Rekenthaler Report: 3 November
The Italian way, Porsche takes hedge funds for a ride, and more.
What follows are the musings of Morningstar's Vice President of Research and sometime Morningstar columnist John Rekenthaler.
Mild in Milano
I spent the past week in Milan, attending an advisor conference and meeting with Morningstar clients.
It's a bit different out here. The Milan stock exchange has plunged like a stone, make no mistake about that. But like the 2002 bear market--and unlike in 2008--the drop in stock prices has yet to affect much of Italy's Main Street. The housing market is vulnerable but has yet to crack; thus, at this stage, Italy is not facing the cascade of failed mortgages, empty subdivisions, reduced consumer spending, and job cutbacks as in the U.S.
The public is also not as disappointed by the stock market's collapse, as they didn't believe entirely in stocks to begin with. Being Italians, they were wary of optimistic, New World notions of an unfettered free-market economy. The Italians always expected that stocks too would have their turn to suffer. (This makes them excellent consumers of asset-allocation advice, by the way.) So they are responding with a shrug, and continuing to move forward. Unlike with U.S. investment conferences, attendance at the Milan conference was brisk.
Even hedge funds have put on a brave face. The Italian Treasury Ministry recently made news by calling hedge funds "absolutely crazy" and a "hellish $2 billion industry," which you'd think would cause a few concerns. But this being Italy, the investment community has grown accustomed to being on the receiving end of political broadsides. Taking a few hits from the politicians along with customer fees goes with the territory. I'm guessing U.S. investment firms will soon understand, oh so well.
Frantic in Frankfurt
Five hundred kilometres to the north in Frankfurt, Porsche has caused quite a stir. As you may have heard, Porsche toyed with both hedge funds, and with the German stock exchange, by manipulating the price of rival Volkswagen. On Sunday, Porsche announced that it had purchased options on 31.5% of VW's outstanding shares, in addition to the 42.6% of the firm that Porsche already controlled. VW shares, rising for several weeks due to Porsche's interest, jumped from just under $400 on Monday morning to a peak of $1,284 per share on Tuesday--a greater-than-300% gain that temporarily gave Volkswagen the world's largest stock-market capitalization.
A squeeze on hedge funds that had shorted VW appeared to have been one of the drivers behind this enormous gain. With VW stock seemingly on an inexorable upward rise as Porsche completed its transactions, short sellers faced big losses becoming even bigger, unless they closed out their positions. However, when attempting to buy long positions in VW, the hedge funds found relatively few sellers, as the float of VW stock was greatly reduced due both to Porsche's position, and to a roughly 20% stake by a German state government.
On Wednesday, Porsche announced that to ease the short squeeze, it would be gracious enough to sell 5% of VW's outstanding shares--of course, at a far higher price than it purchased them. As to the options that Porsche had purchased? Their fate remains unknown, but it's also a pretty good bet that Porsche managed to exercise more than a few of those, at a very large profit per option.
While many who despise hedge funds are happy to see them beaten so badly at their own game of market manipulation, it's a disaster for the financial markets. It's yet one more example where the tail wagged the dog, as the driver of the price of VW stock this past week was not VW's business prospects, but rather the machinations of a wealthy and privileged investor. Fundamentals be damned. Main Street, be damned.
Lament in London?
The London property market has also been softening, not yet for as long or as seriously as in the harder-hit parts of the U.S., but the process has begun. And based on my admittedly anecdotal observations, it's hard to imagine the decline stopping anytime soon. My last couple of visits to London, I have felt as 1980s visitors described Tokyo--in a never-never world where broom closets sold for $250,000 and where flats in fairly ordinary neighbourhoods charged in rent per week what it cost per month for a similar apartment in an attractive part of Chicago. Yes, everything in London was expensive due to the huge boom in wealth created by the exploding financial-services sector, and the influx of oil money from the Middle East and Eastern Europe, but property was at another level yet.
I felt at the time, this must end in tears. I suspect that the tears are now beginning, and worry they won't stop for quite a while.
