funds [Bloomberg]
Citadel Investment Group hired Adwait Masurkar from Merrill Lynch to boost its Asian Funds

Carlyle to shutter Blue Wave Hedge Funds [Bloomberg]
Carlyle Group is liquidating its Blue Wave hegde funds after assets fell by a third

UBS wins U.K. Court Order in Vestra Wealth Dispute [Bloomberg]
UBS AG, won a court order stopping a company set up by former employees

JPMorgan to move European head office to Canary Wharf [Bloomberg]
JPMorgan is in talks to move its European headquarters to Canary Wharf

This person will regret this statement in about 12 months.

Veteran traders know that capitulation is close when you have people making such outlandish statements. While I understand what he is trying to say (with respect to asset bubbles) but he is comparing apples to oranges. Taken from the TheStreet.com:

Learning From Japan's Experience 1/4/2008 2:41 PM EST
Does anyone remember how the Japanese stock market opened 1990 on a similar note to the U.S. market this year? That was caused by the collapse of Japan's real estate bubble.

The cause and effect relationship doesn't appear to so different here. So I believe that the Japanese experience (a decade-long bear market) has considerable relevance.

Position: None

Wow...talk about a "bold statement." Here is the truth from my perch: the Japanese asset bubble is nothing like we are experiencing at the moment. The Japanese bubble was just downright aweful...Some highlights from the their bubble economy:

US bailout of Fannie and Freddie

With confidence waning at Fannie Mae and Freddie Mac, the US government has decided to step in and bail out the two beleaguered firms. The companies, known as government-sponsored enterprises, or GSEs, affect nearly half of the nation's mortgages by either owning or guaranteeing them. More precisely, by issuing securities they provide liquidity to the mortgage markets. They make their money by charging a guarantee fee on loans this is has securitized into mortgage-backed securities.

Treasury Secretary Henry Paulson asked Congress for authority to buy unlimited stakes in and lend to the companies. This would also include increasing the credit lines for both firms.

Interestingly, this purchase in equity would be the first time ever that the US government has taken an equity position in either firm.

Asset bubbles and valuation. (Part II)

Part II will look at recessionary periods that occurred this decade and in the 1990s.

Learning to be good traders means that we should learn from current events and take notes. We should also look at the past as a guide - history, as they say, tends to repeat itself.

Make no mistake...we are in the middle of an asset devaluation period and maybe even a recession. This afternoon comes news that the White House has put together a rescue plan for Fannie Mae and Freddie Mac that will include the funding of stock purchases and the infusion of cash all in the neighborhood of $15 billion.

With that said, there are basically three questions that concern investors at the moment:

1) How long will this last?
2) How bad will it be?
3) What was the cause?

I believe the best way to answer these questions is to explore our economic past for a bit of insight. Specifically, let's revisit our previous recessionary periods and the consequences of them:

Asset bubbles and valuation. (Part I)

Part I discusses the current US asset bubble and its effects

The selloff in the equity market should be expected. None of us should be surprised...and why you ask? Here are few reasons why:

1. Interest rates (and the fed funds rate in particular) were so low, for so long that it made money "cheap" and induced a borrowing frenzy of epic proportions. The effective fed funds rate dipped below 2% for the first time in almost 40 years. (For those unfamiliar with the fed funds rate, it is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions, usually overnight.)

From a "macro" standpoint, promoting low interest rates will give corporations the incentive to borrow which in turn creates an expansionary environment thus higher economic growth. And, as you will see later, higher cash flows and earnings growth will lead to higher asset prices.

2. Inflation rates never forced the Fed to "moderate" growth as they have in the past. Under the premise of higher economic growth, it was usually expected that higher inflation would follow. However, due to better Fed policy management, inflationary pressures never really set in this decade. As a result, the Feds kept rates for longer than it should've.

3. Revenue growth and unsustainable profit margins also played an important role. With the advent of global demand and the US consumer, firms prospered from unprecedented economic growth. Demand kept profit margins at a healthy clip this decade.

With all of that said, let examine how these factors quantitatively transformed into higher asset valuations and, in some case, bubbles:

Och Ziff Funds report performance losses in 4th Qtr.

