With the S&P500 up 100 points since last week’s low of 1882, the worry about global growth and earnings has been given a breather in the last few days trading. Last weeks low was about 12% below the May high (today’s close is at -8.6%). Last week, the vampire squid themselves lowered their S&P500 EPS forecast for 2015 and 2016 to $109 and $120 respectively, or approximately 18.2 and 16.6 times today’s close with the snappy by-line that “flats the new up”.
The forward PE, according this FACTSET report, as at last Thursday’s close (1924) was at 15.1, down from 16.8 in early May (as per this post).
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Year on year revenue growth for the S&P500 is still hard to find with Q3 expected to mark the third quarter in a row of declines, with energy and materials being a particular drag. Interestingly, telecom is a bright spot with at over 5% revenue growth and 10% earnings growth (both excluding AT&T).
Yardeni’s October report also shows the downward estimates of earnings and profit margins, as per below.
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As usual, opinion is split on where the market goes next. SocGen contend that “US profits growth has never been this weak outside of a recession“. David Bianco of Deutsche Bank believes “earnings season is going to be very sobering“. While on the other side Citi strategist Tobias Levkovich opined that there is “a 96 percent probability the markets are up a year from now“.
Q3 earnings and company’s forecasts are critical to determining the future direction of the S&P500, alongside macro trends, the Fed and the politics behind the debt ceiling. Whilst we wait, this volatility presents an opportune time to look over your portfolio and run the ruler over some ideas.
Posted in Equity Market
Tagged David Bianco, debt ceiling, Deutsche Bank, earnings forecasts, energy, EPS forecast, estimates of earnings, flats the new up, forward PE, macro trends, materials, Patience on earnings, profit margins, S&P 500, SocGen, telecom, Tobias Levkovich, vampire squid, volatility
Businesses with strong cash-flow are rightfully held in high esteem as investments. Google and Apple are good examples. Betting/gambling firms and insurers (in non-stressed loss periods) are other examples of businesses, if properly run, that can operate with high positive cash-flow.
The banking sector is at a completely different end of the spectrum as liquidity transformation is essentially the business. Everybody knows of Lehman Brothers bankruptcy, which was instigated in late 2008 by an immediate need to find $3 billion of cash to meet its obligations. The winding-up of the Lehman Brothers holding company in the US is estimated to return approximately 26 cents on the dollar according to this FT article. It was therefore a surprise to read in the FT article and in another recent article on the expected surplus of £6 to £7 billion from the winding up of Lehman Brothers operation in London after all of the ordinary creditors have been repaid in full. This outcome is particularly surprising as I understood that the US operation of Lehman did a cash sweep across the group, including London, just prior to entering bankruptcy.
In his book (as referenced in this post), Martin Wolf highlights the changing perceptions of value since the crisis by using ABX indices from Markit which represent a standardized basket of home equity asset backed securities. The graph below shows the value for one such index, the ABX.HE.1, to the end of 2011. These indices are infamous as they were commonly used to value securities since the crisis when confidence collapsed and can be used to demonstrate the perils of mark to market/model accounting (or more accurately referred to as mark to myth values!).
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I have included the more recent values of similar ABX indices in the bubbles as at last year from Wolf’s book. This graph accentuates the oft used quote from Keynes that “the market can remain irrational longer than you can remain solvent”.
Wolf argues that the 3% liquidity ratio proposed under Basel III or indeed the 5% proposed in the UK are totally inadequate and he suggests a liquidity ratio closer to 10%. On capital ratios, Wolf argues for capital ratios of 20% and above with a strong emphasis on tier 1 type equity or bail-inable debt that automatically converts. This contrasts against the 6% and 2.5% of tier 1 and 2 capital proposed respectively under Basel III (plus a countercyclical and G-SIFI buffer of up to 5%). Wolf also highlights the bankers ability to game the risk weighted asset rules and suggests that simple capital ratios based upon all assets are simpler and cleaner.
Wolf supports his arguments with research by Bank of England staffers like David Miles1 and Andrew Haldane2 and references a 2013 book3 from Admati and Hellwing on the banking sector. Critics of higher liquidity and capital ratios point to the damage that high ratios could do to business lending, despite the relatively low level of business lending that made up the inflated financing sector prior to the crisis. It also ignores, well, the enormous cost of the bailing out failed banks for many tax payers!
For me, it strengthens the important of liquidity profiles in investing. It also reinforces a growing suspicion that the response to the crisis is trying to fix a financial system that is fundamentally broken.
- Optimal Bank Capital by David Miles, Jing Yang and Gilberto Marcheggiano
- The Dog and the Frisbee by Andrew Haldane
- The Bankers New Cloths by Anat Admati and Martin Hellwing
Posted in Economics
Tagged ABX indices, ABX.HE.1, Admati and Hellwing, Andrew Haldane, bail-inable debt, Bank of England, banking sector, Basel III, capital ratio, confidence collapsed, countercyclical buffer, David Miles, fix financial system, G-SIFI capital buffer, home equity asset backed securities, Keynes, Lehman Brothers, Lehman Brothers bankruptcy, Lehman Brothers holding company, liquidity profiles, liquidity ratio, liquidity transformation, mark to market accounting, mark to model, mark to myth values, Markit, Martin Wolf, remain irrational, remain solvent, risk weighted assets, solvency ratio, standardized basket, strong cash-flow, subprime mortgages, synthetic CDOs, tier 1 equity, value securities, Why Liquidity Rules
In many episodes of fervent investment activity within a particular hot spot, like the current insurance M&A party, there is a point where you think “really?”. The deal by Mitsui Sumitomo to take over Amlin at 2.4 times tangible book is one such moment. A takeover of Amlin was predicted by analysts, as per this post, so that’s no surprise but the price is.
With the usual caveat on the need to be careful when comparing multiples for US, Bermuda, London and European insurers given the different accounting standards, the graph below from a December post, shows the historical tangible book value levels and the improving multiples being applied by the market to London firms such as Amlin.
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Comparable multiples from recent deals, as per the graph below, show the high multiple of the Mitsui/Amlin deal. Amlin has a 10 year average ROE around 20% but a more realistic measure is the recent 5 year average of 11%. In today’s market, the short to medium term ROE expectation is likely to be in the high single digits. Even at 10%, the 2.4 multiple looks aggressive.
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There is little doubt that the insurance M&A party will continue and that the multiples may be racy. In the London market, the remaining independent players are getting valued as such, as per the graph below tracking valuations at points in time.
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When the hangover comes, a 2.4 multiple will look even sillier than its does now at this point in the pricing cycle. In the meantime, its party like 1999 time!
Posted in Insurance Firms, Insurance Market
Tagged 99% T-VaR, 99.5% VaR, Amlin, average ROE, bermudian insurers, commercial insurance pricing, dilution of terms and conditions, European reinsurers, fervent investment activity, insurance M&A, insurance mergers, insurance pricing pressure, insurance valuation, Lancashire valuation, London based specialty insurers, london insurance market, London market, M&A premium, Mitsui Sumitomo, reinsurance pricing, reinsurance rates, ROE expectation, specialty insurance sector, tangible book value, tangible book values