Monthly Archives: November 2014

Happy Thanksgiving from the Freezing Assets Editorial Board!

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We at Freezing Assets would like to wish everyone a very Happy Thanksgiving. We are thankful for a lot here at our blog. First and foremost, we are thankful for your readership. We value your time and attention more than anything, and we know that you have thousands of other reading options so we appreciate you choosing us.

Additionally, we are thankful for our contributors. Like every other website, our content is everything to us. Nothing happens without it. Here at Freezing Assets we are blessed with many outstanding local volunteer content contributors. This is what makes our site unique—excellent and diverse material submitted by our peers and friends for our CFA Minnesota members.

Though this is a site specifically designed for our region, others are taking notice. In fact societies around the country have either launched a site like ours (e.g. CFA Society Chicago), or from what we hear are in the process of starting or considering one of their own based on the success we have had with Freezing Assets.

That is just one reason we feel blessed this Thanksgiving. Let us know what you think of the site, and how we can make it more useful for you. Better yet, consider becoming a contributor yourself. Just write to info@freezingassets.org, and we’ll let you know how to get started. It really is very easy. If you wish to help out in other ways besides writing, that’s great too. We take all comers.

Thanks for your readership, and everyone at the CFA Society of Minnesota for making Freezing Assets special.

 

Have a great Thanksgiving,

The Freezing Assets Editorial Board

Trivial Pursuit.

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John Boylan, CFA

Way back when people could entertain themselves without electronic devices, we played a board game called Trivial Pursuit. The bane of my existence in that game was earning the pink entertainment chip, as for some reason I dislike watching movies and TV shows so it was a challenge for me to answer those questions. That’s where I would get absolutely smoked.

I also would get smoked when I would turn my investment theses into trivial pursuit games. All too often I spent countless hours striving for that last bit of information that would perfect my thesis and make my earnings model seemingly impenetrable—at least in my own mind. However the vast majority of investment failures that I have made and have seen others make were not when we failed to uncover that last nugget of new information, it was when the risks of an investment were well known. Our error was underestimating something already known and anticipated, and we refused to challenge our own investment thesis. Our attitude was how can our thesis be wrong when we know the company so well? Many of us have a greater fear of looking ignorant in not knowing every detail of a company when confronted than admitting the weaknesses in our thesis up front in front of our co-workers, superiors, and clients. Too much bravado can be a very bad thing.

In my view, we investors often confuse intelligence with wisdom. Intelligence is the capacity to hold and retrieve information. Wisdom is the humble application of intelligence and experience. Why is it a humble application? Because wisdom is usually imparted by Mr. Market whacking us upside the head, and us actively looking for that proverbial swinging two-by-four aimed squarely at our temple in our future analyses. Getting whomped on the noggin so many times does give you a much better idea of where your weaknesses lie and how you need to know, accept, and yes even celebrate your shortcomings.

That’s why we as investors should try to actively look for and embrace our failures whenever possible and try to find out where we went wrong and how we can improve on our processes in the future. In other words, actively confronting and embracing the lessons learned from failure as often as we can. This includes seeming investment “successes” as well. Through the years I have discovered that many times I was right for the wrong reason (aka lucky), and that by looking for failure in my analyses that are disguised as successes has been equally as helpful.

Therefore perhaps we should spend much less time on that incremental bit of information about a product in a company’s product line that might move your model by less than 5% and spend more time looking for, embracing and learning from our failures. We might not win the Trivial Pursuit game (and earn that elusive pink entertainment chip), but we may just win the investing game in the long run.

MV=PQ

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John Boylan, CFA

Most people who read this column on a regular basis know I am not a big fan of reading too much into potential short-term Fed actions or other macroeconomic prognostications of the day. More often than not they are just transient noise. You do have to pay attention to the data behind those prognostications as sometimes you can see trends that could impact your investment thesis in the longer term.

