A few years ago it seemed that all we heard about from stock market pundits were the exchanges and how they were literally printing presses for money. They were the gate keepers at the toll booths of trading, taking a small cut every time a trade matched. As trading volume increased, and platforms became more efficient, the ability to generate steady and growing profits seem limitless. And then of course, the market sold off, trading patterns and hot products changed, and the stock prices of the exchanges corrected.
As the charts of the Nasdaq OMX (NDAQ) and NYSE Euronext (NYX) show (Source: StockCharts.com), it has been a difficult two months for the stocks of the exchanges. The drop in prices has been severe enough that many of the stock pickers that seemed to continuously pump the exchanges, even through the current downturn, have recently found themselves throwing up their hands and admitting defeat.
This week Barron's has an article that is taking a different approach, laying out an argument why one exchange in particular, the Nasdaq OMX, may be a good buy. With estimates of $2.50 a share in earnings (a little on the high side from consensus estimates), a 25 multiple would value the company at $62.50 a share. Why use a 25 multiple? Both Visa and MasterCard tend to be given 25 multiples, and when you get right down to it, Nasdaq OMX is a transaction processor without credit risk, similar to Visa and Mastercard. Beyond financial estimates, another reason for considering Nasdaq OMX involves the benefits they are seeing from their recent acquisitions which have helped to diversify their businesses, as well as provide a global presence. Revenue is nicely spread out between global issues (20%), market data (19%), derivatives (17%), U.S. equities (15%), Nordic equities - OMX merger (9%), market tech (8%), and other (12%).
It really is astounding to think that only 15% of Nasdaq OMX revenues now comes from U.S. equity trading. If you believe that global markets will continue to boom due to the increased levels of global capitalism and subsequent flows of capital worldwide, then Nasdaq OMX may be well positioned to take advantage of this growth. In addition to global growth, Nasdaq OMX is also increasing their exposure to the higher margin derivative business, now at 17% of revenues, and expected to increase.
While the story is intriguing, buying Nasdaq OMX at this point in time may require a little leap of short-term faith, given that you picking a bottom in the stock after the recent correction, even though the Barron's article should provide some near-term support and buying pressure. Nonetheless, at $23.70, the stock is obviously well off its recent highs, and unlikely to hit its 2003-2005 lows under $10 per share given the current diversified revenue stream (unless the current market meltdown continues and spreads - not totally out of the question). While the stock could be poised for a rebound, and again will most likely get some type of Barron's bounce or support, it may be safer to wait for additional market clarity. This is not to say that the stock will not rally from here, it very well may (I have been burnt betting with and against the Barron's rush before), but it needs to remembered that the stock has been a "good buy" all the way down from $50. It may be worth a few points to wait for a retest of the support that was recently broken to see if stock can hold up without the Barron's bounce. While the Barron's article may provide the catalyst needed to push the stock price back through previous support (now resistance), whether or not it holds will depend on more than another trader or article discussing how the stock continues to be a good buy.
If you have not already had a chance to check out the Pickens Plan, have a look. It is worth the time to visit the site and watch the short video (linked below). Regardless of your impression of T. Boone Pickens, his past politics, or any skepticism you may have about motivation, it is worth your time to begin thinking about the energy issue, and this is a good place to start. There is actually a little there for just about everyone, including natural gas producers, hybrid, electric, and alternative fuel automobile makers, solar, wind farmers, and electricity producers. Both green and conventional cleaner burning sources are considered. Even crude oil will still have a presence as we make changes in how energy is used over the next few decades. I applaud Mr. Pickens for at least coming up with a plan for people to begin discussing and debating. As Pickens states, we need to settle on something and start marching in the same direction. Time is no longer on our side.
Zubin Jelveh provides an interesting chart (reproduced below) over at the Odd Numbers blog at Portfolio.com. In the article, Jelveh discusses how the S&P 500 (which is officially in -20% correction bear market territory) has been in a bear market six times since 1950. The chart shows the number of days it took to hit the bear market, how long from bear market start to market low, and low long before it made its way back to the previous peak. Overall declines are also included.
From the chart, Jelveh identifies that there are two kinds of bear markets: Short (1961, 1966, 1968, and 1987) and Long (1973, 2000). If you take the averages, the current bear market will probably hit the low next summer, but not reach the peak again until 2011-2012. If that was not enough to depress you, it could get worse. Given that this bear market has the makings and headwinds of the longer version, this could be a difficult number of years. Hopefully in 10 years we will not be talking again about the "lost decade".
There is an interesting article over at the Capital Spectator blog concerning rising market volatility, and what it means for predicting the market bottom. The recent bear market in volatility ended at the end of 2006, beginning of 2007. See the chart below:
Source: The Capital Spectator blogAs mention in the post, falling volatility is a byproduct of rising prices, while rising volatility is often an indication of falling prices. While not perfect, it may be useful as another indicator in our toolbox, and another reason to assume that the bottom has not yet been made.
