ARCHIVED COMMENTARY
The Market That
Would Not Tank
For edition of November 21, 2005
The Market That Would Not Tank turned a promising dive into a swoon Friday, but not before letting us get short on the high tick of the day. We had an offer in to sell two E-Mini S&P contracts short at 1252.25, precisely where the index peaked early in the session. We covered half the position six points lower, but when selling appeared to dry up near 1246, I put out a bulletin to cover the rest at will. The S&Ps had dropped sharply in the morning after spiking to the hidden pivot at 1252.25, and we might have expected contrite bulls who got trapped near the top to inundate any rally attempt with urgent supply. Instead, the S&P futures made a v-shaped bottom at 1242.50, then climbed steadily higher for the remainder of the session. By the final bell, they’d come within three ticks of the morning high, settling back slightly to close up five points on the day. I don’t know how CNBC may have spun this performance, but I take it as further evidence that complacency remains Wall Street’s best friend these days. If investors have become inured to the possibility of a Friday stampede, as it seems they have, then we are probably closer to a top than the “seasonality” bulls think.
(Click on chart to enlarge)
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GM Bankruptcy Odds
Following is an interesting back-of-the-napkin analysis of GM’s bankruptcy prospects. It is the work of Gordon Haave, another contributor to my favorite chat group. While it is possible to hedge one’s bets on GM, my gut feeling is that pessimists should take the odds on this one. The Devil can only view GM as a huge pension fund primed to go bust, and there’s no reason why Beelzebub will show any more kindness to auto workers than he has to airline employees.
With all the speculation about how Helicopter Ben might handle the recession that could scuttle GM (and Ford), few have observed that the U.S. is already hemorrhaging funny-money vouchers to prop up the airlines. This is being done, not surreptitiously, or through the Bernanke-friendly provisions of the Monetary Control Act, but indirectly and in such a manner as to have us infer that the bailout is just capitalism at work. We see that the U.S. Pension Benefit Guaranty Corp. has made commitments well in excess of its capital, receiving airline shares in return. Good thing at least one quasi-governmental investor still has faith in the airlines, since individual investors continue to treat their shares like toxic waste. Is Delta Airlines as good a risk as Chrysler was 25 years ago? How about GM? Before you leap to Kirk Kerkorian’s side, consider the logic of our Mr. Haave:
What Would You Pay?
“Working off of round numbers and my faulty memory…I propose we take Occam's Razor to GM to distill the probability of bankruptcy and or the value of GM shares:
"What would you pay for the following cash flows?
- $15 billion in cash, it is yours
- $3 billion in industrial and consumer finance earnings
- Then we have the obligation to invest a $90 billion pool of assets. This pool must earn 9 percent. If it earns more, the you keep the difference. If it earns less you have to make up the difference.
"The problem is that there are restrictions on how you can invest this pool. Presume probably one third must be fixed-income. Of the equity portion you are probably topped out at 25 percent international. While you can probably do some hedge funds, it is probably on a broad scale where your performance is not likely to be greater than your average fund of funds.
Market Says $13B.
"So, what would you pay for these cash flows? The market says $13 billion.
"The model is very, very simple. It is the kind of thing I think about in the car, as opposed to, in front of a spreadsheet. What I find interesting of course is that I think, given the restrictions, one would be hard pressed to justify a long term expectation of greater than 7% earnings on the asset pool. Meaning, if everything stays the same, the value of GM is wildly negative.
This leads to a few thoughts:
1. Contrary to the view of the unions being outfits that exploit their workers, the UAW has in fact extracted every bit of producer’s surplus for themselves, leaving zero for the shareholders.
2. At the current stock price, there is a significant bet being placed that the union will cave instead of allowing bankruptcy.
3. The presumed amount at which the union caves will be whatever combination of current wage concessions and benefit cut brings the present value of the cash flows to a slightly positive state.
4. Given the UAW's past ability to extract all of the surplus for the workers, and given managements total incompetence in allowing them to do so, and given the huge benefit cuts that will be necessary even to bring the present value of the cash flows to zero, what are the chances that shareholders will have more than 13 billion of value left over?
"I wouldn't guess very high."