Och Ziff Capital Management (ticker: OZM) repoted that all four of its funds experienced losses in the firsdt quarter.  The OZ Master fund, which is the firms flagship fund, is down 0.85% year-to-date while the Europe Master Fund has fallen 1.75% YTD, the Asia Master Fund is down 2.58% YTD, and the Global Special Investments Master Fund declined 0.60% in the same time frame.

This of course comes on the heels of a dismal fourth quarter when the firm announced that assets were down $774 million. 

This morning stock is trading at $20.00 per share which is down roughly 44 cents (-2.15%) from yesterday's close. 

Traders burned as I suspected....

Last week, I posted the following notes:

"-The number of bearish put options traded on Lehman's stock exceeded call options by 3-to-1 and put volume in the first three hours of the day topped the daily average of the past 20 sessions."

"-A so-called bear spread of almost 20,000 Lehman options contracts traded at 9:51 a.m., according to traders and Bloomberg data. An investor using the strategy buys puts while simultaneously selling them at a lower strike price. The position reduces the overall cost of the trade and also caps the total potential profit if the stock falls."

And then I made the following prognostication:

"-Hmmm!  Sounds like some traders are going to get burned.  Its been my experiences that more times than not, when people take a huge "speculative, rumor-based, negative" position like this...they usually lose.  This is action can be great to watch but I wouldn't dare engage into it.  This one will be fun to see unfold."

Fast forward to today:  Lehman is trading at $43.94 up $6.34 or 15.50%.  Wow!  I sure hope they unwinded the trade before this morning.

Intraday: Bond Insurers Rally, Google Falls!

- Bond insurers were dealt some good news...Moody's agency rating reaffirmed their "AAA" rating on MBIA this afternoon.  Shares of MBIA were up 3.5% to $15.10 after the well-received news. 

-  Google shares are taking a beaten right now after an industry report published this week showed a decline in key measure for how Google gets paid by advertisers.  UBS trimmed its first quarter EPS (est.) to $4.66 to $4.76.  That now means that Street consensus, excluding one-time items, now stands at $4.69 a share.  The range of those estimates:  $4.23 to $5.02.  Longer-term I still believe in the name but would expect some for form of near term volatility.

-  As I have said before, I enjoy watching other traders and reading into their sentiments as they relate to current market conditions.  Doug Kass being one of the "famed traders".  His favorite long is UltraShort Oil & Gas ProShares (DUG), while his favorite short is Retail HOLDRs (RTH).  Basically, he is bearish on the market in the near term and has choosen to short sell oil/gas and retails stocks.  Not sure I agree with those picks.  And based on closing market prices, it appears as though Dougie has taken it in the chin today:  DUG was down 2.785 and RTH was up 1.21%.  Ouch!

-  CNBC's Charles Gasparino said within the past half hour that their may be a bailout in the works for mortgage insurers.  More to come...

         

      

Thoughts from Monday's Action...

-  What can I say?  The Dow up 189 points and the S&P 500 up almost 20 points.  Probably the biggest news was that Standard & Poor's affirmed its ratings for Ambac Financial Group Inc. and MBIA Inc., raising hopes that troubled bond insurers will emerge from the credit market crisis on solid footing.  Just don't buy the stocks and keep in mind that rating agencies have a tendency to be "late to the party."  If you decide to engage the bond insurer stocks then I say two words: "caveat emptor".

-  S&P outperformed the Nasdaq today based primarily on the equity fuel in energy-related stocks.

-  Dowgrades today included: GM (GM), Peabody (BTU), and a big SELL rating on New York Times (NYT).

-  The one that interests me the most is the New York Times downgrade.  The stock has been up some 50% since late January.  One would expect that at some point NYT will axe some of the current dividend payment.  As it stands right now, the dividend is 92 cents a share and with the stock trading at 19.59 then the effective dividend yield is 4.70%.  Way too high you ask me...With that said, I say that you should expect the axe on the dividend! 

-  Famed hedge fund manager, Doug Kass, has said that he is getting back into the UltraShort Oil & Gas ProShares (DUG).  Thinks that energy stocks prices are somewhat overpriced.  Note that the last time he took this same position in DUG, then he made about 15%  in two weeks.

   

Weekend Notes.

