Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
8:30 AM EST, Friday, August 10, 2007: "Father,"
the son asked, "Is there a guaranteed way to make a small fortune?"
replied the father, "start with a large one."
Today we all have
a small fortune. Ultimately, the markets will recover. They always do. Here's
what happened earlier this year when we had another big day fall:
The biggest problem
facing markets today is no longer the billions lost on bad, stupid, foolish
loans to deadbeats to buy houses they couldn't afford -- . 10% to 20% of whom
never made even one payment on their home loan. (I kid you not.) It's
what else is wrong. And there are three other BIG things that might be
1. Easy money
loans to other places. When the Fed dropped rates to almost nothing, it
made money cheap and plentiful. Investment bankers organized loans to everybody
and their uncle for not just subprime home mortage loans. Credit requirements
were loose. Which ones have gone wrong? And who is still holding the bag? Loans
these days are moved around, sold like hot potatoes from one institution to
another. Companies now holding these loans are in big trouble. Right now we
don't know who they all are, nor the full extent of the damage. Not knowing
is not good for stockmarkets. They get fearful. Fear drives them downward, viz.
2. Loans to
hedge funds to buy equities. Many, many hedge funds borrowed cheap money
to finance the purchase of equities. They did because it increases their return
-- if the stocks go up. For example I own a stock that goes from $100 to $10.
Hence I made 10% on my money. But if I borrow $50 to finance my buy, then my
return had risen to nearly 20% (i.e. $10 divided by $50 less the interest on
the loan). Let's say I borrow $90. Suddenly I've made nearly 100% on my money
(i.e. $10 divided by $10 less the interest on the loan). If the stock rises
to $120, my returns start to look really interesting. What happens, however,
when the stock falls by $11? The bank calls me in a panic. They're about to
lose money. I know own collateral that's worth less than the loan. They
insist I sell the stock before it gets worse. I do and it gets worse. Selling
creates panic and more selling. Hence yesterday's drop.
The sad part we
simply don't know the full extent of the hedge fund disaster. Many hedge funds
actually borrowed from several places, i.e. they had severla prime brokers.
Many are leveraged up huge amounts -- like 100 to one. They borrow $99 to buy
$100 stock. (I kid you not.) It takes only a small hiccup in the stockmarket
to wipe out their net asset value (the value of their stocks less their debt
obligations). Yesterday was not a small hiccup. It was a large one.
3. Many private
equity deals are about to south. Private equity funds have been buying big
public companies and taking them private. This has driven up the value of all
companes, since many investors expect their favorite companies to be bought
at a price higher than what it is currently trading at. Private equity funds
borrow money to help pay for these takeovers. Many people call these takeovers
LBOs -- leveraged buyouts. There'll be less money around for these deals. Hence,
there will be fewer LBOs.
In these columns
recently, I have been predicting exactly what happened yesterday. And I can
see further big falls. Will we now flop into a recession? It's possble. It is
clear that it will take time for this mess to unravel. But it will unravel.
It always has. Stick with my rules. But remember the BIGGEST rule of them all,
"When in doubt, get out" -- i.e. examine each stock you own.
Dump the ones that might be harboring upcoming problems. That includes all
In the long-run?
My friend, Dan Good, a successful (now retired) investment banker, forecasted
this morning, "The world economy is strong and after we give back the
gains for 2007 and the credit markets stabilize, we'll be back to normal markets,
probably in the late fall." I suspect he may be right.
Now, let's do some reading. The Wall Street Journal posted this piece early
this morning, "Typhoon of Anxiety Roils Global Markets"
As questions grow about the extent of potential fallout from the mortgage
crisis, the wave of anxiety that swept European and U.S. markets yesterday
kept its momentum overnight, with asset prices dropping across Asia and a
handful of central banks pumping extra liquidity into their local markets.
in Japan, Australia and Singapore injected cash into their local money markets
in an echo of yesterday's moves by the European Central Bank and the Federal
Reserve to keep lending rates at targeted levels, Dow Jones Newswires reports.
Meanwhile, authorities in Malaysia, the Philippines and Indonesia stepped
into the foreign-exchange markets, selling dollars to support their currencies.
In Tokyo, the Bank of Japan injected a trillion yen, or $8.4 billion, after
lending rates rose above its policy rate, while the Reserve Bank of Australia
coughed up about $3.2 billion, twice the liquidity required, Dow Jones says.
