When Muddy Waters (MW) strikes, the immediate aftermath will be a double-digit percentage plunge in high volume in the share price of the stock being shorted. When MW strikes, it always provide lessons and entertainment for investors unless you happen to be vested in the company attacked by MW. MW sends shudders down the spine of CEOs of public-listed companies. Olam CEO Sunny Verghese must be cursing MW now. Why me? When he learnt of MW's first strike, it was fearsome enough to make him cancel his flight while waiting in the departure lounge.
Olam is a component stock of the Straits Times Index. As a Singaporean investor, I do not think this is a healthy development for our local stock market. On the other hand, shortists do play an important role in the stock market by knocking sense into an over-confident Mr Market who overlooks risks. For this, Singaporean investors (except Olam's of course) should thank Muddy Waters for opening our eyes to the risks of investing in Olam and in providing us keen investment lessons. Their Olam report is an interesting exercise in forensic accounting and due diligence.
In this battle between Olam and Muddy Waters, I hope to see Olam emerging as the final victor. Not through the court-room but by business savvy and creation of shareholder value. I would like to give some suggestions to Olam in their fight against Muddy Waters, although I am definitely not qualified to do so.
MW's main thrust of attack is that Olam is a complex business which is not only hard to understand but also easy to manipulate. MW contends that the biological gains and Level 3 derivatives in Olam's accounts allow management the discretion to manipulate profits to mislead investors. To counter this attack, Olam management needs to win investors' trust so that we trust their highly discretionary profit numbers. One way of doing this is substantial insider buying of Olam's stocks. Preferably, the insider buying should consist of multiple insider buying from executive management, starting from the CEO. Each insider should spend a substantial(>20%) portion of his net-worth or 2 years' salary to buy Olam's stocks. A few months' salary worth of buying is not sufficient. Buying too little and appearing too desperate may backfire if investors treat it as a public relations exercise to win confidence. While CEO Sunny Verghese share purchases a few days ago is to be applauded, his impatience to announce it even before the market closed is highly unusual and may be taken by investors as a desperate measure to win back confidence. Once investors are convinced by the insider buying action that top management's interests are aligned with theirs, then they will be less worried that the profits are being deceptively manipulated.
Please, no more company share buybacks. Don't use shareholders' money to prop up the share price, particularly when MW is alleging that senior management has pledged significant numbers of their own shares and could be facing margin calls. Management could be exposing themselves to shareholder lawsuits if they use shareholders' money to support the share price only to see it plunge later due to management's forced selling from margin calls.
Cumulative negative operating cashflow is a major bugbear for Olam investors. Profits are useless if they do not generate cash. In fact, it is worse than useless because it generates suspicion among investors. It was for this reason that I cease becoming an Olam shareholder a few years ago. I first became a shareholder because of the impressive profit growth. Initially, one can accept the argument that for a high-growth company, operating cashflow is negative in the beginning due to enormous upfront capital expenditure. However, investors lose patience if operating cashflow continue to remain negative over a multi-year period and the company keep asking for more money from shareholders and bondholders. This is the case for Olam. Operating cashflow has been cumulatively negative since FY2008. The poor operating cashflow also lends credence to MW's contention that Olam executes terribly in its acquisitions. Although Olam has rebutted MW on this point, no amount of clever persuasion is enough unless you can show me the money (cash, not accounting profits!). Good execution must show up in the numbers eventually. By numbers, I mean hard cash and not profits determined by opinions of accountants or management.
One suggestion to Olam's management is to, at least for the time being, base their staff's bonuses and promotion on cash-flow metrics, not profits. MW compared Olam to Enron for their shared appetite in acquiring companies to create fake profits through complicated accounting. By pegging staff incentives to real cashflow and not opinionated profits, investors need not fear Olam staff are motivated to practise Enron-like behavior of spending real $10 on acquisitions to create fake $5 of accounting profit.
