Markets await Greek Vote on Austerity Plan

As Greek unions continue their 48-hour general strike before the vote by lawmakers on the proposed five-year austerity plan on Wednesday, markets have been slightly optimistic today. Given that European stock indices are up today (with banking stocks particularly strong), Greek 10yr bond yields are at a three-week low and CDS spreads have tightened, it looks as if the market is quietly betting on Greece's Prime Minister George Papandreou to gain lawmakers' support in tomorrow's vote. The decision on whether or not to pass Papandreou's €28bn austerity measures is a crucial one that will likely have a significant impact on the financial markets, considering that a failure to pass the plan could result in the euro area's first sovereign default. After all, Greece will only receive the fifth €12bn installment of the €110bn bailout from the EU and the IMF if its parliament will vote in favor of Papandreou's plan. The tranche will ensure that Greece will be able to pay creditors through mid July. After that, the country will be dependent on a new EU/IMF bailout package believed to be worth €120bn that, too, is conditional on the passage of the austerity program and the laws needed for its implementation.

Meanwhile, European banks are discussing ways of contributing to this second rescue package for Greece. French institutions announced they would be willing to roll over 70% of their Greek debt maturing between 2011 and 2014. Apparently, 50% of the proceeds from those bonds would be reinvested in new 30-year bonds with the remaining 20% to be invested in zero-coupon AAA bonds with deferred interest. It is possible that the new bonds will be placed in a special purpose vehicle (SPV) backed by the European Financial Stability Facility (EFSF) so they won't show up in the banks' balance sheets anymore. According to Deutsche Bank's Josef Ackermann, German banks are looking into the French model as well as other possiblities, too. Although it was Germany's Angela Merkel who first proposed a private sector participation, again it is Nicolas Sarkozy who seems to be getting things done. Mrs Merkel continues to appear indecisive when it comes to actually closing deals instead of merely coming up with possible strategies. Anyway, France has a special interest in Greece not defaulting on its debt, because French banks have the biggest exposure to Greek debt with €65bn in liabilities. Next in line is Greece itself with around €59bn, followed by Germany (€40bn) and the UK (€19bn). The ECB remains the largest single creditor with €49bn worth of Greek bonds on its balance sheet.

The private sector's search for a good strategy for helping with the rescue of Greece is also made difficult by the fact that rating agencies could classify such an undertaking as a default event, depending on how it were to be executed. Fitch already said it was likely that the company would cut Greece to default if the EU were to go through with its plan to have private investors roll over their Greek debt. In any case, it is very important that the Greek parliament will back its Prime Minister on Wednesday. This will send positive signals to investors worldwide. I am not sure anymore whether Greece can be saved from defaulting, though. It is important for the EU to have a strategy in place for such a scenario. An orderly default of Greece might be unavoidable in the long run if the EU's other member states do not want to throw ever more good money after bad.

Stock Markets Down on Fed Projections

Stock markets are down worldwide today after yesterday's Federal Open Market Committee (FOMC) June meeting and the release of its economic projections (PDF). The Federal Reserve projects unemployment in the U.S. to be high through the year 2013, when it should be 7 to 7.5 per cent, according to the Fed's latest estimates (this is up from last month's projections of 6.8 to 7.2 per cent). The wide range of projections even suggests the unemployment rate to be between 6.5 and 8.3 per cent (see image from the FOMC report below).

I think it's unsettling that unemployment is likely to remain that high until at least seven years after the start of the recession! Investors will be thinking the same, as suggested by international stock markets today. It certainly didn't help that Federal Reserve Chairman Ben Bernanke didn't hint at potential new steps to boost economic growth. Apparently, Mr Bernanke believes the current slowdown of economic growth to be temporary. Therefore, the central bank, which is ending its $600bn bond-buying program at this inauspicious time, will remain on hold for at least two more months before deciding about further interventions. Interestingly, the Dow Jones index temporarily jumped up yesterday right after a tweet by PIMCO's Bill Gross saying that August would likely bring first hints at QE3. However, as soon as the FOMC published its downgraded economic outlook for the US, markets turned down again.

Today's losses in Europe could also be due to profit taking after mostly good stock market performances on Tuesday. Charts below the fold. Continue reading "Stock Markets Down on Fed Projections"

Social Networking Bubble Inflating

Technology companies like LinkedIn, Pandora, Groupon and Facebook are being valued at mind-boggling revenue multiples. In the face of relatively meager earnings, the fast-growing niche of social networking looks severely overvalued, bringing back memories of the last decade's dot com bubble.

