2009 May 25 » New Jersey CFO

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Bernanke’s wager is on a virtual free lunch by printing money.

“Fed chair Ben Bernanke has long argued that central banks can bring down long-term borrowing rates by purchasing bonds “at essentially no cost”. His frequent writings rarely ask whether foreigner investors – from a different cultural universe – will tolerate such conduct. Mr Bernanke is betting that under a floating currency regime there is no risk of repeating the disaster of October 1931, when the Fed had to raise rates twice to stem foreign gold withdrawals, with catastrophic consequences.”

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The UK’s AAA-rating is at risk. (Bloomberg, MarketBeat, EconomPic Data, Zero Hedge)

Bye, bye miss american pie…..

Don’t wait…..buy Gold and Gold Mine Stocks!

In for a dime, in for a dollar. “The GMAC funding is an illustration of how rapidly the government effort to rescue the U.S. auto industry is escalating in cost and scope.” (WSJ)

GM Borrows $4 Billion From U.S. to Push Loans to $19.4 Billion
General Motors Corp., facing rising cash needs before a June 1 bankruptcy deadline, tapped $4 billion more in U.S. aid to push its total to $19.4 billion.

Is the Required Yield Theory better than the Fed Model? (CXO Advisory Group)

What aggregate return thresholds are critical to investors in deciding whether to accept or reject equity and bonds for investment portfolios? In their December 2008 paper entitled “A Required Yield Theory of Stock Market Valuation and Treasury Yield Determination”, Christophe Faugère and Julian Van Erlach argue that investors first require that U.S. stocks and bonds in aggregate prospectively provide a real after-tax earnings yield directly related to real long-term GDP per capita growth. Investors then decide between stocks and bonds based on the better after-tax real return. Applying this Required Yield Theory (RYT) to quarterly data over the period 1953-2006, they find that:

Real, after-tax Treasury and S&P 500 forward earnings yields reliably revert to positive means. For stocks, the mean yield is very close to the long-run average real GDP per capita annual growth rate (2.24% during 1929-2001 and 2.03% during 1929-2006).
The equity risk premium derives mostly from business cycle risk, as measured by the growth in book value of equity per share (productivity growth). Inflation risk and fear-based risk have only transient, secondary impacts on the premium. The equity premium is always positive or zero relative to long-term Treasuries, but may be negative relative to short-term Treasuries when short-term productivity outpaces medium-term and long-term trends.
Periods when the after-tax 30-year Treasury bond yield is below the nominal required yield indicate that a fear-based premium is present.
Using quarterly data, the RYT Model fits the S&P 500 forward earnings yield with adjusted R-squared statistics of 88% over 1953-2006 and 94% over 1978-2006, about 19% better than the fit provided by the Fed Model (see chart below). Transient deviations from the model arise from: (1) economic, productivity or policy shocks that impact the equity risk premium; (2) shocks to earnings, productivity or inflation forecasts; and, (3) short-term noise trading.
Treasury yields are a function of short-tem productivity growth relative to its long-term trend. The RYT Model fits the yields on 1-year, 10-year and 30-year Treasuries with adjusted R-squared statistics over 66%.
Using the difference between long-term and short-term growth in aggregate book value per share, the RYT Model largely explains the spreads in yields between long-term and short-term Treasuries (term spread), with adjusted R-squared statistics over 58%. The model successfully generates 10 of 12 yield curve inversions over the sample period.
RYT partially validates the Fed Model since both the S&P 500 forward earnings yield and the 10-year Treasury yield both derive from the required yield (long-term real U.S. GDP per capita growth)

An important question at Custerstock:

Are activist investors to blame for horrible corporate balance sheets? (Clusterstock)

On Squawk Box this morning, DealBook maven Andrew Ross Sorkin made some comments about the role investor activism played in getting companies to lever up their balance sheets during the boom times.

That this happened is indisputable, as conservative boards and executives were constantly getting pilloried for taking on too-little debt, paying out too low of a dividend or not executing stock buybacks rapidly enough.

The converse to this idea is that more entrenched, conservative boards, impervious to investor activists would’ve been more likely to resist the temptation of leverage. (If there’s any academic literature on this question, please let us know.)

Perhaps the most striking thing, though, is not just that companies and investors levered up during the boom times (that’s obvious, people always think that they’ll last forever) but that calls for more buybacks and debt were occurring very late into 2007, early 2008. We remember going to media industry banking-sponsored in early 2008, when it seemed pretty obvious that the writing should be on the wall, and yet investors would barrage management with requests for more buybacks. As we wrote, elsewhere, companies frequently complied.

Too bad more boards didn’t have the spine to stick with common sense.

“The creation of risk capital, of which I.P.O. demand is a leading indicator, is crucial to getting the economy back on its feet.” (Breakingviews)

In the grand scheme of the global capital markets, half a billion dollars is a drop in the bucket.

But that sum, the amount raised by three market debutantes this week, says more about the spirits of investors than its size might suggest. Strong demand and robust pricing for riskier companies hints at a latent desire by investors to put money to work. That’s a critical component in any economic recovery.

Make no mistake: it is unlikely to be the definitive start of a new bull market. And the near-$500 million raised by the market’s newest entrants — DigitalGlobe, SolarWinds and OpenTable — amounts to less than 5 percent of the cash that Bank of America pulled in overnight on Tuesday.

But the ability of a few unproven companies with visible warts to attract such interest shows that investors are willing to move on from a strict focus on repairing the balance sheets of troubled companies with time-tested track records.

Take the online restaurant reservation service OpenTable. Its pending initial public offering is no big deal at just over $50 million. But it is noteworthy that a company so highly geared to fine dining can attract more than a glimpse from investors during a recession. It is even more extraordinary when one considers that nearly half of the deal’s proceeds are going to its venture capitalists rather than to expand the business.

Nonetheless, OpenTable’s underwriters were confident enough to raise the deal’s indicative price by as much as 50 percent on Tuesday night. The shares should begin trading on Thursday.

Similarly, shares of SolarWinds, a software maker, popped 10 percent on their opening on Wednesday, even though the company had priced its offering a third above its own initial expectations. The company, which competes with Cisco and I.B.M., also routed a chunk of the proceeds to selling shareholders.

The creation of risk capital, of which I.P.O. demand is a leading indicator, is crucial to getting the economy back on its feet. So when companies like these enjoy such vigorous attention it is hard to see this as anything but a beneficial sign, just so long as investors don’t engage in too much ebullience too soon.

New Jersey CFO

Beggars Are We All…..

Out Of Control! Welcome to USAWagen

The Required Yield Theory of Asset Valuation

The Danger Of Greed and Short Term Focus

I.P.O.’s Offer Encouraging Signs

Analysis & Commentary