MORNING BID – I was dreaming when I wrote this…

Aug 25, 2014 14:37 UTC

The move by Roche to buy biotech company Intermune for $8.3 billion at a 38 percent premium isn’t going to make Janet Yellen happy, given her thoughts on the valuation of certain biotechnology and Internet retailing names. Still, with the Fed chair on board for low rates for some time given the slack situation in the labor market that the Fedsters keep talking about (basically, the unemployment rate, like the old grey mare, ain’t what she used to be), the long march to 2,000 on the S&P looks like it’s probably going to be over before long (it’s been done on an intraday basis, and now we’re just waiting on a close above that level), representing a tripling in that average in a bit more than five years and raising again all those questions about whether this all makes sense and if anyone cares anyway.

On the first point, well, nobody knows anything – earnings were generally strong in this most recent quarter, particularly when one expands the universe to the Russell 1000, where Credit Suisse points out more companies that are beating analyst expectations are growing sales, a sign of improved demand.

About 70 percent of the Russell 2000 beat on earnings estimates (about 62-65 percent if you exclude the ones that only beat due to reducing share counts through buybacks), and of that group, 84 percent did so while growing sales, pointing at least to some hope on improved demand. But there’s always weakness out there somewhere, and it appears to be among the true small-caps – the Russell 2000, which has been trailing the S&P and yet still looks overvalued based on a number of measures and has been seeing more negative revisions even as the stocks struggle.

The weakness in those names, along with some lackluster stock performance out of consumer discretionary stocks, explains in part why hedge funds are once again struggling, up less than 1 percent for the year compared with about an 8 percent gain in the S&P 500 for the year (after 2013’s ridiculous rise, of course, when hedge funds wouldn’t have been expected to keep up in the first place).

Still, it’s been a rough outcome this time this year – heavy overconcentration in a lot of the social media names early in the year dampened performance when those stocks went belly-up, and after that heavy exposure to discretionary shares did them in, so just kind of an uphill battle ever since – which actually suggests the desire to catch up may result in more gains for the rest of the market throughout the rest of the year. To wit – Credit Suisse’s most recent data shows health care becoming a net overweight position among hedge funds, with long exposure increasing in the last few months.

MORNING BID – Two to Tango

Jun 25, 2014 12:52 UTC

Wednesday’s version of reading tea leaves involves Argentina’s economy minister Axel Kicillof, who will be in New York to speak to the United Nations about Argentina’s debt situation. In case the U.N. missed it, Argentina defaulted a while back – 12 years ago – and they’ve been fighting with a group of investors on paying some of their debt since. Which is a roundabout way of saying Kicillof may not just be in New York to talk to the U.N., not when NML, Aurelius and the other holders are all also in New York too, and the judge in question, and any special envoy he introduces to try to wring some kind of compromise out of this situation. There’s a big coupon payment due June 30, and the country has been prohibited from doing so unless it pays the holdouts, which it has pledged not to do, giving it a 30-day grace period before being declared in default.

So the thing to watch for is something like a clandestine meeting between all parties to find a way to reach an accord, even if it’s the kind of thing that comes down to the July 30 wire – when Argentina would be considered in default again (double-secret default, as Dean Wormer would have it, and really, if John Vernon were alive, he’d have solved this mess a long time ago).

Argentina is worried about being on the hook for as much as $15 billion and not just the $1.33 billion-plus-interest owed to the holdout hedge funds – Moody’s puts the number closer to $7.5 billion, maybe up to $12 billion, per an overnight story from Dan Bases. Neither is a number Argentina wants to deal with, hence their reluctance to participate in any kind of negotiation that amounts to a gun to their heads.

There’s going to be a lot of face-saving going on. Whether the holdouts will get their $1.33 billion is in question – it’s likely to be something less than that, with some kind of provision that allows it to be implemented, perhaps, after the expiration of a deadline at years-end that would obviate the need for the South American nation to consider paying the rest of the bondholders something additional.

