Markets live chat transcript for the chat ending at 11:56 on 20 Aug 2007. Participants in this chat were: Paul Murphy (PM) Neil Hume (NH)
PM: Welcome to Markets Live, FT Alphaville daily markets chat.
PM: Neil Hume is with me.
PM: We are both back from holiday
PM: Just sorting the usual tech gremlins
PM: Neil should be online soon
PM: 
PM: fingers crossed
PM: toes crossed
PM: Someone — principally Helen — has been going on about how busy it has been in our absence
PM: Not quite sure what she was talking about
PM: Market looks quite calm to me
PM: Footsie was up 1 per cent earlier. Asia was strong overnight. What’s the problem?
PM: Footsie might have come back a bit. — but hte Top 100 still up 42.4 at 6106.6
NH: morning. up and running. only took me 10 mins to get into the system. some things never change.
NH: and I also dont have a reuters screen
NH: Er, you have been keeping a vague eye on events from the comfort of your beach towel, no?
PM: No probs with market at all
PM: Has something important been going on?
NH: Well, few bit and pieces….
NH: Credit crunch
NH: emergency Fed action
NH: Wall St scalps claimed
NH: Europeans have poured scores of billions into the money markets to try and keep things open
NH: flight to quality
NH: yen carry trade unravelling
NH: de-leveraging all round
NH: apart from that it has been a typical quiet August
PM: Oh, right. I ve clearly got some catching up to do.
NH: I think you have
NH: Anyway, things have calmed down significantly this morning. Sea of blue on the equity front – reflects relative calm across just about all other financial markets
NH: Relative calm, that is
PM: Actually, im just kidding about the fact that I didn’t know armageddon had kicked off just as I was packing my Factor 30.
NH: And what are you people saying about it all now that you are back?
PM: Learnt about it on Friday.
PM: Well – that it’s not over.
PM: What are your people saying?
NH: They’re saying it’s not over either. V v v cautious –waiting for a flood of sellers dumping stock into a suckers’ rally.
NH: Quite difficult to read all this when been off for three weeks
PM: Actually, you know I think we have a bit of an advantage here.
NH: Like what?
PM: Well we can just flick through the rubbish and read the decent stuff.
NH: Such as?
PM: Well, ive happened upon a fascinating piece from the investment strategy and macro research desk at Lehman Brothers in New York.
NH: Do share
PM: Well, its dated August 9 – just when things were starting to turn really nasty – focusing on Quant Funds – equity market neutral hedge funds that we getting their shirts shredded at the time.
PM: Here’s a quick paste from the intro:
PM: Over the past few days, most quantitative fund managers have experienced significant abnormal performance in their returns. It is not just that most factors are not working but rather they are working in a perverse manner, in our view. The names that are short are outperforming, often notably, while the names that are long are underperforming, although less severely.
NH: Oh, that’s so helpful.
NH: “The names that are short are outperforming, often notably, while the names that are long are underperforming, although less severely.”
NH: What does that mean – stocks that were supposed to go down according to the quant models went down, but by farther than expected.
NH: And those that were supposed to go up went up – but not by as much as expected
PM: Well yes, I guess so. But there’s more from Lehman…
PM: Moreover, there appears to be very little news coming out surrounding these names and all of this is occurring against the backdrop of the general markets appearing to calm down. This has led to our fielding a large number of calls from our quantitative asset management clients, trying to understand what is occurring in our market.
NH: Excellent – so they are just plain confused!
PM: Ah, but that was back on Aug 9.
PM: I’ve now got the latest Lehman view from Ian Scott – and he’s anything but confused.
NH: Oh, yeah?
PM: Think should just start with some pasting…
PM: Stocks are experiencing a correction, but are
priced for “calamity”
NH: Calamity?
PM: Wait – let me paste some more.
PM: No, we did not see this coming, and as always when markets move sharply, there are
explanations
NH: Well I think quite a few other people saw it coming – in fact people have been going on and on and on about it for months
PM: Look, let me just paste this stuff
PM: Let us get some perspective. Global equities, based on the FTSE
World Index, are down by 11% in dollar terms from their all-time high reached on 13
July, having risen by 117% over the past five years. They still post a 1.3% total return (in
dollars) for the year; this is a correction not .a calamity., to use St Louis Fed President
Poole.s terminology.
PM: Valuations on the other hand suggest a major crisis or recession is
now in the price. Undoubtedly a big reason for the disconnect between fundamentals and
valuations is the rapid removal of leverage from the system. With so much money being
borrowed short to invest in long duration assets, short-term mark-to-market and VAR
pressures have dominated fundamentals. As investors with longer horizons step in, we
believe this disconnect will unwind.
NH: So they are saying “BUY”
PM: They are….
PM: The lasting impact of this sell-off will be lower leverage applied to financial markets,
less speculation, less of a mismatch between the duration of assets and liabilities, less
reliance on historical realised risk and return as a gauge for future returns, in our opinion.