One such current debate is how much longer the Fed will keep interest rates low, with one in the Fed (our own Minneapolis Fed President Kocherlakota) arguing we should continue the bond buying stimulus program as inflation is still too low.

However, are we investors focusing on the wrong longer term trend? It seems, at least to me, that there is only so much left the Fed can do. For me at least, it appears what we should be focusing on now is now what the Fed will do next but rather what will change the trajectory of money velocity in the longer term. Looking at the classic equation MV=PQ, where M is the money supply, V is velocity, P is the price level and Q is output, all seem to be doing OK except for velocity. Therefore I feel we will not reach full growth potential and acceptable levels of inflation until velocity changes. Consider the following charts:

The amount of money growth in the system is within normal ranges, and was relatively elevated in the not-so-distant past.

(click on image to enlarge)

M2 Money Stock

Additionally, productivity (output) seems to be holding in OK.

Labor Productivity

Source: Bureau of Labor Statistics

 

Inflation, as measured in CPI, likely isn’t optimal in the Fed’s view, but it doesn’t appear deflationary either and is still muddling along.

Consumer Price Index for All Urban Consumers

Money velocity is a different story however.

Velocity of M2 Money Stock

Therefore despite all this monetary pump priming and productivity and prices doing OK, money velocity has been in a notable downward trend. Therefore velocity seems to be an, if not the, anchor to growth.

Can the Fed control velocity? Well after trillions of dollars of stimulus later, one can plausibly argue no. While I agree with Friedman that inflation is always and everywhere a monetary phenomenon, there appears to be limited money turnover and demand, stunting the impact of increased monetary stimulus. That tells me that this is a fiscal policy, not a monetary policy, issue.

Therefore I am watching to see if there is a change in the fiscal environment as I feel that will move the needle macro economically long-term more than anything else. However this will require movement not from the Fed, which can only impact monetary policy—it will require movement from our federal and state legislatures and executives putting in place pro-growth fiscal policies.

Will it happen? One can only hope, and it bears watching closely as the New Year starts.

 

Knowledge Base: Aren’t Public Companies Required To Disclose SEC Investigations?

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Back in 2000 I pioneered using the Freedom of Information Act (FOIA) as a research tool with the SEC. Through the years we discovered countless undisclosed SEC probes and helped thousands of professional investors learn to interpret those that are disclosed. In fact, SEC comment letters are now posted now to the internet for free largely a result of my early efforts with the FOIA (This is the letter I sent to the SEC (link is external) in 2004 on that proposal.).

I’ve personally met with untold numbers of sophisticated investors and spoken at professional gatherings across the country about what we learned from our FOIA work and how SEC investigations really work.

This is my first in a series of articles I plan to post on things you as an investor need to know when it comes to SEC activity. If you like them, please let me know and I will gladly write more.

I leave you with kind wishes,

John P. Gavin, CFA
Founder and CEO
Probes Reporter, LLC
feedback@probesreporter.com
Or click here to use our online Contact Us form

Let’s start with some basic knowledge you need to have when it comes to SEC investigations —

  • Public companies are not technically required to disclose the existence of all SEC probes. Consistently, I hear investors say they thought otherwise.
     
  • When a public company discloses the existence of SEC activity of any kind it is likely because they felt the situation was serious enough it HAD to be disclosed.
     
  • Public companies hate talking about anything bad. Never forget that.

 

Public companies are not technically required to disclose the existence of all SEC probes.

Time and again, I am amazed to find out how few people actually know that public companies are not “required” to disclose when they have an SEC investigation. This is because public companies are only required to disclose matters that they deem “material”.

The consequences of undisclosed SEC investigations can be severe. We also know some SEC investigations go nowhere, so we are not necessarily critical of a company for not disclosing all the probes they have – or that we discover though our FOIA work.

Here’s the problem: Management, who could have self-serving reasons for not disclosing an investigation, gets to be the judge of what is and isn’t material. It’s not at all hard to imagine investors having a view that differs from management on these judgment calls.