I hope Olam will pause its capital-raising activity for the time being. Show us some cash first before you continue asking for more cash from us. Despite its impressive growth, Olam's Piotroski score is only 1 for FY2011. However, I am not sure if this is accurate as this was computed by a software I wrote early this year when I had plenty of time being unemployed.
MW is a tough opponent. Its latest move to pay for Olam's debt to be rated is cunning. It is an offer that Olam simply cannot accept. Even if the bonds are rated at better-than-expected ratings, it is useless because Olam's bonds are already trading near distressed levels. It is a lose-lose situation if Olam accepts. If Olam rejects, it appears as if Olam has chickened out. This offer by MW was designed to embarrass Olam.
I hope to see Olam emerge as the final victor. Not vested at the moment but enjoying the show. Will consider investing once Olam starts showing us some real money (cold, hard cash).
Showing posts with label Market commentary. Show all posts
Showing posts with label Market commentary. Show all posts
Sunday, December 2, 2012
Sunday, November 27, 2011
Market commentary 27 Nov 2011 - European debt crisis dominates
Individual stock picking has not been effective since August 2011. Market movement is dominated by events related to the debt crisis in Europe. When markets make big moves up and down, the source of the news is almost always traced back to Europe. In such a backdrop, macro-analysis makes more sense than bottom-up investing in individual stocks.
The Straits Time Index, along with most global stock indices, bottomed on 5 Oct 2011. A new rally began the next day, topped on 28 Oct 2011 after which it started its decline. From the STI chart, the market went into correction on 18 Nov 2011. It was a short-lived rally.
What happened near 28 Oct 2011 which marked the start of the decline? Global markets anticipated a European rescue plan which explains the rally which started on 6 Oct 2011. After the rescue plan was announced on 27 Oct 2011, global stock market began its descent again. The rescue plan was not enough to reassure the markets. On the day of announcement, global stock indices actually made a massive rally. Then, it looked like the rally that started on 5 Oct was here to stay. On the next day, new worries emerge when Italian 10-year bond yields tops 6%. On Nov 25, 10-year Italian bond yields reached 7.23% despite mighty ECB buying the bonds. This is serious because (1) Italian bond market is the 3rd largest in the world. A disaster there is highly contagious. (2) Greece, Ireland and Portugal were forced to seek financial rescues when their bond yields reached around 6.5%. Italy today is worse (3) Italy has high debt(118% of GDP) and slow economic growth. How can Italian bond investors be confident that their debts can be repaid in full? Besides, further austerity (demanded by Germany) may slow down growth further or even tip country into recession.
One feature of the rescue plan was that investors who bought CDS (credit default swaps) on Greek debt as insurance will not be paid because the deal agreed to was voluntary. Now, investors who hedge their sovereign debt risks using CDS are scared. If investors cannot reduce credit risk by buying CDS as insurance, then they have to reduce credit risk by demanding higher bond yields. I think this is a major reason European bond markets came under increasing attack almost right after the rescue plan was announced.
In the past weeks, every time European bond yields go up, global stock indices will go down. In the coming weeks, European bond yields should be the key indicators to observe for equity investors.
I am waiting for something to happen for global stock markets to have a solid rally. This something is Germany agreeing to print money. Printing money is the least painful way to repay debt. I am not sure whether money printing is a good economic solution because there are side effects like inflation. However, I am highly confident that once Germany agrees to money printing, a global rally in equities lasting months will follow. See what happened in 2009 after massive money printing by the Fed.
The alternative to money printing is austerity. It is by no means superior to the money-printing solution. When debt levels are too high (like the PIGS countries) and requires strong future economic growth to pay down debt, then austerity actually worsens chances of paying off debt by weakening the economy. Furthermore, austerity dampen domestic consumption by cutting spending and raising taxes. Therefore, economic growth must come from strong exports. Problem for Europe is, export to who? If everyone else is tightening their belts for austerity, who is going to buy the exports? Germany? The great export-machine of Europe to transform into a big import-sucker? European demographics worsen the problem. Too many old people, too few young people is bad enough for growth. Protective labour laws and culture further worsens the situation by protecting the old workers who are hard and expensive to fire at the expense of young workers, many of whom are on contract work, don't get good training opportunities or simply unemployed. Today, Spanish youth unemployment is a whooping 21.2%. When corrective economic measures are too painful, it may cause social riots. The situation can be highly unpredictable and chaotic. The last time a great nation was subjected to great economic pain, the people elected a madman into power. That mad-man was Adolf Hitler.
