After a short hibernation, the Microsoft-Yahoo saga is back in the news (for the time being I am taking the ! off the Yahoo name given that the excitement is now gone). Per the Wall Street Journal, Microsoft and Yahoo have decided to give up their plan courtship, but of course, each leaves open the right to form some type of partnership in the future. Yahoo then went right out and got engaged to Google (which it can back out of with a change in leadership - i.e., Yahoo decides later it really prefers Microsoft).
To be honest, it is all a little boring anymore. Like many merger agreements and talks, value usually gets destroyed instead of created. This certainly seems true for Microsoft, given that Yahoo is now partnering with their main rival Google. For their troubles, Microsoft left with nothing but a bruised ego and a stronger main competitor. Microsoft stock did pop on the news, as investors were glad that the distraction was gone, at least for now. Eventually they will realize they lost this part of the Internet, and will begin scratching their heads and wondering what to do next - as well as praying that the Xbox 360 numbers are better than expected, and that Vista is not really that bad. Sigh.
Of course, Yahoo really did not fair much better. For a company that built itself on search, they have essentially farmed-out the business to their main competitor. Exactly how this is good in the long-run is difficult to understand. But as Yahoo CEO Jerry Yang mention, this will bring $800 million in annual revenue through improved monetization. No mention was made of loss of market share. Sigh.
And of course, there are the billionaires - Icahn, Pickens, and Cuban. Cuban will not get his board seat, and Icahn and Pickens, well, they will not get richer - at least not yet. I am sure they will be fine. As for the other Yahoo investors, some of which were invested through funds, well, they did not fair as well. Each may have a wait a while before seeing Yahoo at the proposed $35 a share price. Sigh.
Any winners? The same winner before everything was put into motion - Google. Without really doing too much it was able to chop a leg out from under and weaken the behemoth Microsoft, who while inept in search and the Internet, still has a lot of money to throw around. At the same time it took its next closest competitor and put a leash on it. Not bad for six months of press releases and the extension of a previous beta test agreement with a competitor.
In the end, nothing much has changed. Microsoft continues to trip over itself when it comes to the Internet, Yahoo continues to destroy value, the billionaires are still rich, small investors still absorb the lost capital, and Google continues to dominate search. Myself? I just feel a little hung-over.
Given all the bad news written about the U.S. economy, in particular energy and food prices, credit problems, financial failures, higher unemployment, and the housing crisis, it would be nice to finally hear some good news. As reported in a Financial Times article, the good news came in the form of the Rand Corporation announcing that the U.S. remains the dominant global player in science and technology. Among all industrialized nations, the Rand study finds that the U.S. still accounts for 40% of global spending on scientific R&D and 38% of patented inventions. A total of 75% of the world’s leading universities are in the United States. A total of 70% of the world’s Nobel prize winners also work in the U.S.
Of course, everything is not rosy, as expected. Policymakers worry that lower standards and decreased spending on research could hurt the economy and threaten national security. The Rand Corporation also warns that more college educated scientists and engineers now graduate in the European Union and China every year, compared to the U.S. As a member of academia who has taught in both engineering and finance departments, the increase of domestic students choosing to enter the work force after graduation as opposed to entering graduate school has been apparent for years. Unfortunately, at this point it is hard to see how the trend can be reversed quickly, even with our continued good standing regarding undergraduate and graduate science, engineering, and technology education. The difficult part is convincing domestic students that the hard work they put in now will pay dividends in the future. Unless we continue to support investment in all kinds of technology (be it biological, energy, computer/electronic, etc.), and give companies the business environment they need to continue to innovate and attract the best and the brightest, this may continue to be a hard sell. But if we can continue to do the right things, and provide the proper environment, there is reason to be optimistic.
As recently discussed at bullbeartrader.com, and followed-up today with another article from Bloomberg, heavy rain is causing corn prices to reach record levels. Prices have essentially risen for 6 straight days after Bloomberg first reported how heavy rains would cut the corn crop estimates. Global inventories are forecast to fall to a 24-year low as prices head higher for the fourth straight year. As reported in the recent article:
Corn's yield potential falls unless plants have emerged from the ground before the end of May in most of the Midwest. Corn planted in wet, cool soils develops shallow roots, increasing the threat of damage from hot, dry weather in July and August. About 60 percent of the corn crop in the U.S., the largest exporter of the grain, was in good or excellent condition as of June 8, down from 63 percent a week earlier, and 77 percent a year earlier, the USDA said June 9 in a report. An estimated 89 percent of the corn crop had emerged from the ground as of June 8, compared with 98 percent a year ago and the five-year average of 89 percent, the USDA said.As the U.S. summer heat begins to increase in July and August, there is an expectation that the USDA will cut its crop estimates even further. Wheat (up 48%), rice (up 62%), and soybeans (up 64%) have also all been rising over the last year.