From time to time, I like to post notes that I think are interesting and relevant (or maybe not).  Its always a good idea to keep an eye on signifcant trades/rumors/speculation etc.  Here's a rundown:

1.  According to the Barron's 13D Filings column, Firebrand Partners and Harbinger Capital Partners are seeking representation on the board of the New York Times (ticker: NYT). The pair of hedge funds said that they have raised their stake in NYT to about 16.9 million (11.82%) shares, after a Harbinger fund bought 793,000 Class A shares for $18.71 each on Feb. 15.

2.  Also, Discovery Group I reported ownership of about 5,175,394 sharess (5.4%) of Drugstore.com (ticker: DSCM), after buying 733,849 from Jan. 4 to Feb. 15 at $2.65 to $3.05 each.

3.  Billionaire investor Edward Lampert raised his Autonation (ticker: AN) stake to 60,714,921 shares (33%), after buying 1,906,157 from Feb. 11 to 13 at prices ranging from $15.18 to $15.55 apiece.

4.  Money manager Steven Cohen (SAC Capital Management) cut its stake in the Vistacare Inc (ticker: VSTA) to 813,538 shares (4.8%), from the 998,493 stake (5.9%) reported on Feb. 1.  Can anyone say, "...don't catch the falling knife?"  I can!

5. Action continues to pick up in Yahoo $25 puts.  Traders are beginning to feel as though the deal could fall apart.  We shall wait and see.  About three weeks ago I did a "Question and Answer" piece on the deal and some of the details. (You can find it HERE)  I still think the deal goes through at this point.  The Softie (another name for Microsoft) PR Machine is full throttle with recent assurances to the public.  The downside for Yahoo stockholders is way too much if the deal falls apart.  Yahoo has tried almost everything to battle the Google giant only to fail and fail miserably.  Incidentally, Softie has done the same thing.  The only difference between the two firms:  Softie pockets are deeper and are looking to buy their way into a showdown.  If you are a holder of Yahoo I say pack your bags, book a gain, and look elsewhere.

6. Seeking Alpha is speculating a Ruth Chris Hostile Bid for its battered and woeful shares...HERE   

7.  According to Xinhuanet.com (www.chinaview.cn), Goldman Sachs raised China's 2008 inflation forecast to 6.8% from 4.5% in light of the rapid growth in money supply.  Goldman's Chief China Economist, Liang Hong, said in a report that inflation may continur to accelerate in the short-term and rise by double digits in coming months.  And he also expects the yuan to appreciate 12% in the coming 12 months.   

Intraday: Stocks Stronger on Upbeat Retail Sales

-  Wall Street is moving up today based on an unexpected increase in retail sales last month and eased some concerned about consumers' willingness to spend despite economic uncertainty.  At this moment the Dow is up over 150 points.

-  There was a rumor this morning that Citigroup's money markets were having liquidity issues.  However, Dow Jones reported that the rumor was incorrect.  Citi is up 18 cents at this point to $26.40 per share.

-  Traders are bidding up Microsoft shares today more than 1.5%.  As I have said in the past, I think Softie maybe good to look at.  They had a real strong earnings report that showed better than expected numbers earlier this month.  And I think the Yahoo takeover is a sign of agressive tactics being made by Balmer to counter the Google brainpower.  Let's hope for Softie's sake it isn't too late. 

-  Speaking of Yahoo...did you know that YHOO last repurchased almost $3 billion in outstanding shares.  And aren't normally, share repurchase plan goods for firms?  Yes, but YHOO badly miscalculated their move....the average share price of their repurchased allotment during last year was over $30 per share.  Keep in mind, that before the takeover bid, the shares were trading at about $17 per share.  Ummm, can anyone say, "stop throwing good money after bad..."?

-  On the other hand, renowned short seller Doug Kass is buying March $25 puts on YHOO for 30 cents a share.  His reasoning:  reports are that News Corp. might be interested in a joint venture with YHOO.

That's all I have for now...stay tuned.

After-Hours: Market Closes Higher!

- Stocks finished the day higher as the Dow closed up 46 points today after three straight days of losses.

- Earnings season is coming to end now.  Almost 80% of firms have already reported.  Earnings season can create shockwaves in the market when macro volatility is existent.  Now we will sit on our hands until April when 1Q08 figures are released.

- 60% of the firms that have reported have met expectations, 25% beat expectations and about 15% missed their earnings expectations.  But always remember that its not always about the numbers but about their forecast of future sales and net income.