Of course, the best solution is economic growth from the creation of real productivity from real products/services of high social utility and not financial engineering techniques like printing money. However, you need plenty of good engineers for that. Engineers have bore the brunt of retrenchments in recent recessions. I know because I am an engineer. This time round, I will not be spared. I have received notice I will be retrenched. Today, there are very few students who want to study engineering and many of the best engineers have switched lines to work in banks. In fact, many engineering students went straight to the banks after graduation without ever working as an engineer.
Eventually, I think Germany will allow money-printing to ease the European debt crisis because austerity is doubtful to be effective. I cannot think of other solutions that politicians can depend on now.
The Straits Time Index, along with most global stock indices, bottomed on 5 Oct 2011. A new rally began the next day, topped on 28 Oct 2011 after which it started its decline. From the STI chart, the market went into correction on 18 Nov 2011. It was a short-lived rally.
What happened near 28 Oct 2011 which marked the start of the decline? Global markets anticipated a European rescue plan which explains the rally which started on 6 Oct 2011. After the rescue plan was announced on 27 Oct 2011, global stock market began its descent again. The rescue plan was not enough to reassure the markets. On the day of announcement, global stock indices actually made a massive rally. Then, it looked like the rally that started on 5 Oct was here to stay. On the next day, new worries emerge when Italian 10-year bond yields tops 6%. On Nov 25, 10-year Italian bond yields reached 7.23% despite mighty ECB buying the bonds. This is serious because (1) Italian bond market is the 3rd largest in the world. A disaster there is highly contagious. (2) Greece, Ireland and Portugal were forced to seek financial rescues when their bond yields reached around 6.5%. Italy today is worse (3) Italy has high debt(118% of GDP) and slow economic growth. How can Italian bond investors be confident that their debts can be repaid in full? Besides, further austerity (demanded by Germany) may slow down growth further or even tip country into recession.
One feature of the rescue plan was that investors who bought CDS (credit default swaps) on Greek debt as insurance will not be paid because the deal agreed to was voluntary. Now, investors who hedge their sovereign debt risks using CDS are scared. If investors cannot reduce credit risk by buying CDS as insurance, then they have to reduce credit risk by demanding higher bond yields. I think this is a major reason European bond markets came under increasing attack almost right after the rescue plan was announced.
In the past weeks, every time European bond yields go up, global stock indices will go down. In the coming weeks, European bond yields should be the key indicators to observe for equity investors.
I am waiting for something to happen for global stock markets to have a solid rally. This something is Germany agreeing to print money. Printing money is the least painful way to repay debt. I am not sure whether money printing is a good economic solution because there are side effects like inflation. However, I am highly confident that once Germany agrees to money printing, a global rally in equities lasting months will follow. See what happened in 2009 after massive money printing by the Fed.
The alternative to money printing is austerity. It is by no means superior to the money-printing solution. When debt levels are too high (like the PIGS countries) and requires strong future economic growth to pay down debt, then austerity actually worsens chances of paying off debt by weakening the economy. Furthermore, austerity dampen domestic consumption by cutting spending and raising taxes. Therefore, economic growth must come from strong exports. Problem for Europe is, export to who? If everyone else is tightening their belts for austerity, who is going to buy the exports? Germany? The great export-machine of Europe to transform into a big import-sucker? European demographics worsen the problem. Too many old people, too few young people is bad enough for growth. Protective labour laws and culture further worsens the situation by protecting the old workers who are hard and expensive to fire at the expense of young workers, many of whom are on contract work, don't get good training opportunities or simply unemployed. Today, Spanish youth unemployment is a whooping 21.2%. When corrective economic measures are too painful, it may cause social riots. The situation can be highly unpredictable and chaotic. The last time a great nation was subjected to great economic pain, the people elected a madman into power. That mad-man was Adolf Hitler.