You can check out a new article called "Chesapeake Peak? - Not Likely" over at the greenfaucet.com site. I will be contributing some exclusive posts to greenfaucet from time to time, in addition to this blog. Check it out. There are some great contributors, articles, and resources.
Tomoko Yamazaki discusses in a Bloomberg article how current market dynamics have created four new power brokers: Asian governments, oil exporters, hedge funds, and private equity groups. The four had a combined $11.5 trillion in funds at the end of 2007, and increased assets by 22% last year. As an illustration of their influence, Asian governments and oil-rich nations invested $59 billion in western financial institutions over the last 15 months. As for the numbers, Asian governments, including sovereign wealth funds, increased to $4.6 trillion over the last decade, oil exporter assets increased to $4.6 trillion by the end of 2007, private equity assets reach $900 billion globally, and hedge funds grew assets under management to $1.9 trillion in 2007.
While each new power broker has provided much needed capital and liquidity to the markets, there are also some potential problems listed. Most notably is how increased liquidity may spur asset price inflation, sovereign wealth funds might use their capital for political means, there is the potential for leverage abuses in the private equity arena, and hedge funds could exacerbate, or even start a financial destabilization given the herd mentality to invest in similar hot sectors, as well as utilize similar trading strategies. While it is mentioned by the author that the rise of the new power brokers could pose risks, it appears that all potential problems have either occurred at one time or another fairly recently, and/or are beginning to show their ugly side once again. Of course, capital and liquidity needs to come from somewhere, and the Federal Reserve and the government can only do so much. So while the trend is intact, we should continue to expect each power broker to have some influence on capital allocation going forward.
As discussed in a recent article in Financial Week, Ernst & Young found that businesses sold by private equity firms last year had more growth in profits, and subsequent value than comparable public companies. The enterprise value of companies previously owned by private equity firms increased 24% in 2007, compared to half that amount for public companies previously listed. In fact, the enterprise value grew by a rate of 32% per year when private. Nonetheless, given the recent downturn in the markets, and the poor environment for IPOs, it is expected that many private equity firms will need to hold on to some companies longer than expected, and may subsequently see slower growth and lower returns when exiting through sale or initial public offerings. Of interest to me was the quote: “The myth of private equity as financial engineers who cut costs to make their money is false.” Actually, this may not be a total myth, but simply not all of the story. Cutting cost is one part of adding value, and apparently, many private equity firms have figured out a way to increase the value of the businesses they own through cost cutting and other means, while also selling them at the most opportunistic times. Timing may be as important as cost cutting and financial engineering.
IndexUniverse is reporting the offering of a new frontier markets ETF on the Nasdaq: the PowerShares MENA Frontier Countries Portfolio (PMNA). The PMNA will track the Nasdaq OMX Middle East North Africa Index, which includes the countries of Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Nigeria, Oman, Qatar, and the United Arab Emirates. Claymore recently offered the Claymore/BNY Mellon Frontier Markets ETF (FRN) on the Amex, which is more global given that in also includes countries in Asia, Europe, and Latin America, along with the Middle East and Africa. As a result of its focus, the PMNA is a little more concentrated in oil-rich countries. In a recent post we discussed the new Gulf States index launched by S&P, called the GCC 40, covering 40 stocks from the Gulf Cooperation Council. Of interest is that this index covers some of the same region as as the PMNA, but is focused more on financial companies, and less on crude oil and industrial companies.
The PMNA ETF may be of interest to those investors looking to participate in the growth of the oil-rich gulf states that are themselves in the process of reinvesting capital. Furthermore, some analysts have recently discussed how Africa could be one of the next regions for growth. If this is the case, then Northern Africa would be a good place to start investment in this continent.
Also, for those who are interested, there is a distinction between emerging and frontier markets. The term emerging market was first introduced by the World Bank and is often used to describe a country with an economy that is in the process of rapid industrialization, and one that usually finds itself between developing and developed status. The term frontier market is often used to describe equity markets of smaller and less accessible countries of the developing world, yet still investable. Frontier markets are essentially "pre-emerging" markets that are expected to be classified as emerging markets once capital and liquidity increase. Frontier markets could have a high level of development, but still be too small to be considered emerging (for instance, the Baltic States, such as Estonia and Lithuania). They could also be countries where investment restrictions have started to loosen, allowing companies to be investable (such as countries in the Gulf States), or be countries with lower levels of development than similar regional emerging markets (such as Vietnam and Pakistan). As to be expected, frontier markets in general may offer higher return and longer-term growth, but will also carry more risk.
As recently reported at Bloomberg, hedge funds have produced their worst first-half performance since 1990, when the firm Hedge Fund Research began tracking returns of the hedge fund industry. Hedge funds are down collectively 0.75% year to date. Lower equity returns, the impact of volatility, and the inability to borrow cheaply due to the credit crunch all appear to be affecting performance.
