Use access key #2 to skip to page content.

If the Squeezes Were Hugs It Would Be Good

Recs

7

February 12, 2008 – Comments (3)

Here is an example of how companies will be facing a squeeze because of debt, this example in the health sector.  The company had float rate debt insured by Ambac, sending the rate from 3.06% to 6%.  In this example the rise in interest rate costs about 1/4 of the operating profit.

Debt servicing costs are likely to go up considerably for many companies.  I can see some companies hit by both increases in debt servicing and input costs could end up really struggling.  I suppose this is how the "reversal to the mean" in profts begins.

3 Comments – Post Your Own

#1) On February 12, 2008 at 6:19 AM, MakeItSeven (31.64) wrote:

This is what Jeremy Grantham has been saying for a while now.  After the apptopriate repricing of risk, profit margin for corporates will be significantly affected.

This was what he said back in August:

The selling might accelerate. On the other hand the markets could easily rally. But in the end risk will be repriced. Whether it's now or in 18 months, risk premiums will be more normal.
...
The focus of the mispricing is in fixed income. That was more impressive than mispricing in equity markets. But the equity markets were also mispriced. The junky companies were selling at a premium to the blue chips. We had never seen such a deviation in performance between the junky rated companies versus the really high quality companies. It's been going on since September of '02.
...
I think this is the very early stages of repricing risk, particularly in the stock market. It may be rapidly entering the middle stages in the fixed income market, although I think it will go quite a lot further in the next couple of years. But the equity markets have barely started to address this issue. Still, today the risky stocks are badly mispriced relative to the blue chips. They have a long, long way to go. I have no doubt they will do it. The pendulum always swings completely. In other words, you can guarantee that one day there will be a substantial premium for high quality companies.

There is a lot of pain still to be had in the equity markets, particularly aimed at the risky end of the spectrum. We think the fair value on the market is about a third lower in the U.S and
EAFE from today and about a quarter less in emerging markets.

Most of that is not because P/E's are high. The great weakness in equities is that profit margins are off the scale globally. They're off the scale for the same reason that the risk premium got so low--that we've had wonderful global conditions, wonderful
global growth, wonderful global liquidity, wonderfully low inflation.
...
In five years, I expect that at least one major bank (broadly defined) will have failed and that up to half the hedge funds and a substantial percentage of the private equity firms in existence today will have simply ceased to exist.

Report this comment
#2) On February 12, 2008 at 9:31 AM, dwot (40.93) wrote:

Yup, this plays out hugely in my dwotbuyback profile, which is less than 20 right now...  I most certainly did not research the picks, but simply went with picks in an ETF of stocks with 5% or more buybacks. 

I also did not research the level of debt, but went with an assumption that many have been borrowing to do these buybacks, which I have seen a lot when I've looked at stocks.  I don't know if the stocks I've looked at that I based my theory on are representative of the market at all, but my perception is that these buybacks have been done disproportionately with debt based on the stocks that I have looked at over the past year and a half.

I should enter them in a profile on marketwatch so I can do some easier and more selective sorting of them.  I have no idea of what kind of hit to the market they have taken relative to the market high in October.  You can't use caps to see the 52 week high and low of a portfolio unless you pick them one at a time.

Holy freaking wow to that last paragraph...

In five years, I expect that at least one major bank (broadly defined) will have failed and that up to half the hedge funds and a substantial percentage of the private equity firms in existence today will have simply ceased to exist.

I too completely expect a major bank to fail, which is why I have stressed a few times on here the need to have your deposits at more than one bank and make sure they are covered by the government guarantee.  I think everyone should have at least two bank accounts even if you are no where close to the limit because if a bank fails accounts could be frozen for a period and that could be more than inconvenient.

My reading to date had suggested that only about 10% of the hedge funds were in rough shape, but I expect it will be tsunami when they start to unwind.  That he is expecting half to be gone is amazing...

Now, when you think about, the jobs that go with the hedge funds and private equity firms are very good paying.  Good paying jobs always have a leverage in the economy.  Commodities is one of the best historical examples to consider.  You get mining coming to a region and the entire wages in the region improve considerably.  These finance jobs go and it is going hurt the economics where they are concentrated big, big, big time.  

This is where a lot of job growth has come from and I see it as completely unsustainable job growth, job growth that only existed because of mispriced debt and mispriced risk that goes with debt.

So many of those exceptionally high priced MBA's are going to find themselves in a dime-a-dozen situtation when these jobs go and they do not come back. 

One of the items I read this past week was about a finance conference of sorts where the guy reporting on it said that out of the 6500 people attending, about 1500 were passing out their resume and it looked more like a job fair than a conference with a business purpose... 

 

Report this comment
#3) On February 12, 2008 at 9:32 AM, floridabuilder2 (99.33) wrote:

i agree... the leveraged companies are in for some trouble......... the cost of debt is going up significantly depending on what sector you are in.... additionally, as bonds come due this year and next (builders) at low rates when times were good, the cost of negotiating new corporate debt will double in some cases... most builders have debt in the 6% range and there is no way they can pay those obligations off and get the same rate on new issuances....  in a bear environoment, debt issuers expect more equity in a deal and they expect that you already have no debt (who wants to issue junior unsecured debt today?  no one

Report this comment

Featured Broker Partners


Advertisement