essays pieces of the puzzle
Friday, October 22nd, 2010
buying back shares

Investors get excited about buybacks, although firms tend to get it backwards, being aggressive when times are good and fearful when times are bad, although the stock could be purchased more cheaply then.  In any case, it’s important to watch not what the firms say but what they do.

A case in point is the last couple of decades in Cisco (CSCO), Intel (INTC), and IBM.  The first five years of the period were great ones for the two upstarts, but IBM was on the ropes in all respects.  But for the last fifteen years, IBM stock has outperformed the other two.  Yes, that includes almost all of the Internet era.  One reason for the disparity is the relentless shrink in the IBM share count, shown above.  CSCO, on the other hand, is a good example of dilution by stock compensation.  It had one secondary offering, in 2000; the rest of the growth was from handing out shares.  It didn’t work.  (Chart:  Bloomberg terminal.  Shares outstanding adjusted for splits.  CSCO owned currently.)

on the bond bubble

It’s always important to remember that industry pieces are a combination of analysis and marketing.  One example comes from American Century (via Advisor Perspectives), and it is representative of a spate of such writings from fund companies regarding the “bond bubble.”  This piece states that none of the classic signs of a bubble are present and that — in regards to “the most extreme economic and interest rate scenarios” — “we believe we have demonstrated conclusively that current economic and market conditions make these sorts of outcomes extremely unlikely at present.”

That could be, although it seems that the Federal Reserve has decided to produce inflation if it can.  Therefore, I wouldn’t say a bond-unfriendly environment is “extremely unlikely.”  More importantly, I don’t think characterizing bonds as having a “relatively pain-free profile” is entirely accurate — because of the way fixed income is used and how expectations are grounded, a different standard of evaluation is in order versus supposedly riskier asset classes, and there have been plenty of painful times for the owners of bonds.  Another quibble is that the scenario analysis in the paper, which uses large instantaneous changes in rates (so the higher reinvestment rate kicks in right away and makes the long-run profile look OK) ignores the fact that the accompanying moves down in price would cause major behavioral adjustments by individuals and their institutional money managers, and huge cash flows out of bonds.

I don’t know whether the firm’s forecast will be right, but I think its odds board is out of whack.

on the correlation bubble

For research on yet another perceived bubble (that’s three such items in the last two editions of pix, counting Wednesday’s, on farmland), I refer you to an item from earlier this month issued by J.P. Morgan.  Its view:  “We conclude that both the realized correlation of stock prices and option-implied correlation are in a ‘bubble’ regime and forecast a significant decline of correlation over a one- to two-year time horizon.”

waiting for the dailies

In case you missed it, the CBOE has started trading weekly options on selective indexes, ETFs, and stocks.  Information and current offerings can be found on its site, which says that the vehicles “can be cheaper to use and can provide investors with more targeted trading opportunities.”  It will be interesting to see if the product takes hold, but I’m left wondering if it’s just another example of “innovation” for its own sake.  I look forward to seeing more analysis of the use of these options and the impact (if any) on markets as a result of their availability.

forgetting to stomp

I happened to pick up my copy of Memos from the Chairman the other day.  It is a compilation of writings over the years from Alan C. (Ace) Greenberg to the troops at Bear Stearns, often about the smallest things and often with bits of advice from some guy with a long name (who was invented by Greenberg).  The body of the very last memo in the book, dated November 13, 1995, in its entirety:

“The media has been having a field day with the problems of Daiwa Bank.  Quoting from NEWSWEEK, ‘It wasn’t that the Daiwa dummies lost $1.1 billion; it is that they lied about it and dissed the Fed.  It doesn’t pay to be too arrogant.’

“This was not the first time nor will it be the last that we have seen what arrogance can lead to.  This danger has been pointed out many times to all of us by Haimchinkel Malintz Anaynikal; it should be brought to the attention of our associates on a regular basis.  Our job is to look out for arrogance and stomp on it every time we see its ugly head rearing up.”