Topics to keep you busy over the weekend...
“Once investors see some kind of merger mania, they perceive that as positive for the market,” says Matthew Smith, portfolio manager at Smith Affiliated Capital. “It’s a coming together in terms of tightening the float of the companies in the sector — so people perceive that as a positive for shareholders as it increases premium values for stocks in that sector.”
The sectors Mr. Smith is talking about include media, where Clear Channel Communications announced a $19 billion buyout deal, and the airlines, which got a jolt yesterday on news of US Air’s proposed deal for Delta Airlines. Overall M&A activity has been strong this year — particularly leveraged buyouts — which has been a boon to equity values.
[A properly skeptical or contrarian investor might look at the pie-in-the-sky mania and think that we are back in bubble mode. Time to get defensive perhaps? ]
Meanwhile, the Consumer Price Index was up just 0.1% in October, and oil prices fell more than $2 a barrel to close at $56.26, the lowest closing price on crude since Nov. 18, 2005. It’s the biggest one-day dollar decline in crude since May 15 and the biggest percentage decline since Aug. 17, 2005. With crude oil off 7.8% year-to-date, and with other commodities prices declining, “all of these are perceived as positives,” Mr. Smith says. Gasoline futures are down 11% on the year, and natural gas is down 31%.[IPS, a finance wonk buy, has been dropping on the declining oil prices. People are missing that profits are going up and the oil companies are still investing in their infrastructure with all the windfall money of the past couple years.]
Iceland’s currency dropped nearly 4% this week through Wednesday, according to Dow Jones Newswires, after Fitch Ratings reaffirmed a negative outlook on the currency. Earlier this year, a crash in the krona foreshadowed a smackdown of emerging markets worldwide, a shockwave that eventually rippled to U.S. stocks. Risky assets such as junk bonds also took a hit, and some investors started to worry about a financial meltdown. The VIX, a volatility index measuring investor angst, doubled, and risky small-cap stocks got hammered.
Markets recovered, of course, and stocks in the U.S. have been in rally mode for months. But there are signs, starting with the krona, of trouble on the fringes. Emerging markets currencies have correlated closely this year, say analysts at Danske Bank, so the recent selloff raises concern. “Judging from the correlation in 2006, this could indicate that one should begin to be more careful about long positions in EM currencies. If the weakness in the [krona] continues in the coming days and weeks, we would clearly see this that as a (partial) indicator of renewed weakness in EM currencies,” they wrote.
[So why is the currency dropping? Because people are unwinding the carry trade (see this article from April). Hedge funds used to be able to borrow in Japan for 1% and lend in Iceland (by buying bonds) at 5-8%. Now they have to get out by selling bonds and Krona. It's a normal adjustment but it may still presage further unwinding that could spread to other markets.]