The impact of less leverage has been discussed for a while now, and the fallout of lower equity returns is evident to all investors. What has not been discussed as much is how increased volatility is apparently affecting some funds. This is ironic given that many funds and traders thrive on volatility, or at least need some type of market movement. Now, many managers are finding that they cannot cope with the changing nature of the markets.
As a result of the poor performance of the market, and in particular hedge funds that are often expected to protect against losses, investors appear less willing to stick around for the long-haul, and instead are looking for more immediate returns. Given the current challenges for hedge fund managers, large established funds with both proven strategies and proven managers are doing well. On the other hand, small funds are seeing lower returns, redemptions, and in some cases are closing up shop (see previous post).
In addition to hedge fund veterans, such as John Paulson and Philip Falcone, whose funds have returned 26% and 42% year to date, respectively, some quantitative funds using computer modeling for investment decision making are also up this year. New funds, with managers spinning off from existing larger, more credible funds are also seeing inflows of capital as investors look for managers and strategies that generate confidence and offer more reliability. No doubt struggling funds will continue to look for ways to generate alpha and keep nervous investors, and their capital, from heading for the exits. The trend of hedge funds scooping up talent, just as Wall Street is cutting back on salaries and bonuses, is likely to continue (see previous post).
As recently reported at IndexUniverse.com, Standard & Poor's launched the S&P GCC 40, covering 40 stocks from the Gulf Cooperation Council markets, a trade bloc formed by the Persian Gulf states of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. The narrow-based index will contain large and liquid stocks that are participating in the current growth in the Persian Gulf. Of note is how Saudi Arabia, a largest market of the six, is excluded since it is not considered investable, or accessible to foreign investors. Stocks included in the index must have a market caps of $400 million or more and average daily volume over three months of at least $1 million. Three countries have the lion's share of the weighting, with the UAE at nearly 35% weighting, Kuwait at around 30%, and Qatar will a little over 29%. Financial companies also hold over 60% of the index weighting. Not surprisingly, the index was up 10.82% from January-May of this year, along with being up 39.22% for the last 12 months.
The index may prove to be popular as investors look for ways to diversity their international exposure away from the BRIC countries, while also participating in the growth spurred by higher crude oil prices, available capital, and increased investment in the region. Furthermore, crude oil and industrial companies do not dominate the index, allowing investors to limit their exposure to this volatile commodity directly, yet still benefit from its recent increases.
The WSJ is reporting on a survey of 96,000 investors, brokers, and analysts conducted by the CFA Institute. The survey found that many of its members want a new regulatory body to oversee rating firms, along with a different set of ratings for structured products, such as for mortgage-backed securities and CDOs. Amazing, the CFA survey found that 11% of the 1,940 respondents globally said they had seen a ratings firm change a rating as a result of pressure or influence from an outside party, such as a bond underwriter.
Around 47% of respondents said regulators should force ratings firms to use different symbols for structured-finance products that differ from ordinary corporate debt, while 42% said they should not. Even with current problems, the number voting for change is significant, given that changing from the AAA scale would be costly and may initially add even more confusion at a time when the credit market is already in a tenuous state. The article mentions how "The SEC proposed a new rule in June that would give ratings firms the choice between using new symbols for structured products or publishing more research about the products' risks. "Given the level of confusion, we felt there should be a more overt requirement" to use different symbols, said Mr. Schacht." I guess we don't need more information about the risk, just a different symbol system. I find it interesting how we cannot have both. I realize that is not exactly what is being said, but it is telling nonetheless. While ranking from 1-10, or something similar would be clearer when distinguishing the move from say, A to Baa, does it really help one understand the risk any better?
There is an interesting article from Bloomberg that discusses how TIPS (Treasury Inflation Protected Securities) are not living up to their goal of protecting against inflation. The principal for TIPS increase with increases in the CPI, yet many bond holders do not feel that the CPI is properly tracking inflation, in particular the large price increases in gasoline and soft commodities, such as corn. Even as prices have increased over the last 18 months, yields on TIPS relative to Treasuries have essentially stayed the same.
As an alternative, some investors are using swaptions, which when purchased give the buyer the right to purchase a swap. Swaptions are essentially options on interest-rate swaps. Inflation swaps allow one party to pay a fixed rate in exchange for the inflation rate. Lately, swaptions have been better at gaining value when the expectations of future inflation increase, even if the CPI is not keeping up. As an example, in April and May one-year inflation swaptions returned about 0.3%, compared with a 2% loss by TIPS of all maturities. Nonetheless, even while reacting to inflation better, some investors still prefer TIPS since they are backed by the government, unlike derivatives that depend on the credit quality of the issuing firm.