Given the need to finance ongoing activities (that is, a recession), time is of the essence. Nobody is going to get entirely what they want – by now the opportunity cost for the hedge funds has to have been significant (they could have hung back and bought a bunch of Greek debt and stakes in Icelandic banks and been done with this), and Kicillof can ill afford to go home and say he caved into the “vultures” that officials blame for the country’s economic strife. So a meeting in New York may not be on the calendar, but one never knows.

MORNING BID: Mo-Mo and the Hedge Fund Reckoning

May 15, 2014 13:34 UTC

Who had the mo-mo mojo and who was crushed by the steamroller becomes evident late in the day Thursday when filings from major hedge fund managers – those things known as 13-Fs – are released.

Hedge funds were hit hard by the decline in the likes of Twitter, Tesla, Netflix and a lot of other names that long/short investors had favored throughout 2013 and early 2014, but their substantial decline cut the legs out of a lot of leveraged managers looking to continue to profit on the big run-up in that sector.

Credit Suisse data shows that investors were generally overweight in the momentum strategy (one of a number of style baskets), especially after a stellar 2013, when stocks ran up all at once. They responded in late March by putting on substantial hedging positions to offset some of those losses and as the declines faded, performance normalized a bit more. There are still some believers (there always are when it comes to internet software and biotechnology companies) but still more investing firms are now going the other direction, boosting their short bets in these names and pulling away from the long side.

Many of these managers had maintained long positions in names as they kept falling. In recent weeks, though, investors have instead started to add to short positions – 3D Systems’ short interest is now hovering about 22 percent, up from about 15 percent at the beginning of the year, according to Markit. SolarCity has seen overall short interest utilization rates rise to about 76 percent from about 20 percent at the beginning of the year (oddly with this name, short bets were very high in 2013, but fell off as skeptics gave up in the face of the overwhelming market rally).

Netflix has been a bit less of a heavily shorted name, but it too has seen a modest increase in short bets, from just 1 percent in mid-January to about 10.5 percent as of this week, Markit data shows. It will be interesting to see if there are any that detail sudden reversals in exposure – from long to short – or vice versa.

(One notable exception to this trend is Twitter, which has seen a notable decline from its heavy short interest in recent weeks. According to Markit data, about 90 percent of the shares available for borrow were being used for such purposes on May 6; by May 12 that had dropped to about 50 percent of shares available to borrow. The reason for this is relatively easy to explain: Twitter’s lock-up period preventing certain insiders from selling expired on May 6, so there’s more available to borrow for short bets.)

That the big selloff in these names didn’t spread to the broader market in any meaningful way is the result of a few things. For one, the stocks were overvalued by most conventional and a few unconventional measures. Also, they didn’t encompass large swathes of the market the way the tech bubble did in 2000, and most other sectors of the market have remained steady on expectations for better economic growth, so the rotation to the likes of utilities and consumer staples stocks has helped offset the losses in the big momentum stocks.

And now, it’s gotten to a point where these hyper-growth names are even undervalued when compared with their historic relationship to the market. Hyper-growth names that derive more than 40 percent of their enterprise value from their future growth prospects trade at about a 51 percent premium to the broader market, per Credit Suisse figures. That’s usually 66 percent, meaning this is where buyers could step in…if they wanted.

MORNING BID – Momentum stocks: A primer

Apr 7, 2014 13:25 UTC

Lots of stocks have been getting killed in the last several weeks and the declines don’t seem really like they’re set to abate headed into a week where news is again at a premium (sure, earnings, but it’s just a few names, and they’re mostly decidedly not in this category of the momentum names that fueled the rally in 2013). So the likes of Facebook, Tesla Motors, Netflix, Alexion Pharmaceuticals, and a bunch of others have seen their fortunes turn in the market. But at this time we thought it would be a good way to get into this topic again by trying to lay out just what the hell a momentum stock is in the first place, because they exhibit a number of characteristics beyond just “a stock that’s going up very high.” So here goes:

Growing Industries: Internet retail, internet security, solar, cloud computing, companies that use the cloud for providing services (think Salesforce.com), biotechnology, and anything else where the prospects for growth are big and related to a growing sector of the economy. Utilities don’t really qualify here, naturally. The reasons are two-fold: for one, in order to jump onto a rising growth story, you’d want to be in a place where the expected future returns outpace the returns you’re getting now, something you won’t get from the telephone company, someone who sells toothpaste, or the guys hooking up the electricity.