Of course, the best solution is economic growth from the creation of real productivity from real products/services of high social utility and not financial engineering techniques like printing money. However, you need plenty of good engineers for that. Engineers have bore the brunt of retrenchments in recent recessions. I know because I am an engineer. This time round, I will not be spared. I have received notice I will be retrenched. Today, there are very few students who want to study engineering and many of the best engineers have switched lines to work in banks. In fact, many engineering students went straight to the banks after graduation without ever working as an engineer.
Eventually, I think Germany will allow money-printing to ease the European debt crisis because austerity is doubtful to be effective. I cannot think of other solutions that politicians can depend on now.
Sunday, September 25, 2011
Update on market commentary on the stock market collapse that began on 2 Aug 2011
This is an update to http://help-your-money.blogspot.com/2011/08/market-commentary-on-stock-market.html
I made a post on 14 Aug 2011 of my belief that a strong rally will come before the market collapses further due to the huge amounts of cash sitting on the sidelines, insider purchases and strong earnings despite the market rout. I acted on my belief and deserved the painful consequences. Based on recent market action, I have been proven wrong and suffered losses. From 12 Aug 2011 to 23 Sep 2011, the Straits Times Index has fallen more than 5%. This is the criteria which I use for being wrong. In investing, I regard losing money as equivalent to being wrong. No point in using excuses like "I am a long-term investor" (as if the stock will surely bounce back later), "The market is irrational" (as if everyone else is stupid except myself), "Short-term fluctuations do not bother me" (self-deception? Losses always hurt)
The global financial markets have grown too dependent on money-printing from central bankers like drug addicts. When QE1 (quantitative easing) neared its end around middle of 2010, global markets slumped like a drug addict as the drug effect wore off. Then, Bernanke administered a fresh dosage in QE2. Global markets rallied in September 2010. The drug effect wore off again after the middle of this year. Come QE3, also known as Operation Twist. Unfortunately, the drug dosage is not enough this time because the appetite of drug addicts grows with every dosage. The immediate negative market reaction is evident of this fact. The bullishness of the precious metals market is a measure of the amount of central bankers' money-printing activities. Look at how Gold and Silver crashed after Bernanke announced Operation Twist.
Operation Twist aims to lower the interest rates of long-term debt by selling short-term Treasury securities and buying the longer-term ones. What else can the Federal Reserve do? The short-term interest rates of US Treasury securities is already near-zero. How to lower the short-term rates further? This is why Bernanke could only work on longer-term interest rates this time. I am not quite sure how to interpret the market's reaction to Operation Twist. Should one interpret the recent market crash as the Fed not doing enough or the Fed has lost the ability to do anything to stimulate the economy? When short-term interest rates are near zero, monetary policy has clearly lost much of its power as an economic tool. Therefore, the US economy has to look towards fiscal policy for stimulation. The recent US debt-ceiling crisis shows that political bickering has paralysed fiscal policy. When one party says taxes are too bloody low and the opposing party says spending is too bloody high, stimulative fiscal policy is impossible because taxes cannot be cut and spending cannot be raised. Actually, the rich world does not have much room to stimulate the economy using fiscal policy given high government debt levels and persistent budget deficits. Austerity is the only way out. If austerity is chosen, the near-term prospects for financial markets will be terrible and uncertain in the longer-term. If fiscal austerity is abandoned in favour of the more political palatable monetary money-printing, then inflation will follow. In this scenario, the financial markets will do well even if fundamentals are poor. When you have too much money chasing too few assets, asset bubbles will be formed. Holding cash in such a situation will be disastrous. Seeing the American politicians in action during the debt-ceiling crisis point towards money-printing being the preferred option.