Traders told the news agency that the Monetary Authority of Singapore injected
nearly $1 billion into that market, although shortly after, the city-state's
overnight deposit rate was a stubborn 2.75%, well above 2.25% a day before.
Other central bankers around the region, including in South Korea, stepped
forward to say they would inject funds if short-term lending rates became
volatile. The events in Asia are particularly startling because central bankers
in the region have kept a steady focus on containing liquidity to fight inflation,
as The Wall Street Journal notes; both the Australian and Korean central banks
raised interest rates this week.
analyst Masuhisa Kobayashi wrote in a research note that Friday's moves either
mean the credit market has destabilized so much that central banks had to
act, or the action was merely meant to prevent such a situation, Dow Jones
reports. "The market seems to have taken the former, more pessimistic
view," he said. Indeed, Asian stocks slumped the most in more than a
year, with benchmarks in the region's eight biggest markets all sliding as
much as 2%, Bloomberg reports. South Korea's Kospi index plunged 4.2%, the
most in three years; Australian shares lost 3.7%, their biggest decline since
September 2001, and in Singapore, investors ignored news that the economy
grew at its fastest pace in two years last quarter and sold off shares to
the tune of 3.2%. In Europe this morning, the ECB also injected cash for the
second straight day, adding nearly $84 billion to money markets as stock indexes
around the region slumped again. "There are indiscriminate sell orders
from panicked investors,'' Liu Juming, a fund manager at Ta Chong Investment
Trust Corp., which manages $1.1 billion of assets, told Bloomberg. "The
old saying in the investment world that 'cash is king' came about because
of days like today."
As on both sides
of the Atlantic yesterday, the big question, as Businessweek puts it, is whether
the large but isolated problem -- liquidity shrinkage prompted by the subprime
crash -- metastasizes into something harder to contain. "It's a question
of confidence," Businessweek cites Charles Diebel, head of interest-rate
strategy for Nomura Securities in London, as saying. "There's plenty
of cash out there, but there are a lot of small fires burning." Where
those fires are burning is the next question: The Journal reports that the
Securities and Exchange Commission is checking the books at top brokerage
firms and banks, including Goldman Sachs and Merrill Lynch, to make sure they
aren't hiding losses from the mortgage meltdown. People familiar with the
matter tell the Journal that the regulator wants to know whether Wall Street
brokers are using consistent methods to calculate the value of subprime-mortgage
assets in their own inventory and that held for customers like hedge funds.
The Journal writes that fund managers have broad discretion in attaching a
value to suprime assets, and it is hard to establish an accurate price for
them because, unlike stocks or bonds listed on an exchange, they can't be
readily bought or sold. "I don't think any of the regulators have a handle
on where the net exposure of subprime is," Christopher Whalen, managing
director of Institutional Risk Analytics, which builds risk systems for regulators
and auditors, told the New York Times.
Mr. Whalen said
the situation is worse in Europe, where even less public data is available,
the Times writes. And U.S. subprime assets that found their way to Europe
apparently may show up in unexpected places. An affiliate of IKB Deutsche
Industriebank, which is currently being bailed out by German private and government-backed
banks, bought bonds backed by U.S. mortgage payments and, to fund such purchases,
sold commercial paper to Robbinsdale Area Schools district in a northwestern
suburb of Minneapolis, to the city of Oakland, Calif., and the Montana Board
of Investments, the Journal reports. The buyers evidently weren't aware of
the potential perils of their investments. "We don't take risks,"
circle ravaged loan desks" came from The Deal last night: This
piece shows how our ills are already beginning to work themselves out..
this message to the moon
amid the credit markets' woes, several private equity firms are angling to
purchase buyout-related loans and bonds at steep discounts from banks' trading
desks, sources said.
these are often the same private equity firms that have forced the banks to
honor loan and bridge financing commitments that the banks now seek to unload
by selling them at a discount.
several market sources, firms such as Apollo Management LP, Bain Capital LLC,
Blackstone Group LP, Carlyle Group, Kohlberg Kravis Roberts & Co., Thomas
H. Lee Partners LP and TPG have been mulling moves to step into the loan and
bond secondary markets to buy bank debt and profit from fire sale prices.