- I have never been a big buyer of restaurant operator stocks...example: IHOP down 11% yesterday and California Pizza Kitchen down over 10% as well.  Two words: caveat emptor!   

Intraday: From my perch...

-  As I said yesterday, one of my concerns was how Cisco would be guide after they announced their earnings.  Well, unfortunately, Cisco provided a poor outlook for product near-term demand.  As a result, the stock has sold off accordingly.  Goldman Sachs believes it will take at least another quarter or two of solid results before the stock can regain sustained positive momentum.  They went on to reduce their 6 month price target from $32 to $28 per share.

-  I am seeing some big traders (including Doug Kass) that are starting to buy CSCO on this dip.  With the stock trading at only 15 times current profit and 13 times prospective earnings, he thinks the stock is a screaming buy.  I, personally, am not a fan of CSCO and telecom.  I say avoid this stock.   

- I am going to start adding to my portfolio based on my conviction list:  Goldman, iShare China and Dow Jones Ultra Index.    I will start with GS based on lower relative vaulation, then purchase DDM on the possibility of to the Dow returning to 13000 levels and a bit of FXI.

- Got my eyes on a few new names for the conviction list:  McDonalds (MCD), Transocean (RIG), and Raytheon (RTN).

- DJIA can't make up its mind whether to be negative or positive...the volatility continues.

Stay tuned.

Intraday: Markets Rebound on Disney news and Productivity results

-  Stocks rebounded slightly today based on better than expected results from Disney.  Disney posted a 26 percent decline in profit late Tuesday, but the results beat expectations. The company reported a 9 percent rise in revenue due in large part to increasing revenues from ESPN, "High School Musical" and "Hannah Montana."

-  Investors were also happy to hear that fourth quarter economic productivity climbed by 1.8% and labor costs rose by only 2.1%.  Both numbers exceeded economists predictions.

-  I am hearing of lots of shorting in the UltraShort Oil and Gas Proshares (DUG).  I sure hope that they are short term traders because, longer term, oil and gas remain a scarce commodity with no alternative anywhere in sight.  Shorting is a dangerous business only unless you have tons of capital and can trade with no emotional ties otherwise run and don't walk away from this trade. 

-  Expect the Bank of England to cut interest rate by 25 basis points to 5.25% tomorrow.  This should continue to devalue the British pound which has fallen to recent weeks from its November peak. 

-  Cisco's shares are up ahead of this afternoon's earnings.  The Street is looking for revenue of $9.79 billion and EPS of 38 cents.  But like all earnings calls, traders want to hear about the firm's outlook...that is the key!  Its always about the outlook.   

-  Yesterday, I predicted an Asian sell-off and it happened.  Asian markets fell the furthest in two weeks prompted by short-selling which knocked the index lower by 5.4%.  Luckily, most Asian markets will now be closed until the beginning of next week for the Chinese New Year - China's exchange will not open again until Feb 12th.         

-  On the Goldman Sachs front, the Massachusetts state pension fund has fired Goldman Sachs for poor performance with respect to the Global Alpha fund.  Nice piece from the dealbook HERE.

As I finish this post - Dow up about 5 points, S&P even and the Nasdaq down 7 points. 

Intraday: Market Pulls Back Again (if you can believe it)!

- All the stocks on my radar are down today - for the exception of one stock: Google.  It's hanging in tough right now at about $502 per share up $7.12 for the day.  I think perhaps bargain hunters are now picking away at this stock.  I am just not so sure about this one right now.  Keep in mind, that in a slowing economic environment, advertising and media stocks will get blasted.  Its the first and easiest line item for executives to trim on the income statement.

- Yahoo remains in its "target" price range therefore its virtually unchanged for the day at $29.30.  Merger talk will do that to a stock.  In case you missed it, be sure to check out my Q&A regarding the MSFT and YHOO deal as it gives a nice synopsis on the current status of the deal and the underlying strategy.

- I am hearing of some late day buying of QQQQs based on an "oversold" conditions.  Honestly, I've never been a big fan of the cubes...too volatile and too much Tech.

- I will be interested in two after-hours "macro" events coming up:  (a) Super Tuesday election results and (b) the extent of an Asian selloff this evening...