The Financial News is reporting how the current methodologies for non-exchange dark pools may be resulting in volumes being reported higher than they should be. Guidelines exist for reporting volume, but there is not a standard way for calculating them. Currently, both the buyer and seller volume are being counted, resulting in a form of double counting. This has been standard practice, but now smart-order routing is causing many sellside brokers and independent pools to count routed volume as well. For instance, by using smart-order routing, an order sent to a dark pool could be matched in the pool, or routed to another dark pool, causing volume to be counted two or three times. When it is match in the second dark pool, it is counted once again, possibly even two more times.
Double counting is often used as a standard practice, many times for no other reason than for marketing purposes in order to show the liquidity offered by a particular dark pool. Nonetheless, not everyone is following the same rules-of-thumb, making it difficult to compare dark pools, and more importantly, get a good read on the real level of trading volume. Some brokerages, such as Merrill Lynch, are choosing to not publish volume data given the industry-wide inconsistencies. To correct the problems, some are reporting both "volume" and "pass through." While using "pass through" to measure routing volume would seem to be an easy fix, it is not quite as simple as it seems given that some pass through trades are "not matched," some or "not eligible for matching," and some are just "touched."
To complicate matters, the exchanges are not free and clear when it comes to dark pools. While the exchanges have seen some trade volume move to the dark pools, and the non-exchange dark pools have generated criticism for their secretive nature, the exchanges are also involved in similar activities. In fact, exchange dark pools not only exist, but have been increasing as the exchanges try to fend off threats from non-exchange dark pools. Approximately 10-20% of consolidated volume occurs on Bats Trading, Nasdaq OMX, and the NYSE Arca exchange-based dark pools. As mentioned by Brian Hyndman, senior vice-president of Nasdaq transaction services: "We have the ability to break our non-displayed liquidity from our displayed liquidity. We are the largest exchange in terms of volume in the US and the largest for non-displayed volume." Such a badge of courage may make Nasdaq investors happy in the short-term, but may also cause problems in the future as regulators begin to look into dark pools and their affects on liquidity and price discovery. Given the recent talk of speculation in the commodities markets, in particular the crude oil markets, any discussion of lack of price discovery, even in a different non-commodity market such as the equity exchanges, may generate un-welcomed attention. The uncovering of increased dark pool activity may be something that not only results in embarrassment, but also causes investors to increase selling volume and execute their own method of price discovery.
The Financial Times and Reuters are reporting that Icap, the interdealer brokerage, is launching a new survey-based reporting of one and three month unsecured bank funding cost. The poll will be released at 10 AM New York time. The move is yet another attempt to find solutions and/or provide alternatives to Libor - which has come into question recently and has been something we have talked about extensively (last article), including proposed alternatives.
The 10 AM reporting for the Icap value will occur when the eurodollar deposit market is the most active. Only rates, and not contributing banks, will be reported - thereby reducing signaling effects. Currently, more than two dozen institutions are involved in reporting for Icap. The British Bankers Association (BBA) is already meeting to discuss alternatives and ways to return confidence to Libor reporting. Moves like the one recently made my Icap will certainly help speed up the process.
As reported from Reuters, the CEO of Potash has recently stated that he believes that the next five years could be "the greatest period of growth" for the company in its history. He goes on to say: "We have a lot of pricing power. We're nowhere near peak pricing." Given recent fertilizer price increases, demand, and stock price activity, this certainly seems like a bold statement. As seen in the daily and weekly charts below (from stockcharts.com), the price activity for Potash has been outstanding. The weekly chart shows a nearly perfect 45 degree line uptrend for both the weekly price and its 50 and 200 week averages.
Charts like this are both exciting and scary. While the chart looks good technically, logic tells us that what goes up must surly come down - or at least take a breather. While not apparent on the weekly chart, the daily chart does show some consolidation before moving back up, albeit somewhat volatile. If the stock can hold above the $210-215 level, then investors may have a little more confidence that the uptrend will continue. Recent comments from the Potash CEO should certainly help provide some short-term buying interest in the stock. If he is correct, and fertilizer prices truly are going up and demand does stay strong, than Potash and its competitors (Mosaic and Agrium) should continue to outperform.
As reported in Bloomberg and elsewhere, a group of 17 banks have come together to create a clearinghouse system to move credit default swap (CDS) trades and cover a failure by one of the market-makers. While the amount of potential CDS loss is closer to $2 trillion, and not the entire $62 trillion in notional value that often gets reported, the possible market exposure is still significant and should be addressed. Just a little over a week ago we discussed the CDS counterparty risk issue in an article that mentioned how regulators and the Fed were looking for ways to limit the exposure from a counterparty failing to meet its obligations.