all trying to get this off the ground," said one professional at a private
One head of
trading at a major investment bank tacitly confirmed that conversations with
the private equity firms are taking place. "We're talking to everybody,"
the trader said. He noted that his firm was not willing to unload its debt
at any price but would sit on it if it had to. "We're a very patient
firm," the trader said.
trend particularly interesting is the fact that private equity firms are looking
at buying debt in deals that have just been completed, and that banks have
been unable to syndicate, which has led to a freezing up of lending markets
that had hitherto been fueling the most active LBO environment in history.
that Apollo has been particularly active, buying a large chunk of the debt
of Thomson Learning, a company that was bought by Apax Partners and Omers
Capital Partners for $7.75 billion. Thomson's lenders, led by Royal Bank of
Scotland plc, were only able to syndicate the deal after adding covenants
and raising interest on the debt.
contend that much of Dollar General Corp.'s subordinated debt has been bought
by one of the bidders who lost out to KKR on the auction for the company.
Although the buyer couldn't be identified, reports have indicated that Blackstone
Group, Bain Capital and TPG were among the bidders for the company in March.
KKR bought discount retailer Dollar General for $7.3 billion, then financed
the deal with an aggressive covenant-lite loan and payment-in-kind bonds that
the lending banks, led by Goldman, Sachs & Co., were unable to syndicate
last month, helping precipitate the current credit-market crunch.
equity firms either didn't return calls or declined to comment.
The buyout shops are attracted to the secondary markets because much of the
debt is trading below par, pushing yields up to double-digit levels. The LCDX
index of bank loans, for example, hit an all-time low of 90 (par value is
100) at the end of July due to the expectation that the majority of a $240
billion backlog of bank loans will get hung up in coming months and the simultaneous
withdrawal of collateralized loan obligation funds from the market. High-yield
bond prices have fallen as well, and, although both loans and bonds have stabilized
in recent days, Thursday, Aug. 9, saw a fall-off in prices prompted by news
that Paris-based BNP Paribas SA had suspended redemptions in three hedge funds,
citing problems in the U.S. subprime market.
prices are forcing the private equity firms to consider bank loans a viable
investment opportunity, because few expect to be able to complete traditional
buyouts in the coming months due to a credit crunch that many see extending
well into the fall.
all looking to get into the asset class because it's dramatically oversold,"
said one leveraged finance banker.
at a major private equity firm, however, notes that while the investment opportunity
is good in theory, several firms are struggling to find leverage to finance
the strategy. Ironically, it is the very same banks that are holding the paper
that will have to lend money to leverage the deals, which is becoming a difficult
proposition in the current environment, where banks are reluctant to lend.
a great idea, but it depends on the tooth fairy giving me leverage,"
the partner said.
One banker noted
that the issue of private equity firms swooping in to buy discounted debt
in the very same deals they've forced the banks to carry may be irksome, but
many desks will do whatever they have to do to sell the debt at the highest
price they can.
your best bid, you're going to sell it to them," the banker said.
When NASA was preparing for the Apollo Project,
it took the astronauts to a Navajo reservation in Arizona for training.
One day, a Navajo
elder and his son came across the space crew walking among the rocks. The elder,
who spoke only Navajo, asked a question. His son translated for the NASA people:
"What are these guys in the big suits doing?"
One of the astronauts
said that they were practicing for a trip to the moon. When his son relayed
this comment the Navajo elder got all excited and asked if it would be possible
to give to the astronauts a message to deliver to the moon.
promotional opportunity when he saw one, a NASA official accompanying the astronauts
said, "Why certainly!" and told an underling to get a tape recorder.
The Navajo elder's comments into the microphone were brief.
The NASA official
asked the son if he would translate what his father had said. The son listened
to the recording and laughed uproariously.
But he refused to translate. So the NASA people took the tape to a nearby Navajo
village and played it for other members of the tribe. They too laughed long
and loudly but also refused to translate the elder's message to the moon.
Finally, an official
government translator was summoned. After he finally stopped laughing the translator
relayed the message: "Watch out for these assholes. They have come to steal
This column is about my personal search
for the perfect investment. I don't give investment advice. For that you have
to be registered with regulatory authorities, which I am not. I am a reporter
and an investor. I make my daily column -- Monday through Friday -- freely available
for three reasons: Writing is good for sorting things out in my brain. Second,
the column is research for a book I'm writing called "In Search of the
Perfect Investment." Third, I encourage my readers to send me their
ideas, concerns and experiences. That way we can all learn together. My email
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