Indeed, Operation Twist may boost speculative activities, particularly in the property market, by reducing longer-term mortgage rates. Already, the loose monetary policy in the US is being exported to Asia and creating bubbles in our property market. In 2008, we had the US banking/real estate crisis. Come 2011 and 2012, we will suffer a full-blown European sovereign debt crisis. The nightmare scenario is that in 2014-2015, it may be Asia's turn to suffer a financial crisis when the property market bubble burst in China, Hong Kong and right here in Singapore.
There is an even darker nightmare. It is the social instability that persistent high inflation and unemployment will bring. This is chaotic and totally unpredictable. High inflation in China in the late 1980s created the conditions for the Tiananmen protests that led to the massacre. Hyperinflation in Germany gave us World War II because the German people voted Hitler into power out of anger.
Most of what I wrote will probably turn out to be empty worrying. It is a habit borne out of worrying about the downside before investing. By the way, I will still be buying stocks however pessimistic. As the macro-picture worsens, it is likely that even good stocks will go down further. However, the chance of permanent impairment (go down and never recover) is quite low when buying in times of recession/depression.
I made a post on 14 Aug 2011 of my belief that a strong rally will come before the market collapses further due to the huge amounts of cash sitting on the sidelines, insider purchases and strong earnings despite the market rout. I acted on my belief and deserved the painful consequences. Based on recent market action, I have been proven wrong and suffered losses. From 12 Aug 2011 to 23 Sep 2011, the Straits Times Index has fallen more than 5%. This is the criteria which I use for being wrong. In investing, I regard losing money as equivalent to being wrong. No point in using excuses like "I am a long-term investor" (as if the stock will surely bounce back later), "The market is irrational" (as if everyone else is stupid except myself), "Short-term fluctuations do not bother me" (self-deception? Losses always hurt)
The global financial markets have grown too dependent on money-printing from central bankers like drug addicts. When QE1 (quantitative easing) neared its end around middle of 2010, global markets slumped like a drug addict as the drug effect wore off. Then, Bernanke administered a fresh dosage in QE2. Global markets rallied in September 2010. The drug effect wore off again after the middle of this year. Come QE3, also known as Operation Twist. Unfortunately, the drug dosage is not enough this time because the appetite of drug addicts grows with every dosage. The immediate negative market reaction is evident of this fact. The bullishness of the precious metals market is a measure of the amount of central bankers' money-printing activities. Look at how Gold and Silver crashed after Bernanke announced Operation Twist.
Operation Twist aims to lower the interest rates of long-term debt by selling short-term Treasury securities and buying the longer-term ones. What else can the Federal Reserve do? The short-term interest rates of US Treasury securities is already near-zero. How to lower the short-term rates further? This is why Bernanke could only work on longer-term interest rates this time. I am not quite sure how to interpret the market's reaction to Operation Twist. Should one interpret the recent market crash as the Fed not doing enough or the Fed has lost the ability to do anything to stimulate the economy? When short-term interest rates are near zero, monetary policy has clearly lost much of its power as an economic tool. Therefore, the US economy has to look towards fiscal policy for stimulation. The recent US debt-ceiling crisis shows that political bickering has paralysed fiscal policy. When one party says taxes are too bloody low and the opposing party says spending is too bloody high, stimulative fiscal policy is impossible because taxes cannot be cut and spending cannot be raised. Actually, the rich world does not have much room to stimulate the economy using fiscal policy given high government debt levels and persistent budget deficits. Austerity is the only way out. If austerity is chosen, the near-term prospects for financial markets will be terrible and uncertain in the longer-term. If fiscal austerity is abandoned in favour of the more political palatable monetary money-printing, then inflation will follow. In this scenario, the financial markets will do well even if fundamentals are poor. When you have too much money chasing too few assets, asset bubbles will be formed. Holding cash in such a situation will be disastrous. Seeing the American politicians in action during the debt-ceiling crisis point towards money-printing being the preferred option.