The volume of undisclosed SEC activity we find, sometimes at just one company, is so high we find it hard to believe all of those management teams involved did not judge anything sufficiently material to warrant disclosure. But it happens.

Unless the SEC steps in and forces a company to disclose certain information (and that can take months or even years) the company gets to decide whether you need to know, what you need to know, and when you get to know it.

Feels a bit unbalanced, don’t you think? But that’s the way it is. So how do you protect yourself? Read on.

 

When a public company discloses the existence of SEC activity — of any kind — it is likely because they felt the situation was serious enough it HAD to be disclosed.

Trust that! Trust that they know this is a serious problem. That’s almost certainly why they disclosed.

Once, after speaking at a CFA breakfast meeting, a person who identified himself as an attorney experienced in such matters came up to me and said that management’s perception of the exposure being serious is the only reason a company will disclose an SEC probe. It was a strong view I couldn’t corroborate on my own. But I will tell you I wasn’t surprised.

In short, whenever a company discloses something bad, you can trust that the act of disclosure itself tells you that management judged the matter serious. This is true no matter how soothing the words or assurances are.

Also, keep in mind that Wall Street analysts are generally not a good source for helping you to interpret SEC probes that are disclosed.

Just as I’ve been amazed at how few people knew companies don’t have do disclose their SEC investigations, I’ve been equally surprised at just how misinformed even professional investors are when it comes to interpreting SEC matters.

For many reasons, they also tend to shy away from pressing a company too hard on an SEC exposure (though we would recommend otherwise).

 

Public companies hate talking about anything bad. Never forget that.

Public companies love happy talk. Wall Street analysts do too. As a result in our experience we’ve found that means most companies will not tell something bad that is impacting them until it becomes serious: Often too late for you to avoid losing money.

This often includes disclosure – or failure to disclose – SEC investigations. Even then, they may use spin and clever word choice to minimize the impact of the bad news. Never forget that.

 

Boom Clap

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Susanna Gibbons, CFA

The Corporate bond market just goes on and on and on. With almost $50 billion in supply, last week saw the biggest calendar since early September. And this was in spite of the fact that we’ve had a couple of months of spread widening. Investors still have plenty of appetite for investment grade bonds, and not just high quality — plenty of crossover bonds found a home. General Motors (Ba1/BBB-) was in the market with $2.5 billion of 5s, 10.5s, and 30s; Owens Corning, Discover Financial Services, and Omnicare also brought crossover deals totaling nearly $2 billion.

The deal of the week, though, was definitely Walgreens. The US drug retailer was in the market with $8 billion of bonds to finance its pending acquisition of British pharmacy Boots PLC. The US$ deal was followed by another $2 billion in Euros and Sterling today. Walgreens, now rated mid-BBB, had been a solid A-rated company until investing in Boots. In 2007, Boots PLC was the largest-ever LBO in Europe at 11.1 billion pounds, and was among the transactions the market was concerned about in the financial crisis. With LBO debt maturities looming, Walgreens took its initial 45% stake in Boots in 2012 for $6.7 billion. That first kiss must have been like a drug, because on August 6, 2014, Walgreens announced that it would purchase the remaining 55% ahead of schedule. This announcement came in spite of the fact that sales will be lower than expected, and it will not reap the benefit of a potential tax inversion. By purchasing the remainder, and agreeing to take on $7 billion in existing debt, Walgreens will have paid $22 billion for Boots, or 2x what the market thought was a pretty full price in 2007.

Walgreens shareholders have been none too happy about the transaction – the stock dropped nearly 20% on the August 6, 2014 announcement. The bond deal, though, went remarkably well, as the company brought 7 different tranches across the curve. The transaction came at relatively generous spreads (+145 on a 10 year is considered generous these days), and bonds have tightened about 7-10 basis points across the curve since pricing.

That is a pretty happy ending for KKR, to be sure. Whether it turns out to be magic for the company’s new bondholders remains to be seen.