Sunday, October 31, 2010

Private Equity

This past week CommScope announced that it had reached an agreement with a Private Equity company, the Carlyle Group, to be acquired for $3.9 Billion at a stock price of $31.50 per share, a 36% premium. This newsletter will review what it means when a publicly traded company like CommScope is taken private and agrees to no longer to be traded on a stock exchange. This newsletter will have the usual things like the weekly recap from Vanguard and some trivia.

Vanguard

The economy's continued growth is good news, but the pace of that growth remains unimpressive. While gross domestic product rose for the fifth straight quarter, this wasn't enough to lower the unemployment rate. The housing market is recovering, but still in a rut. Likewise, consumer confidence and durable-goods orders were both up, but nobody was overdosing on optimism. For the week, the S&P 500 Index remained unchanged at 1,183 (for a year-to-date total return—including price change plus dividends—of about 7.8%). The yield of the 10-year U.S. Treasury note rose 1 basis point to 2.60% (for a year-to-date decrease of 125 basis points).

Private Equity

The acquisition by a Private Equity company taking it from being owned by shareholders to a group of investors is very important to understand. Bottom Line: When you see Private Equity Companies buying stock you should too.

First, what is the the Carlyle group and who can invest with them? Because of applicable U.S. securities laws, firms such as Carlyle work only with "accredited investors" and "qualified purchasers" as those terms are defined under the securities laws. These types of investors are highly sophisticated investors with considerable financial resources, such as high net worth individuals and institutional investors. Carlyle is prohibited from offering its products to the general public under applicable securities law regulations.

The federal securities laws define the term accredited investor in Rule 501 of Regulation D for an individual as:

1) a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase
2) a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year

An individual who is a Qualified Purchaser as defined by the Investment Company Act of 1940, has at least $5,000,000 in investments.

Why does Carlyle only want these types of investors? To minimize transaction cost and also because these categories of investors can not file a lawsuit.

Why do Investors keep giving Carlyle to invest? This happens when this is the best alternative of getting the highest return with the lowest risk. With the low interest rates for fixed income from treasury bonds these investors are getting a higher return for a fixed income style investment.

What does it mean for us? Carlyle made the investment and paid a 36% premium because the stock price was cheap and the company was consistently generating profits and cash flow from operations. When Private Equity companies start acquiring it means that relative value of stocks is inexpensive. Also, it reduces the total number of shares by publicly traded companies raising the value of stocks.

Halloween Trivia

•Halloween candy sales average about 2 billion dollars annually in the United States.
•Chocolate candy bars top the list as the most popular candy for trick-or-treaters with Snickers #1.
•Halloween is the 2nd most commercially successful holiday, with Christmas being the first.
•Halloween was brought to North America by immigrants from Europe who would celebrate the harvest around a bonfire, share ghost stories, sing, dance and tell fortunes.
•Tootsie Rolls were the first wrapped penny candy in America.

Sunday, October 24, 2010

Predicting the Future Direction of the Stock Market

The economic news this past week was that the economy remains in the recovery mode and has not yet gotten to the growth mode. This newsletter will cover the topics of predicting the future direction of the stock market and bank stocks after the weekly recap from Vanguard.

Vanguard

This week's economic reports were variations on a now-familiar theme: notes of growth with melancholy undertones. The Fed's latest report reiterated expectations of a "modest" recovery. The housing market and employment situation remained troublesome. For the week ended October 22, the S&P 500 Index rose 0.6% to 1,183 (for a year-to-date total return—including price change plus dividends—of about 7.8%). The yield of the 10-year U.S. Treasury note ended the week at 2.59% unchanged from last week (for a year-to-date decrease of 126 basis points).

Predicting the Future Direction of the Stock Market

With the economy in a recovery mode what does this mean for the future direction of the stock market? Every investor needs to have indicators that give direction. I use 2 indicators, the Federal Reserve and the Volatility Index. The best indicator for longer term direction is the actions of the Federal Reserve. The best indicator for shorter term direction is the direction and level of the volatility index.

When the Federal Reserve is taking action to grow the economy, like now, this is a positive indicator for the stock market. When the volatility index is dropping and at a low level, like now, this is a positive indicator for the stock market.

This means that now is a good time to buy and hold mutual funds that invest in the stock market.

Bank Stocks

Bank stocks remain in the headlines as the Attorney General for multiple states are investigating issues with issuing and foreclosing of mortgages. News exist that the FBI is now investigating improper behavior. Anytime the words Attorney General or FBI are in a news story it is not good.

For an investor with a short term time horizon this makes bank stocks unsuitable. It is difficult to see how bank stock prices can increase in an environment of legal investigation and potential lawsuits.

For an investor with a longer term time horizon this creates a buying opportunity. Bank stocks are posting better than expected earnings with a reduction in bad loans on the balance sheet and lots of money in reserve thanks to bank stress tests of 1-2 years ago. If you look at the financial picture without this issue these stocks look cheap. Sometime in the future this legal investigation will end and the financial performance of the individual companies will be more important.