- Expect Google to lay on the heat with respect to antitrust political pressures on a proposed deal between MSFT and YHOO.  MSFT did the same to GOOG during the GOOG and DoubleClick deal.  I guess its payback time.

- With respect to buying and selling equities, I would recommend sitting on your hands for a bit more...remember no huge bets and cash is not a bad thing.

END OF DAY UPDATE:  Dow Jones loses 360 points on the session.  Stay tuned for more updates...

Microsoft goes "HOSTILE" on Yahoo! A Q&A Perspective...Part I

A successful hostile takeover from the perspective of the bidder is a rare occurrence.  Generally speaking, hostile deals are frowned upon by not only some shareholders on both sides of a deal but also by the bankers that sometimes provide the financing.  The synergies are also highly scrutinized as history has not been kind to these types of deals.  But this case may be different...

As we all know, Microsoft placed a $44.6 billion bet that buying Yahoo can give it the Internet presence that it has longed for in recent years.  After years of testing and research, Microsoft's foray into online search and advertising can be summarized in one word:  FAILED!  With Balmer at the helm, he is determined to change that here and now.  The software giant's surprising, unsolicited offer for Yahoo represents a 60% premium over the Internet company's recent share price.  If the deal goes on to close, this would be the biggest tech transaction ever recorded.

With so many details and questions surrounding this deal and the use of a "hostile" strategy, I have decided to tackle this deal from a Q&A standpoint.... 

What is a hostile takeover and why is Microsoft forcing a hostile takeover on Yahoo?

Normally, when a bidder makes an offer for another company, it usually informs the board of the target beforehand. If the target board feels that the offer is such that the shareholders will be best served by accepting, it will then recommend the offer be accepted by the shareholders.  This is commonly referred to as a "friendly" takeover.  A hostile situation is complete different.  In the case of hostile takeover normally one of the two (if not both) following conditions will exist between the respective parties:  (1) the board rejects the offer, but the bidder continues to aggressively pursue it, and/or (2) a bidder goes public to make an offer without informing the board prior to such offer.

In the case of Microsoft and Yahoo, I would say both conditions, to some extent, exist.  In 2006, Microsoft began showing interest in a Yahoo deal.  But after some initial discussions, Yahoo pushed Microsoft away.  Yahoo figured that they could go "Lone Ranger" by way of strategic partnerships and internal growth initiatives.  Well that failed miserably.  In recent years, Yahoo has suffered from disappointing online-ad sales, declining web-search market share and high management turnover. 

With Yahoo turning its back to Microsoft, that basically meant that the desktop giant had no choice but to take the deal public and make a hostile bid for it.  And, in all fairness, to Microsoft, its a smart move knowing that they themselves are in a "must win" situation.

Is it possible that other potential buyers could enter the fray at this point? 

Possible but very unlikely.  I am not sure that there is anyone, at least among those who might be interested in making a play on Yahoo, that has the kind of financial firepower and war chest of cash that Microsoft has on hand.  And in this world of high powered private equity firms, the turmoil of the credit markets make it unlikely that any consortium of dealmakers could ban together to pick up Yahoo.

So at this point I don't see any white knights entering into a bidding war with the Goliath of desktop software. 

I heard of a tactic that Yahoo may use which involves enacting a "poison pill"...what is it and how does it apply in this case?

The "poison pill" is a takeover defense used by target firms and can take many forms as it applies to defense.  The most common poison pill is known as a shareholder rights plan.   

In a shareholder rights plan, the target company issues rights to existing shareholders to acquire a large number of new securities, usually common stock or preferred stock, at a discount to the current market price. The new rights typically allow holders (other than a bidder) to convert their right into a large number of common shares if anyone acquires more than a set amount of the target's stock (typically 10-20%). This dilutes the percentage of the target owned by the bidder, and makes it more expensive to acquire control of the target.  Many times the dilution can kill pending deals. 

In the case of Yahoo, the firm does have a shareholder rights plan in place which could make the deal expensive.  However, the timing of the deal suggests the Microsoft (aka "Softie) might be looking to take its case to shareholders via a proxy fight for Yahoo board seats.  If Softie wins seats on the board then they could in effect have the new board members drop the provisions of the poison pill and let Softie close the deal without a shot fired.

What are the odds that this deal is consummated? 