Hedge funds will focus less on leverage, more on capital protection; long-only investors
will be tempted back into risky assets to assess higher volatility, higher risk, but higher
returns over the long run.
PM: At least at the time of writing, this sell-off should not cause a recession. As Jack Malvey
pointed out in last week.s Global Relative Value publication, wealth destruction has not
occurred on a large scale.
NH: So panic over, says Lehman.
PM: Basically.
NH: You know Lehman’s view corresponds with that of Christine Lagarde.
PM: What, the French economy minister?
NH: The very one.
NH: She’s also saying the panic is over
NH: I think the worst of the crisis is behind us. I don’t exclude that, particularly in America, a number of funds could find themselves in difficulty but this is a classic phenomenon of American finance which is often gulty of excess.
NH: That’s from a French radio interview.
PM: As Toto points out below — BFM radio
NH: and don’t you just love the dig at the Americans there.
PM: Yes, but if the french economic minister is saying “buy”…
PM: … im saying pass me my tin hat
PM: These stocks are going WAY down
NH: yes, i think i would take the contrarian view
NH: seems to the comments from Lehman have riled FX Trader
PM: Im with FX trader on this — if they yen carry trade was really unwinding you would see the Yen at 80/90 to the dollar — not 115 as it currently is
PM: De-risking has only just begun
NH: and the FTSE 100 would not be above 6,000
PM: you have got to remember that when people are selling in conditions like this they are only able to sell the stocks they should really be holding on to
PM: Old fact of bear markets — for those who have never seen one
NH: i not that old but i remember when the FTSE 100 was down at 3,500 points in march 2003. now that looked like a bear market
PM: It — was stocks in a death spiral with insurers forced sellers on that ocassion — only halted by FSA relaxing the solvency rules
PM: All we have had to date from the authorities is liquidity pumped into the short term money markets
NH: ok. enough of the doom and gloom.
NH: let’s move on to some stock specific stuff
NH: not that there is much around this morning
NH: a few broker upgrades in the likes of British Energy and Tullow Oil
NH: results from Michael Page
NH: but none of that is too interesting
NH: the only real action has been in the LSE
PM: Ok - we can do stock specific stuff — but I want to come back to the Big Picture stuff — speclifically this German issue taht some of the readers mention below.
PM: But yes — on to the LSE…
PM: 
NH: News this morning is that Nasdaq has appointed advisers to “explore alternatives” to divest its 31% stake in the LSE
PM: that means they are looking to sell it
NH: yep
NH: UBS and JP Morgan have been appointed to handle the divestment
PM: good luck to them. If they can get a third of the LSE away in the current market environment then they deserve their bonuses
NH: don’t be too hasty, there could be a lot of buyers out there for the LSE stake
NH: I can think of a number of candidates in the middle east and Asia
NH: sovereign funds etc
PM: Why are Nasdaq looking to sell? To increase their offer for OMX perhaps?
NH: Back story for anyone of you who have been on hols like us, is that Nasdaq offer for OMX was trumped by a bid from Brose Dubai
PM: Dubai offer pitched at Skr230
PM: OMX is the high tech Swedish upstart taht has been busy selling its trading system to various bourses around the world
NH: the statement says that Nasdaq will use the proceeds of any sale to retire senior debt and repurchase shares
NH: Nasdaq reckons its current market cap does not reflect the value of its holding in the LSE
PM: So what’s 31% of the LSE worth
NH: LSE shares are 26p at £12.96 at the moment
NH: which makes the holding worth £770m
PM: and Nasdaq is valued at?
NH: $3.6bn, or £1.8bn
NH: I reckon the reaction of the LSE share price is the most interesting thing about this statement
NH: obviously, if a third of a company is due to be placed in the market then its shares should fall
PM: But the LSE are up
NH: and that reflects the fact that somebody like a Borse Dubai or a Temasek could buy the nasdaq stake
NH: I know Borse Dubai have got the OMX bid on their hands at the moment but they have deep pockets
PM: You’re right — deep pockets and long arms
PM: though I would point out that if someone buys 31% of the LSE they will be obliged to launch an offer for the rest of the company
NH: Yeah the but the sale could be constructed so that someone buys just under 30%
NH: thinking about could the NYSE be interested
PM: Think Nasdaq would choke at selling to them
NH: going back to Borse Dubai, another point worth making is that its boss Per Larsson made a bid for the LSE back in 2000
PM: Of course he was CEO of OMX at the time
NH: which is interesting
PM: OK. So how does this affect the OMX situation?
NH: well, OMX shares are currently trading at Skr237
PM: Which implies that Nasdaq might raise its bid
NH: yep. If they retire senior debt, then in theory they should have more firepower to increase its offer for OMX
NH: however, that could be a dangerous game. One imagines that Borse Dubai could top any offer Nasdaq care to put on the table
NH: actually there is another theory doing the rounds?
PM: Which is?