Sunday, October 17, 2010

Bank Stocks

The news this past week, other than the rescue of the miners in Chile, was on suspending mortgage foreclosures and the impact on bank stocks. This newsletter will look at bank stocks, in particular Bank of America, and the impact of suspending mortgage foreclosures. First will be weekly recap by Vanguard and at the end will be some trivia on Columbus Day which also occurred last week.

Vanguard

If you're old enough to remember the 1970s, you may think inflation is a dirty word. Lately, though, some economists (joined, this week, by the chairman of the Federal Reserve) have dared to utter an even dirtier one: deflation. For the week ended October 15, the S&P 500 Index rose 0.9% to 1,176 (for a year-to-date total return—including price change plus dividends—of about 7.1%). The yield of the 10-year U.S. Treasury note rose 16 basis points to 2.57% (for a year-to-date decrease of 128 basis points).

Bank of America Stock

This is one of a few stocks that I have previously recommended. This recommendation is a result of the company acquiring Countrywide Mortgage and Merrill Lynch Investments during the financial crisis at a bargain basement cost without issuing shares of stock for the purchases. Anytime a company can grow revenue and profit without issuing more shares is very positive for a stock holder. Since the acquisition, additional shares have been issued but not as many as the sum total of the 3 companies.

As far as the item in the news, the delay in foreclosures, it would have been a lot better if we would have had these delays when the loans were being made. So instead of doing due diligence when the loans were issued we are now researching if the loans were done properly, it think this is called looking at the technicalities now instead of looking at the fundamentals when the loan was made. Ultimately, a mortgage loan has to be either paid or the property goes back to the originator as stated in the contract. The best thing for everyone is for economic prosperity to return to our country so that this foreclosure issue goes away and people can pay their loan.

Bank of America stock went down 11% last week because of this issue. The concerns include: higher costs associated with the issue reducing profits, loss of revenue ie. mortgage payments, and uncertainty about the future for these loans. The size of the drop does not make sense to me.

The real question is what does this mean for an investor and the future price of Bank of America stock given that they report earnings in 2 days? Since morgage loans are a fraction of the business and they are not getting revenue anyway from these loans that are in the foreclosure process the impact on earnings will probably not be very large. This looks more like a footnote item rather than a headlline item.

If you are an investor with a short term time horizon that is nervous about the issue then selling on a price rebound makes sense. If you are an investor with a long term horizon then holding and buying more makes sense. I would be much more nervous if Bank of America only did mortgages. An improving economy is always good for a bank stock.

Columbus Day Trivia

A U.S. national holiday since 1937, Columbus Day commemorates the arrival of Christopher Columbus in the New World on October 12, 1492. The Italian-born explorer had set sail two months earlier, backed by the Spanish monarchs King Ferdinand and Queen Isabella. He intended to chart a western sea route to China, India and the fabled gold and spice islands of Asia; instead, he landed in the Bahamas, becoming the first European to explore the Americas since the Vikings set up colonies in Greenland and Newfoundland during the 10th century.

Later that month, Columbus sighted Cuba and believed it was mainland China; in December the expedition found Hispaniola, which he though might be Japan. There, he established Spain's first colony in the Americas with 39 of his men. In March 1493, the explorer returned to Spain in triumph, bearing gold, spices and "Indian" captives. He crossed the Atlantic several more times before his death in 1506; by his third journey, he realized that he hadn't reached Asia but instead had stumbled upon a continent previously unknown to Europeans.

The first Columbus Day celebration took place in 1792, when New York's Columbian Order–better known as Tammany Hall–held an event to commemorate the historic landing's 300th anniversary. Taking pride in Columbus' birthplace and faith, Italian and Catholic communities in various parts of the country began organizing annual religious ceremonies and parades in his honor. In 1892, President Benjamin Harrison issued a proclamation encouraging Americans to mark the 400th anniversary of Columbus' voyage with patriotic festivities, writing, "On that day let the people, so far as possible, cease from toil and devote themselves to such exercises as may best express honor to the discoverer and their appreciation of the great achievements of the four completed centuries of American life."

In 1937, President Franklin D. Roosevelt proclaimed Columbus Day a national holiday, largely as a result of intense lobbying by the Knights of Columbus, an influential Catholic fraternal benefits organization. Originally observed every October 12, it was fixed to the second Monday in October in 1971.

Sunday, October 10, 2010

Refinance Mortgage, US Dollar

I hope you have enjoyed this special day of 10/10/10. This will cover the topics of refinancing a mortgage as well as valuation of the US Dollar. First is the weekly recap from Vanguard.

Vanguard

Despite welcome news that service-sector activity expanded in September, the week ended with a downbeat employment report. Instead of an expected no-growth September, the report showed a weak gain in private-sector jobs wiped out by a decline in public-sector employment, for a net loss of 95,000 jobs. For the week ended October 8, the S&P 500 Index rose 1.6% to 1,165 (for a year-to-date total return—including price change plus dividends—of about 6.1%). The yield of the 10-year U.S. Treasury note fell 13 basis points to 2.41% (for a year-to-date decrease of 144 basis points).