Revenue, Revenue, Revenue: Credit Suisse’s quantitative research models shows that the big winners in 2013 were those whose price when compared to enterprise value showed most of the value in the stock wrapped up in their future growth prospects. Lots of these types are showing a big boom in the money they’re bringing in every year, even if that’s not translating yet into earnings – Tesla, for instance, saw its revenue rise by about 75 percent in 2011, which then doubled in 2012, and increased nearly four-fold in 2013. That’s growth, and that’s what feeds the expectations for more growth. The exception here is probably biotechnology, where much of the prospects are given over to expectations for a drug approval – though it’s notable that Alexion, for example, has posted revenue growth of 37 percent or better for five years running.

Rising Stock Price: This is sort of a no-brainer, but it’s a little more nuanced than just “OMFG LOOK AT THAT.” (Ok, maybe not much, but let’s unpack it anyway.) There’s a lot of talk about stocks that steadily rise and then go through a period of what people blandly call “consolidation,” but in a sense that kind of thing is important – it means that investors are seeing their stocks sit, churn for a while, and not really move, but those confident in the prospects and in the valuation of a company will buy as these dips occur, thus ensuring a “base” when the stock falls back. They’re not “value” investors, but they’re investors believing that a company’s value sits at a certain price where they’d be willing to buy, again and again. But these stocks exhibit no such pattern – they don’t really come up for a breather at all, and sort of just simply keep going and going and going. So investors who get into these names, including but not exclusively hedge funds, are doing it and finding what Mike O’Rourke of JonesTrading called “instant gratification from price appreciation.” When investors talk about stocks going “parabolic,” that’s what they’re referring to – look at Netflix last year, rising with barely a stop from around $90 to more than $450 a share.

Volume and Volatility: This is an underappreciated aspect of the stock-price move, and that when you see these stocks start to take off, often volume will bust out in a big way on the up days as more and more people jump in to take advantage. They also tend to move around a lot.

Short Interest: Not always necessary, but often an added part of this. Just as these stocks often attract hungry buyers, there are a lot of hungry sellers who jump in as well and believe – as is likely the case – that the valuations are absurd. But with momentum stocks, that doesn’t really matter, so you see lots of shorts get burned. Green Mountain Coffee Roasters, Tesla, Netflix and a few others are good examples of those that built a stubborn short base for quite a while. Eventually, they will be right, but they may not even be in the stocks anymore, having gotten run over by big big mo.

Faddish Industries: Those that buy these names can either be emotionally connected to a story – prostate cancer drug maker Dendreon had for years a fervent group of followers who lived and died on every regulatory announcement – or they come out of brands that naturally attract buyers because they have a consumer appeal as well. Netflix, Priceline, TripAdvisor, or Tesla all work in this description. Sometimes they’re even an outlier in an otherwise slow-growing industry because of “fad” appeal – Crocs was a big momentum stock for a long time too.

So what’s all this make out as? The question is when people start to find value in these names, but given that tradition valuations don’t work (Netflix is valued at 20 times sales; the S&P is 1.7 times), investors start to see the upward momentum in these names sag, and then quickly exit as fast as they got in – Morgan Stanley points out that a basket of stocks consistent with hedge-fund overweights lagged a basket of HF underweights by 7.7 percentage points from March through April 4. There’s a point where these stocks become “broken” – and it can take several attempts before it happens, as it did in the dot-com era, but once it happens, there’s little real way to stop it. The average price paid by investors in a lot of these names ends up being higher than where the stock is at a given point, and that acts as a ceiling on a rebound. A few stocks escape this, but many don’t.

