Today is Day without a Gay – we all call in gay and do community service for a day, in (very) peaceful protest of our second-class citizenship.
So there will be no column today for those of you who think Charles and I don’t deserve equal rights under the law.
For everyone else . . .
GOBS AND GOBS
Chris Brown: ‘A high-risk trade is to buy LNY (Landry’s Restaurants). The company is being taken private by the CEO for $13.50 per share. Financing has been arranged, and the CEO has been buying gobs and gobs of shares in the open market. The stock is at $11.33, and the deal is expected to close around February 15. If all goes well, that’s a 19% profit in 2½ months. I’m not the first to notice this. C.L. King mentioned it in a research note on Nov. 18. The risk is that the company has a lot of operations in Galveston, which have been damaged by Ike and will likely suffer further by the downsizing of the medical center there, so, without a buyer for this company, it could be a $6 stock. Additionally, the company has a bunch of bonds coming due in 2009, so if they don’t get a buyout or some sort of financing, it could be a $0 stock as the bondholders could own the company. However, the company has stated publicly that they have a commitment to refinance their debt even if it is not bought out. For me, given the confidence of the CEO to put gobs and gobs of his own money on the line already, the Fund is long LNY and short long-dated LNY puts (that have a lot of time premium embedded in them, but become worthless when the buyout becomes effective). BUD traded at a huge discount to its takeout price in spite of financing being in place; I think this is the same situation. There are simply better arbitrage opportunities in a market where so many participants need capital.”
☞ I should have posted this a week ago when Chris first sent it – last night the stock closed at $11.81 (and by now, Chris says, the pricing on the puts is unattractive). Still, 12% in two months, if the deal gets done, isn’t bad. And maybe the stock will fall back a little in the meantime.
Chris runs the fledgling, nascent, teeeeensy Aristides Capital, a long-short hedge fund (up 5.74% net of fees since its inception August 15, versus a loss of 30.68% for the S&P 500) that tries to discover ways to make money without taking too much risk (like that Ford common / preferred strategy he shared last week). He is smarter than the average bear . . . and is actually not a bear at all. He writes:
The grim news is that we have entered a recession which many believe will be longer and deeper than anything we’ve encountered since the mid-1970s, and the earnings per share of U.S. companies will contract dramatically in 2009, to something like $65 for the entire S&P 500. The good news, as we discussed last month (a call which was either wrong or early), is that there may not be a lot of sellers left in the intermediate term. There are as many short ideas as long ones on television’s most popular investment show, the hot stock selection service of the day has started advising potential subscribers to “remain hedged at all times,” the public short ratio has increased 75% over the last three years, and fewer than 25% of investment newsletter writers are now bullish, in spite of a recent rally. That sort of pessimism often leads to good stock market returns going forward.
The market itself is finally showing some signals of strength. According to Jason Goepfert, yesterday the 10-day moving average of the “up issues ratio” on the New York Stock Exchange reached three standard deviations above its yearly mean for only the 5th time on record. This sustained buying pressure has, in the past, been a sign of good things to come, leading to significant 6-9 month (or longer) rallies on the four prior occasions. Is this a sure recipe for a new bull market? Obviously not, but with the yield of the S&P 500 roughly equal to the yield of the 30-year bonds being issued by the single largest debtor nation on earth, even if the sky really is falling, there’s a good chance it won’t hurt as much as we expect when it bonks us in the head.
For evidence that even the savviest market observers can be wrong, look no farther than the first line of Bill Gross’s current missive. Six years ago, he predicted that the Dow, then 8,500, would fall to 5,000 – and instead it rose to 14,000.
And yet there is no one smarter or whose views are better respected than his – with good reason – and he acknowledges some causes for optimism . . .
Today’s Q ratio has almost never been lower and certainly not since WWII, implying extreme undervaluation, as seen in Chart 1 . . .
Another long-term standard of valuation comes from the good ol’ P/E ratio, where earnings per share, or E, is compared as a function of P, or price. Chart 2, going all the way back to 1871, shows the same relatively massive undervaluation, not only in the U.S. but elsewhere. This has been a global bear market. Yet here one should be careful. The sage of rationality, Yale’s Robert Shiller, cautions us to look at earnings on an historical 10-year moving average to remove adverse or fortuitous cyclicality. When measured on this basis, P/E’s are cheap but less so, slightly below their mean average for the past century . . .
☞ Yet, if you read the whole thing, you will see he concludes it is a better time to own bonds than stocks. Which brings us to:
CAN THE MARKET GO TO ZERO?
The surprising answer to this question is . . . yes. (Sort of.) And not even the way the Russian market did in 1917. The world doesn’t have to end for this to happen – nor end if it does. It’s just that much (three-quarters?) of corporate financing takes the form of debt, not equity – just as the financing of your $200,000 home may be take the form of $150,000 in remaining mortgage debt and $50,000 in accrued equity. Could your home decline in value to $150,000? Yes. Would it disappear? No. But your equity would have dropped to zero . . . and, if you couldn’t make your payments, ownership might transfer from you to the lender.
Well, in much the same way, ownership of some of our largest and most recognizable companies could conceivably shift to the bondholders. The companies would still be there (you have surely flown on your share of bankrupt airlines and still arrived safely at your destination); it’s just that the old shareholders would have been wiped out in favor of the bondholders, who would now own the company.
This is surely not going to happen with every company – maybe not even every automobile company. But, as silly as it is to think of the Dow going literally to zero, I’m not sure it’s all clear sailing for the stock market from here, either.
If you’re 27 with no dependents, this is a brilliant time to put every penny you can each month into stocks, planning to do so for many years.
And, yes, I am greatly heartened by the new team and the new competence and the new hope sweeping into Washington. There is much to feel good about for the long term.
But – as always – the stock market is no place for money you might actually need in the next few years.
Quote of the Day
In 1800, 75% of [an American's] working man's expenditures went for food alone. By 1850, that had dropped to 50%. Today it is a little more than 11%.~The Wall Street Journal, September 20, 1996
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