Indeed, Operation Twist may boost speculative activities, particularly in the property market, by reducing longer-term mortgage rates. Already, the loose monetary policy in the US is being exported to Asia and creating bubbles in our property market. In 2008, we had the US banking/real estate crisis. Come 2011 and 2012, we will suffer a full-blown European sovereign debt crisis. The nightmare scenario is that in 2014-2015, it may be Asia's turn to suffer a financial crisis when the property market bubble burst in China, Hong Kong and right here in Singapore.
There is an even darker nightmare. It is the social instability that persistent high inflation and unemployment will bring. This is chaotic and totally unpredictable. High inflation in China in the late 1980s created the conditions for the Tiananmen protests that led to the massacre. Hyperinflation in Germany gave us World War II because the German people voted Hitler into power out of anger.
Most of what I wrote will probably turn out to be empty worrying. It is a habit borne out of worrying about the downside before investing. By the way, I will still be buying stocks however pessimistic. As the macro-picture worsens, it is likely that even good stocks will go down further. However, the chance of permanent impairment (go down and never recover) is quite low when buying in times of recession/depression.
Sunday, August 14, 2011
Market commentary on the stock market collapse that began on 2 Aug 2011
The recent global stock market collapse began on 2 Aug 2011. As of today, the Straits Times Index has dropped more than 10%. As of now, I do not have a significant position in the market to bias my opinion on the market. Differing opinions are most welcome.
Even if the global economy is headed for recession, I am actually quite confident that we will at least have a strong rally before the Singapore stock market heads down further (assuming it does). I don't think the Singapore market will continue its decline at this point.
In the week before 2 Aug 2011, I was surprised by the resilience of the Singapore market in the face of weaknesses in the European and US markets. Compare the price charts of the Straits Times Index with the European and US markets to appreciate its resilience. I suspected foreign fund inflows into the Singapore market to explain our market's resilience. The negative swap offer rates complained by UOB reinforced this suspicion.
There are plenty of cash on the sidelines. In fact, there is so much cash hanging around that the Bank of New York Mellon is charging fees on big deposits instead of paying interest.
The market needs cash to feed a rally. Otherwise, expressions of optimism are just empty talk that cannot be translated into action. At this moment, there is plenty of cash in waiting to jump in once the market stabilises and rationality comes back.
In the past 2 weeks, I observed several SGX announcements on insider purchases. Meanwhile, there are still several stocks on the watchlist with valuations which allows one to buy with peace of mind. In the US, CEOs have been buying back their stock in the past two weeks.
Hence, I am quite confident that we will at least have one more strong rally even if a global recession is impending. I do not think the Singapore market will continue its decline at this point.
Even if the global economy is headed for recession, I am actually quite confident that we will at least have a strong rally before the Singapore stock market heads down further (assuming it does). I don't think the Singapore market will continue its decline at this point.
In the week before 2 Aug 2011, I was surprised by the resilience of the Singapore market in the face of weaknesses in the European and US markets. Compare the price charts of the Straits Times Index with the European and US markets to appreciate its resilience. I suspected foreign fund inflows into the Singapore market to explain our market's resilience. The negative swap offer rates complained by UOB reinforced this suspicion.
There are plenty of cash on the sidelines. In fact, there is so much cash hanging around that the Bank of New York Mellon is charging fees on big deposits instead of paying interest.
The market needs cash to feed a rally. Otherwise, expressions of optimism are just empty talk that cannot be translated into action. At this moment, there is plenty of cash in waiting to jump in once the market stabilises and rationality comes back.
In the past 2 weeks, I observed several SGX announcements on insider purchases. Meanwhile, there are still several stocks on the watchlist with valuations which allows one to buy with peace of mind. In the US, CEOs have been buying back their stock in the past two weeks.
Hence, I am quite confident that we will at least have one more strong rally even if a global recession is impending. I do not think the Singapore market will continue its decline at this point.
Subscribe to:
Posts (Atom)