Refinancing a Mortgage

This week the average rate for a 30 year mortgage reached the very low rate of 4.27%. The Federal Reserve has stated that starting in November they may purchase long term US Treasury bonds that may reduce this rate even further. So if you have a mortgage and you have a rate above 4.5% now would be a good time to investigate refinancing it. In fact, this week I refinanced our mortgage and reduced the length of the mortgage using the adage that a bird in the hand is worth 2 in the bush.

Refinancing can be done a couple of ways, traditional and no-cost. The traditional way is to get the very lowest interest rate and pay closing costs which can be expensive. I chose the no cost option and paid a little higher interest rate without paying any cost. The reason for selecting this option is if the Federal Reserve does purchase enough bonds to drop mortgage rates even further I want to take advantage of it.

Conventional wisdom with a traditional refinance is that the interest rate has to drop about 2% to recoup the finance costs. I can not imagine that Federal Reserve buying enough bonds to drop the 30 year mortgage rate to below 3%. I can imagine a 0.25% to 0.5% drop. With the no cost method, I can refinance once again and take advantage of the even lower rate. Even if interest rates do not drop, I am happy with my new lower interest rate.

Valuation of the US Dollar

You may have noticed that the cost of gasoline went up this week. Is the cost being manipulated or is some free market forces at work? The answer is the value of US Dollar dropped this week, especially versus the Euro, causing this increase. While European countries have adopted a strategy of reducing their national budget deficits the US government is continuing to grow its budget deficit. This means that the US is printing more money relative to the European nations which lowers the value of the US Dollar.

Things such as commodities that are purchased internationally, like copper and oil, are going to go up because it takes more US Dollars to buy it. Given the current strategy of continuing to grow the US economy by going further in debt and printing more money this trend will likely continue for awhile. A falling US Dollar is also very good for US manufacturing companies as it lowers the cost of goods sold internationally.

The way to make money with a falling US Dollar is to purchase a mutual fund that invests internationally. Just like commodities going up, so will the value of other things purchased internationally such as stocks. If you know it is going to happen, you might as well take advantage of it.

Sunday, October 3, 2010

Make a Portfolio Safer By Using A Risky Asset

We made it through September, less than 3 months to Christmas. September started off with the experts saying that the economy was bad and people should be fearful of the future. Guidance from some experts was to get out of the stock market. The stock market rose significantly during September, the best September in 71 years. These well paid experts did not do anyone any favors.

This newsletter will include the weekly recap from Vanguard, a section on how to make a portfolio safer by using a risky asset, and some trivia on October.

Vanguard

The economy expanded in the second quarter but remains weak. Manufacturing continues to grow but also at a slow pace. Consumer confidence fell, even as incomes rose and spending increased modestly. For the week ended October 1, the S&P 500 Index fell 0.2% to 1,146 (for a year-to-date total return, including price change plus dividends, of about 4.3%). The yield of the 10-year U.S. Treasury note fell 10 basis points to 2.52% (for a year-to-date decrease of 133 basis points).


Making a Portfolio Safer Using a Risky Asset

Traditional thinking is that if a person wants a conservative portfolio that only conservative investments should be included. These investments include short term bonds and money market funds that typically give a low return.

An alternative approach is to use the principle of co-variance where risky assets that move differently from each other give a better return with a portfolio with the same low risk. The idea is to have an asset that go up when another goes down with each asset going up with time. The normal approaches is to put stock mutual funds and bond mutual funds together in some proportion.

A different approach is to use a risky asset that goes the opposite direction of the stock market. The concept is to purchase a volatility index that goes the opposite direction of the stock market. This volatility index has considerable leverage which moves at a faster rate than the stock market.

A perfect example of how to use this approach is investing during September when the experts are giving advice that now is a good time to take profits. Instead of getting out of the stock market and missing out on the stock market rally the approach is to sell a fraction of stock mutual funds and purchase the volatility index. In this manner, the volatility index acts like an insurance policy. A drop in the stock market is ofset by an increase in the volatility index and the investor maintains balance.

Trivia

October is the tenth month in the Gregorian calendar. It received its name from the Latin numeral “octo” meaning “eight”, because in the first Roman calendar it was the eighth month.

Dayight Savings Time ends every year at 2:00 A.M. local time on the last Sunday of October.

The German Oktoberfest celebration (now held around the world) originally began on October 17, 1810, the wedding day of King Ludwig I.

In merry old England during olden times the month of October was once named “Winmonth”, which meant wine month. It has also been called ‘Teo-monath’ (Tenth month) and ‘Winter-fylleth’ (Winter full moon) in the Old Saxon traditions.

Canada celebrates their Thanksgiving on the second Monday of October.