Tough to put numbers on it but if I were forced to do so, I would say about 75% chance it gets done.  Microsoft can make a great case and has the war chest to put together a hefty deal.  And Yahoo, on the other hand, has very little leverage in light of the poor financial results and forecasts that they have provided shareholders in recent quarters.  So, with that, I say that a deal is definitely "more likely than not."

Should I buy Yahoo stock on the premise that Microsoft will probably up the target price at some point?

Absolutely not!  This is a risky transaction that has many hurdles and potential pitfalls (proxy vote, antitrust problems, white knight scenario, etc.) that could kill the deal and send Yahoo's stock tumbling into a complete free fall.  It could easily lose 30-40% in minutes if news broke that the deal is off while the upside at this point is pretty much capped.

If anything, you might be able to look at the weakness in Softie's share price as an opportunity to initiate a position.   

How important is this deal to Microsoft?

This deal is real important to Microsoft.  While I hate to cast a superlative on Microsoft, I will say that Microsoft's long term survival is very dependent on their Internet success or lack thereof.  And up to this point, Microsoft has struggled mightily to establish a foothold in the search and online ad market.  With that said, it's a must do deal for Balmer and Co.

This Q&A is to be continued, please stay tuned...

 

February is going to be an UP month!

I will predict right now that February will be an "up month" for equities all across the board.  Stocks were battered so much last month that momentum traders will pick up "cheap" names and move them higher.  My predictions for the month...

DJIA will be up about 4% for the month

S&P 500 will be up about 5% for the month

and the NASDAQ will move up somewhere near 7% but will end the month still in negative territory for the year...

Microsoft offers to buy Yahoo for $31/share..

Great deal!  MSFT made an unsolicited $44.5B takeover offer for YHOO.  This is a must-do deal for the Balmer & Co.

As usual in an offer of this magnitude....the firm making the offer is down for the day while the target is up significantly based on the takeover premium.

Yahoo trading at 27.63 is up $8.44 (+43.90%)

Microsoft trading at 30.58 is down $2.01 (-6.17%)

Market Rallies after Morning Sell-Off...

After a rough morning of economic news, stocks reversed course and are up about 77 points as of this post.  The labor department said initial jobless claims soared by 69,000 to 375,000.  This of course comes as bad news while we await the government's January nonfarm payroll numbers.  Tomorrow should surely be an interesting trading day.

From an equity performance standpoint, the month of January has been rough for holders of stock.  Thus far...

DJIA = -6.8%

S&P 500 = -8.2%

NASDAQ = -12.0%

Please note that these are month to date numbers.  I would expect that, at a minimum, we retrace these losses over the next 6 weeks.  Financials should lead the way.  I will sit on my hands until we have more economic clarity.  No purchases or sales today...

Other thoughts from my perch...

Need to start reviewing and considering adding to financial stocks.  Brokers and banks are typically considered "interest rate sensitive" to the extent that they perform very well in an enviornment that see lower interest rates.

Among the names to look at:

Goldman Sachs (GS)

Bank of America (BAC)

Lehman Brothers (LEH)

Morgan Stanley (MS)

All are moving higher this afternoon...

Why I don't trade Fed Futures...

...cuz I was wrong on the size of the cut.  The Fed moves to cut the rate by 50 basis points citing deteriorating credit and housing market.  As I write this, the Dow is up 80 points.  In all fairness to Bernanke, he is pushing the pedal at full throttle to provide the economy with some serious liquidity and avert further economic weakness.  I just wonder how much lower we can go on the Fed Funds rate and real rates, for that matter... 

FYI, dollar weakens more....

Fed's Ex-Dallas Prez Robert McTeer says 25 basis points "most likely"...

Says he would like to see Fed Funds rate down 50 basis points today but says 25 basis points is "more likely".  I echoed the same sentiment yesterday...for some reason, I get a feeling that the Fed doesn't want to be bullied around by the markets and it shouldn't be.  I don't care what anyone says about that.  Monetary policy should, generally, not be a function of market performance.

FYI, I believe a 25 basis point cut would mean a selloff over the next day or two. 

China Strategy: "Soft Landing" in Play.