Technology companies like LinkedIn, Pandora, Groupon and Facebook are being valued at mind-boggling revenue multiples. In the face of relatively meager earnings, the fast-growing niche of social networking looks severely overvalued, bringing back memories of the last decade's dot com bubble.

Over the past couple of weeks one must increasingly have been under the impression that technology history may be about to repeat itself. Again, technology companies, many of which are still in their start-up stages, are being valued at mind-boggling revenue multiples that the respective companies and venture capitalists are trying to justify by pointing to web statistics such as page views, unique visitors, registered users or even entirely new metrics they invented themselves ("income before expenses", as they are often called). Groupon, for instance, introduced a metric called "adjusted consolidated segment operating income" (short: Acsoi). Supposedly, Acsoi is the firm's operating profit minus its marketing and acquisition expenses. Under US accounting standards, Groupon shows a loss of more than $400m, using Acsoi this magically turns into a $61m profit.

What do these income-before-expense-metrics tell about the companies' financial situations and outlooks? This is a rhetorical question, of course, with the answer becoming evident when looking at technology stocks in the early 2000s. What they are supposed to cover up, is that most of the new web start-ups are severely overvalued not only in terms of the 2010 revenue multiples, but also based on multiples derived from current 2011 revenue outlooks. Is it the year 2000 all over again?

Almost. This time it is not the entire technology sector that is overvalued, but it is the relatively narrow niche of social networking firms. The shares of professional networking site LinkedIn, for example, jumped more than 150% to $122.7 on the day of its IPO on May 19, 2011, only to fall back to $67.92 as of this writing. LinkedIn reported a profit of $3.4m last year, mostly from advertising and membership fees. This is a tiny profit, considering the firm's current market capitalization of $6.4bn. Pandora, an online radio site which is valued at $4bn despite revenues of little over $100m last year, benefited from LinkedIn's IPO too. But under its current licensing terms, the more songs users listen to, the more Pandora ends up paying in royalty fees. This deal alone lacks entrepreneurial brains, in my opinion.

Granted, social networking firms are growing fast. But as long as web 2.0 companies are not able to translate their extreme popularity and growth into sustainable profits, I prefer to remain sceptic. Advertising alone cannot be the answer to this problem. With the increased use of ad blockers and general "ad blindness" by today's internet users, relying almost exclusively on paid ads will turn out to be a dangerous business model. Even Google has realized this by now and is beginning to branch out into new markets such as cloud computing, operating systems and telecommunications.

Unfortunately, it is not just the absence of robust business models that should caution potential investors. The aforementioned creativity in terms of financial accounting and reporting is just as big a problem. As an investor, I choose not to trust a company that is desperately trying to cover up losses and turn them into profits using non-standard accounting rules.

Recommended reading:
- Accidental Billionaires: Facebook (Paperback) | (Kindle Edition)
- The Google Story (Paperback)(Kindle eBook)
- Wikinomics (Paperback) | (Kindle eBook)

Stock Markets Crash, Banks Crunch

For the past few weeks I've been watching the stock market - not in fear, but in amazement. Before you continue reading you should know that I'm based in Germany, so lots of what I'm saying here is directly related to what I perceive to be the current economic situation in Europe, especially in Germany. I think, however, that some of it relates to the USA and other countries, too.

I've been watching the stock market and I've been reading the news. But this I do not understand: Why is it that everybody is selling off their stocks? By "everybody" I really do mean everybody. It is as if there was nobody left willing to invest in the stock market anymore. That doesn't seem logical to me. Although most of the publicly traded companies will be affected by the coming recession, I don't see how the extreme losses in the stock markets of 50% or more can be justified.

Let's take Daimler as an example. Daimler's stock price fell below €20 earlier this week, it was at €80 about one year ago. That would mean the company lost 75% of its value in the stock market, but that does obviously not represent its real market value. Daimler is still expecting to make a nice profit in 2008 (although it's a lot smaller than what was predicted at the beginning of the year), and the company has cash available. In addition, it is an established brand well-known for its high-quality products, which it successfully sells to customers everywhere in the world. The company didn't shrink to 25% of its value overnight.