NH: that Nasdaq will sweeten its offer for OMX
NH: and in return for Borse Dubai will abandon its bid for OMX and take the LSE stake from Nsadaq
PM: Now that would be interesting
PM: But why would Nasdaq want the OMX instead of the LSE
NH: Perhaps they have realised that they could never afford the LSE. Perhaps they are worried about Mifid as FX Trader points out below.
PM: Good point
PM: one imagines the Borse Dubai could put an offer on the table that Clara Furse at the LSE would at least have to consider.
PM: But that’s enough on exchanges, shall we turn to banks?
NH:
NH: Banks
NH: Northern Rock has rallied this morning
NH: up 18p at 727p
PM: Was as high as 748p earlier
PM: Why the bounce?
NH: partly because of a ludicrous bid rumour
PM: Oh, go on
NH: according to a couple of brokers Lloyds TSB wants to buy NRK
PM: please!
NH: look don’t shoot the messenger
NH: I also think the story is rubbish
NH: aside from the fact that NRK’s business model has been exposed by the current credit crunch, it has a poison pill
PM: it does and it is one we have written about before
PM: the Northern Rock charitable foundation
NH: yep and they own a special class of shares which entitles it to 5 per cent of group profits
NH: in the event of a takeover this converts to an 18% of the ordinary shares
PM: so whatever anyone pays for NRK they have to buy an extra fifth of the company
NH: yep and even after NRK’s recent dismal performance I reckon that is likely to put bidders, including Lloyds, off
PM: Ok, so if this story is rubbish, what’s driving the share price
NH: well, the Fed’s move on Friday indirectly helps NRK
NH: short sellers buying back positions this morning
NH: and Caz are pushing the stock this morning
PM: What are they saying??
NH: they don’t believe the capital markets will stay closed for NRK for a significant period of time, if at all
NH: Caz also reckons NRK has sufficient flexibility to meet its funding needs
NH: shall I paste some of the note??
PM: yes do
NH: In our view there are two main issues confronting Northern Rock in the short term: an increased cost of funding due to a spike in 3-month LIBOR, and the possibility of wider spreads being demanded by investors given current market conditions.
NH: If the recent increase in 3-month LIBOR were sustained over the next 18 months then we estimate it would reduce Northern Rock’s 2008E EPS by 13%. Swap rates have fallen, however, consistent with moderating interest rate expectations, so the rise in LIBOR seems due to a liquidity squeeze. It is plausible that a more normal LIBOR level could be re-established over the next few months in which case the impact would be limited.
NH: We do not believe the capital markets will be closed to Northern Rock for any significant period of time, if at all.
NH: The group has an A+ credit rating (albeit with negative outlook from S&P) and a well-established Granite securitisation programme that issues UK prime RMBS.
NH: We estimate Northern Rock has a gross funding requirement of £8.0bn for the remainder of 2007 followed by £26.5bn next year. In the short term we believe the group has sufficient flexibility to meet its funding needs.
PM: That looks a bit optimistic to me
PM: ONly have gross funding requirement of 8bn for this year — and then a cool £26bn for next year….
PM: Things need to get pretty “normal” again to guarantee that sort of cash
PM:
PM: Northern Crock brings us to the German banks — some of whom have been pursuing the same sort of approach
PM: Going too far with new fangled financing techniques that they may or may not fully understand
NH: go on
PM: Well, my understanding is that several of these second and third tier German banks have very rigid systems for agreeing which trades they can take on….
PM: … and once a particular type of trade clears their internal committee system…
PM: They have a tendency to dive in headfirst — whatever the financial weather outside
PM: Hence we have problems developing like the Sachsen LB issue — which just came out of thin air
PM: In sort — i suspect that are lots more nasties to come out of Germany over the coming weeks
NH: i think you’re are right
NH: the credit lines that have been extended to these conduits are all very murky
PM: Anyway, there is a good conversation underway on this below amongst the commenters…
PM:
NH: a few conspiracy theories floating around about Firday’s intervenntion by the Fed
PM: Such as?
NH: that it was timed to coincided with an options expiry
NH: index options expired in the US on Friday and the Fed knew Because index options expire this morning at the open. The Fed knew this would cause the maximum pain to the shorts. Not only did this force a massive short covering and rally, it was also a warning to short sellers
NH: its also another reason for thinking Friday’s gain was not as real as it seemed
PM: Nice theory
PM:
PM: Very briefly — going back to this German bank issue — which seems to be a pop topic this morning
PM: Very good point below that the German state banks have been using — or abusing — their AAA ratings
PM: Dangerous combination — cheap money and stupidity
NH: on that note, we will sign off for today. should be fully up to speed tomorrow
PM: Yes — we need to do lots more reading in
PM: Dont take your tin hats off!
NH: no, keep them firmly on
PM: Thanks for all the comments this morning. Keep em going on the transcript and we will try and add some more thoughts later.
PM: We will be back tomorrow at 11 — with Neil fully logged in and working. And our extra Reuter screen will no doubt be installed by then.
NH: bye