Some quick notes on China and FXI:

VISIBILITY IS A PROBLEM -  And this is due to three reasons:  (1) the US credit crisis has spilled over to global debt markets; (2) China's economy may be overheating; and (3) companies' earnings and liquidity in the equities markets.  With that in line, Chinese stocks have seen some weakness as investors are pricing in the expectations of lower shareholder returns and high equity risk premium which is a bi-product of outlook uncertainties.

IMPORTING GROWTH - The Chinese have been "importing" global growth by exporting Chinese produced goods.  These goods include everything from steel, copper to other often used commodities around the world.  Basically, the products that fuel economic growth.  However, in times of slowing global growth, China may act to help alleviate global weakness by trying to sustain long term growth which means that at some point they need to accept some moderating of their torrid growth pace. 

TIGHTENING THE CREDIT MARKETS - This may also mean tightening lending standards.  Investment projects in China are likely to face headwinds when they apply for approvals and bank credits.  When exports falter and signs of slowing in investment growth appear then imbalances in credit and hypergrowth should better align themselves.

I still believe that over a 12 month time frame, FXI remains an excellent longer term choice (12 month plus).  I would caution investors trying to day trade the stock or play on a very short term basis.  The equity markets in China are super-volatile as compared to the US markets.  Not sure most of us would have the stomach to see broader market numbers moving 10 to 12% on a daily basis as we saw last week on Asian exchanges.   

Economy Stalls Out?

The economy nearly stalled out in the 4th quarter with a growth rate of just 0.6%, capping its worst year since 2002.  This comes as economists were expecting a 1.2% growth rate.  As a matter of reference, the 3rd quarter growth rate sat steadily at 4.9%.  A change from 4.9 to 0.6 is pretty hefty.

The Commerce Department's report on GDP, released Wednesday, showed an economy that deteriorated significantly from October to December as the housing and credit markets both dried up. 

The timing of this announcement couldn't have been better.  With the Fed scheduled to meet tomorrow, they almost have to act before we stall into a nose dive.   Stay tuned!

Dow Opens Higher as Investors Await Fed

Investors are anxiously awaiting this weeks FOMC meeting.  The Fed's rate decision is clearly the market's focus this trading week, so trading will be marked by investors' conjectures about policymakers' sentiments on the possiblity of a weak economy. With a decision not expected until late Wednesday, the market will continue to digest Tuesday's data on earnings, consumer spending and durable goods.

This week the Fed surely has a lot on its plate.  I think perhaps the biggest problem was that they probably overextended with respect to last week's 75 basis point cut.  With my retrospective advantage in mind, I would have done 50 last week and 50 this week to get the Fed Funds rate down to 3.0%.  But now they are probably stuck to 15 basis.  Taking the Fed Funds rate lower than 2.5% over the next months would put real rates into negative territory.  Thats a real dangerous situation to say the least. 

Given that as our backdrop, one of arguments that, inevitably, shows up at a time like this is that by lowering rates too much, as Bernanke & Co. could be doing, they are setting up the possibility for further asset bubbles.  Lower rates, which assisted the economy since 2001, created the huge "housing monster".  I would say at the moment, going lower than 2.5% on the Fed Funds rate might mean further bubbles. 

Caveat Emptor!

Source: Yahoo.com

Stocks Move Higher for Lower Rates? Oh No!

Wall Street advanced yesterday after a big drop in new home sales and disappointing earnings...and you ask "why?"...everyone thinks rates get cut again.  Traders who are betting on the Fed's next move and are pricing in a more than 80% chance of a half-point cut.  Anything less than that would be a letdown...

My take:  I think we will be lucky to get the 50 basis point cut.  In fact, I feel about 75% comfortable that we get a 25 basis point cut.  I just wish traders would manage their personal expectations on rate cuts...maybe I will be wrong but I think not.

In other news...

a) the dollar fell against most major currencies except the yen

b) gold prices were up again

c) crude oil rose 28 cents to close at $90.99 a barrell on the New York Mercantile Exchange

7 Months Later and the Blowup Happens!

Last July I posted that the subprime market was about to blowup and Bear gave us the forewarning.

Unfortunately, most investors/investment bankers didn't take it serious and now we are paying the price.  And with that we are now facing the possiblity of a recession.  On the heels on a deep global selloff, the Fed cut the discount rate by 75 basis points.  The Federal Reserve normally tries to avoid reacting directly to financial markets but with the global markets in a freefall, their hand was forced.