I believe panic is a profound factor. Investors have been panicking and selling off their stocks as quickly as possible. I blame the media for playing a significant role in this, too. Whether you turn on the TV, read a newspaper or listen to the radio, it is nothing but gloom and doom these days. It is as if there was no tomorrow, as if the major global players wouldn't be existing next week anymore. That might have been true for some banks and financial institutions, but it won't happen to the businesses in the real economy. I'm talking about companies with a sustainable business model. The banks and funds that got caught up in the crisis mostly had eyes for quick profits. They didn't seem to be thinking about the future of their businesses as long as profits were on the rise and managerial salaries and bonuses were gushing. The products they were selling were so complicated that even some of the bankers themselves didn't fully understand them.

I am not saying there won't be a recession. We have to face the truth. The global economy is headed for a recession, and the USA might be the first to arrive at that point. European and Asian companies will be hit, too. Revenues will decline, but they will get back up. I don't believe the panic. I've been investing in companies with solid business models and "real" products to sell. Many of those companies are undervalued in today's market, in my opinion. Make no mistake; investing now is risky given the uncertainty of most market participants and investors. You never know what they'll be selling or buying tomorrow. (Nobody saw Volkswagen getting from €200 to €1,000 within two days, for instance. Hedge funds lost billions because of this unpredictable development.) So little makes sense in the stock markets today. But if you have money that you can afford to lose in the worst-case scenario and if you can wait patiently, this could be an opportunity for you to buy stocks at low prices. It will probably take some time, but stocks will eventually get back up.

The economy will get back on track. There is also a difference between some economic crises of the past and today, because this time governments and central banks have been faster to react. They're pumping money into the markets to keep the banks liquid, which is risky, but it has been the right thing to do. One thing, however, has not been done very well, I think:

In Germany, the government decided to put up €500 billion for banks in need of money. That's been the right thing to do, but the way it was done hasn't been good. German banks do not have to take the money. Why would anybody refuse to accept billions of Euros in cash, you might think. Here is why:

Firstly, if banks take money from the hefty rescue package in Germany they must agree to cap the annual salaries of their managers at €500,000. That means the bankers are not very inclined to take money from the German government because it means they will earn a lot less annually. I would think the managers are intelligent enough to understand that the overall economy is more important than their personal net worth, but you never know. There sure is a conflict of interest that should have been anticipated earlier.

Secondly, most Germans have a hard time understanding why the government is putting up €500 billion to save banks that got into the situation they now find themselves to be in by their own fault. The taxpayers understandably don't like the fact that it is ultimately them who will be financing the €500B package. Therefore, if a bank accepted money its image would be damaged.

A third reason why German banks have been so careful about taking money from the package, is that it could be perceived as a new sign of the bank's weak financial situation, which in turn would lead to a further decline in the bank's stock price.

Taking these reasons into account, I can only come to the conclusion that the situation has been handled a lot better in the United Kingdom. There, banks must take the money. That means they cannot be blamed for taking it and they don't have much to lose. Yesterday, news came in that the German banks are going to claim money from the rescue money collectively to avoid bad press for individual banks. That’s a smart move the German politicians should have thought of from the beginning.

Summing things up, I wouldn’t panic in today’s situation. We’re headed for a recession, but the situation could be much worse. If you’re an investor, if you’re not risk-averse and if you have disposable cash, it could be a good opportunity to buy stocks from undervalued companies. Many companies are undervalued in today’s troubled market. Central banks and governments are doing their part to help get the banks and the overall economy back on track. I trust that it has been the right decision to pump massive amounts of cash into the markets, although it’s me and you who finance that package, because in the long run we will benefit from that decision. Without the various financial rescue packages, the recession would probably turn out much worse.

I’d be interested in hearing your opinions on the current economic situation, especially from an investor’s point of view. Do you plan to invest in the stock market now that many stocks can be bought for cheap or are you going to wait longer before taking that rather risky step?

House prices through the floor

The Economist has a chart showing the trend of US house prices from 1920 to 2008. It shows that house prices have fallen by 18% in real terms since 2007. This means house prices have fallen faster than during the Depression in the 1930s.

European buyers are already entering the US real estate market, because they can now buy houses at very low prices. Many houses are being sold in foreclosure sales and on top of that the US Dollar is weak compared to the Euro, so Europeans pay even less than American buyers currently looking to purchase a home.

The same applies for domain names too, by the way. I've said it before: If you're based in Europe you can save a lot of money when buying domains from US sellers now!