Can Mathew Martoma accept money from Steve Cohen?

Ben Walsh
Jan 7, 2014 23:14 UTC

DealBook’s Matthew Goldstein and Ben Protess report that “prosecutors never thought their insider trading case against Mathew Martoma would go to trial… [He] appeared to have every incentive to cut a deal against a boss who fired him in 2010”. Martoma, a former analyst at SAC Capital now facing federal insider trading charges, seemed to have plenty of incentives to cooperate with authorities: a solid case against him, a wife and three children, and the possibility of a decades-long prison stay ahead of him.

But he didn’t cooperate, and apparently didn’t implicate SAC chief Steven Cohen. That, Goldstein and Protess report, worries prosecutors: “Mr Martoma’s resistance… has baffled officials… Some authorities have grown suspicious about his motives… noting that Mr Cohen is paying for Mr Martoma’s defense.”

Put bluntly, if Cohen paid, promised to pay, or otherwise influenced Martoma not to testify against him in order to protect Cohen’s innocence, is this obstruction of justice?

The Congressional Research Service has an excellently detailed and relatively plain English overview on the topic. Cornell’s Legal Information Institute also does great work chopping up the voluminous US Code into linkable little bits.

The most relevant Federal statutes to answer that question in the Martoma case are:

  1. Witness tampering (18 USC 1512) or bribery (18 USC 201): fairly straightforward in this context. If Cohen paid Martoma not to cooperate with Federal prosecutors by withholding testimony against Cohen, that could be, in the language of the US Code 1512, “corruptly [persuading] another person, or [attempting] to do so, with intent to… withhold testimony” or “hinder, delay, or prevent the communication to a law enforcement officer or judge of the United States of information relating to the commission or possible commission of a Federal offense”. He would also likely be in violation of the similar, but distinct  prohibition against bribing federal witnesses.
    The same would likely apply if Martoma decided without Cohen’s coercion not to cooperate, and Cohen paid Martoma to not use evidence against Cohen in Martoma’s defense.
    Martoma can withhold testimony he believes may incriminate himself. The testimony that is privileged under the 5th Amendment relates only to self-incrimination, however, and as such does not necessarily extend to Martoma’s testimony with respect to Cohen. If Martoma believed that responding to specific questions about Cohen would incriminate himself, he has grounds to decline to respond. However, if the question asks for information that Martoma reasonably thinks would incriminate Cohen but not himself, the same right does not apply.
  2. Obstruction of administrative proceedings (18 USC 1505): This would apply if payment from Cohen to Martoma influenced in almost any way the “due and proper administration of the law under which any pending proceeding is being had before any department or agency of the United States”. If Cohen did pay Martoma to withhold testimony, “proper administration of the law” would likely have been impacted.
  3. Conspiracy to defraud the United States (18 USC 371): A more vague statute, this applies “if two or more persons conspire either to commit any offense against the United States, or to defraud the United States, or any agency thereof in any manner or for any purpose”. This could be moot, however: if there were any sort of financial agreement between Cohen and Martoma that resulted in withheld testimony against Cohen, it’s doubtful prosecutors would need to reach this far down the list to find an indictable offense. If, on the other hand, prosecutors were to include the kitchen sink of charges, they could throw this in as well.

More tangentially, if Martoma shared any confidential information connected with the trial, except with his lawyers, defense experts, and potential defense witnesses, he could be in violation of a Federal order. Interestingly, even if Martoma considered Cohen a potential defense witness, Cohen could only see confidential information as it related to “the purposes of the criminal proceedings”. If Cohen extracted an agreement to change and/or restrict Martoma’s testimony in the case, that would very likely violate the order.

All of which is to say, it’s basically impossible to pay, or promise to pay, or otherwise influence a criminal defendant to not testify against you in any sort of legal manner. Except that is, by paying for their defense lawyer.

COMMENT

seriously? “Excellently detailed?” Not “well detailed” or simply “detailed,” but “Excellently”.

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