The Dow Jones Industrial Average (DJIA), down as much as 464 points early in morning trading, later recovered to close down 128.11 points, or 1%. European markets, which were falling for a second straight trading day, reversed course and closed higher on the Fed's action.

Bonus News for the Afternoon:  Apple beats estimates BUT falls on forecast!  Shares traded 10% lower after Apple execs warned on possible weakness in upcoming quarters.

http://online.wsj.com/article/SB120102062256706905.html?mod=hpp_us_whats_news

On tap for this week (Jun 11 - Jun 15)...

This week will see much action on both the macroeconomic side and coporate earnings front.

Tuesday  June 12

• Lehman Brothers Earnings Report

Wednesday June 13

• Retail Sales for May (forecast = +0.6%)
• Import Price Index (forecast = 1.5%)
• Fed's Beige Book

Thursday June 14

• Producer Price Index PPI (forecast = +0.5%)
• Initial Jobless Claims (forecast = 309,000)
• Goldman Sachs Earnings Report
• Freddie Mac Earnings Report
• Adobe Earnings Report
• Bear Stearns Earnings Report

Friday June 15

• Consumer Price Index CPI (forecast = +0.6%)
• CPI ex-energy (forecast = +0.2%)
• Industrial Production (forecast = +0.1%)
• Capacity Utilization (forecast = 81.5%)
• UMich Sentiment Index (forecast = 88.3)
• Carnival Coporate Earnings

Upgrades / Downgrades for 3 Jan 07

CHANGES IN RATINGS

Chesapeake Energy downgraded at Goldman Sachs - Downgraded to Neutral from Buy based on less credit for unbooked resource profit and drilling rig ownership. Also noted that company closed out some hedges in mid-December and has greater risk exposure. GS also cut its price target to $35 from $40.

Seagate downgraded at Goldman Sachs - Goldman said it is downgrading STX to Neutral from Buy due to concern over weak tape during seasonally slow period. See notebook demand running ahead of expectations for December quarter. Price target at $28.

T. Rowe Price upgraded at UBS - TROW upgraded to Buy rating from Neutral at UBS. Price target lifts to $52 from $50. Also, introduces 2008 eps estimate of $2.55.

 

CHANGES IN ESTIMATES

Baidu.com numbers raised at Piper - Piper said it is raising its target price on BIDU to $131 from $110 due to increased confidence in expanding margins.

Chicago Board of Trade target price raised at Credit Suisse - Credit Suisse said it is raising its target price on BOT to $169 from $159 following strong December volume growth.

Google target price raised at Piper - Piper said it is raising its target price on GOOG from $600 to $630 due to increased adoptions of non-search products and increasing brand affinity.

 

On another completely different topic: football.  Recently, an economics professor at Cal Berkley put a study together that suggests that Pro Football teams should "go for it" on fourth down a lot more often than they currently do.  Here it is:  http://elsa.berkeley.edu/~dromer/papers/PAPER_NFL_JULY05_FORWEB_CORRECTED.pdf

Opening Bell: 3 Jan 07

I hope everyone had a good time during the recent holidays.  I sure did.  Now its time to get back in the saddle.  While we only have three trading days left this week, we have enough action on the calendar to, potentially, create an interesting trading environment.  Here's a rundown:

Wednesday - Release of the minutes from the Federal Open Market Committee's (FOMC) last meeting.  During the Dec 12th meeting, the Fed kept rates unchanged at 5.25% for the fourth consecutive time but it appears some on the board are concerned with inflation.  This release should give us a clue in what the Fed believes may or may not be happening in the near-term economic front.

Thursday - Reports on construction spending for November and auto sales for December from General Motors, Ford and Toyota.  I guess we get to see Toyota (once again) increase their market share!  Also on deck this Thursday is the Initial Jobless Claims. 

Friday - Nonfarm Payroll Data will be the headliner.  Economists project that roughly 110,000 jobs were added during the month, down from about 130,000 in November.  The unemployment rate is expected to remain steady at approx. 4.5% and the average workweek is predicted to stay at 33.9 hours. Finally, hourly earnings are forecasted to rise 0.3%, compared with growth of 0.2% in November.  I would expect any significant deviation in either direction could have a significant impact on Friday's trading.

Stay tuned!