Of concern is not so much the failure of one bank or counterparty, but the possible systematic risk that would be felt by the entire financial system. The new system will allow the market to trade against the central counterparty, mitigating the consequences of failure by a major institution. In addition to systematic risk, the system should also help prevent a Bear Stearns-type of failure since there will be less need to make a run on a specific institution.
Other benefits of the clearinghouse will be increased liquidity and transparency. Providing a clearinghouse will encourage more swap trading, and larger volume will allow for a more efficient market and more reliable mark-to-market process. This will make it easier for investors to have a better idea of the true exposure that a company is taking, allowing for a better valuation and more efficient stock price. Currently, it is difficult for companies to even know what their credit risk exposure is given that the CDS market is thin and delayed, not to mention opaque at best. The new center counterparty system is a good step towards helping to shine light on the CDS market by reducing credit risk, and allowing for more real-time price discovery.
Unfortunately, it will not be enough to suffer losses from just regular credit default swaps (CDS) and collateralized debt obligations (CDO). As reported in the WSJ, additional pain from synthetic CDO losses may be just around the corner. Synthetic CDOs have been around for a while, but have become popular in the last few years as a way for insurance companies, banks, and funds to invest in a diversified portfolio of companies without directly purchasing the bonds of the companies. While many of the problems with CDOs linked to mortgage debt have been uncovered and are currently being felt, problems with CDOs linked to regular corporate debt are now raising the interest of rating agencies.
Unlike normal CDOs, synthetic CDOs do not contain actual bonds or debt. In order to provide the normal income stream generated by CDOs, synthetic CDOs provide income by selling insurance against debt default. Each synthetic CDO typically has numerous companies with good to high "investment-grade" credit ratings. Like a normal CDO, different tranches, or levels of risk and return are sold. The tranche structure allows some investors to receive higher returns (while taking higher risk), while making it possible for others to take much less risk, but also receive lower returns. Again, much like a normal CDO, it is possible to create a higher investment grade asset (tranche) out of lower quality securities. Additional details regarding collateralized debt obligations can be found here.
Insurance companies typically purchase the higher rated senior and mezzanine tranches, while hedge funds, looking for higher return, yet willing to bear or hedge the additional risk, typically invest in the lower-rated or unrated equity tranches. As with any CDO, in order to increase the returns of the equity tranche, the banks that created the CDOs can simply include lower-grade (higher return) debt. As the credit crunch progressed, more of these lower-grade companies have defaulted on their debt, causing the CDO losses to move up to the higher tranches. Given the synthetic nature of the CDO, rating companies are now being forced to develop new methodologies that will allow them to examine synthetic CDOs.
New downgrades will surely result from this closer examination, forcing additional selling of already distressed securities, putting further pressure on the markets. Combined with higher energy costs, this should prove to be a challenging time for some companies and investors, as well as the market in general. The old saying, "may you live in interesting times," will certainly get tested as we move into the dog days of summer.
Richmond Federal Reserve Bank president Jeffery Lacker is warning about consequences from the decision of the Fed to lend to securities dealers. Of concern is how investment banks are not subject to the same level of regulation and oversight as are commercial banks. Paraphrasing, Lacker points out that the effect of the recent credit extension on the incentives of financial market participants might induce greater risk-taking, and that this increased risk-taking could give rise to more frequent crises - the classic case of moral hazard.
Robert Eisenbeis from Cumberland Advisors points out that some of the Fed officials may be having "buyers remorse" with regard to going down the path of opening-up securities lending to investment bank. As a result, some are starting to discuss potential problems in public, possibly in an attempt to begin sending a message to the market that this is not something that the investment banks can always rely on. Many economist have pointed out that once the Fed bailed out Bear Stearns and opened up the discount window, they let the cat out of the bag and will have a difficult time getting it back in. As other investment banks run into trouble, they will no doubt be expecting similar treatment, including cheap borrowing and a market for illiquid assets.
Eisenbeis mentions possible ways to begin correcting the perception, including preventing investment banks from being prime dealers - in effect preventing them from being a conduit for implementing Federal Reserve policy. The Fed could also force the investment banks to change their charter, allowing the Fed more flexibility to take necessary actions to secure the assets available for borrowing. Nonetheless, any changes will be difficult. Since it is unlikely that the Fed will make any formal declarations, the market will no doubt have to wait until the next potential failure before it will know for sure what actions the Federal Reserve is willing to take. Hopefully this will not come sooner than later.
Given that the weekend link summaries are a little dated, in the future I will just post the shorter summaries as I write them in an effort to make them a little more timely.
