U.S Debt Ceiling... Too Close for Comfort?

The US debt ceiling is front and center across all financial new outlets and will likely be the driving factor behind macro market moves in the near future. Question is: does the market really understand what the debt ceiling really is? Or does the market assume it understands based on what is reported on CNBC? Here’s my shot at trying to clarify what the debt ceiling is, and how it might affect the macro picture over the next couple of months.

The US debt ceiling is tied to the US budget (which is set to officially expire on Sept 30, 2013 at midnight), and dictates how much the government can borrow to pay for public services. Back in 2011, the debt ceiling was set at $16.4 Trillion, which was technically reached on December 2012, but through some miraculous measures from the treasury department managed to continue operating. However, the U.S government has now reached a point where they no longer have the budget for non-essential activities (national parks, museums, etc.). Essential activities, air traffic control for example, would not be shut down.

At this point, the US government has two options:

1. Re-negotiate a budget and have all parties agree to it before the deadline (very unlikely at this point).
2. Agree to what is known as a “Continuing Resolution” (CR) which allows the government to continue to operate on last year’s budget. A CR that runs to December 31 is likely at the moment. Note that the political parties involved will drag out any sort of agreement to a CR until the last possible second like they always do, so an agreement is likely only by late Monday night.

Generally, a debt ceiling increase follows a CR or new budget agreement. Considering that the US’ economic growth is still fragile, running the economy at a deficit makes logical sense; as a result, the debt ceiling should be raised. Since sound, logical reasoning and political actions can deviate quite drastically at times, raising the debt ceiling could take some time. I wouldn’t be swayed by financial media outlets about the next few weeks; it is much easier to grab viewer attention by claiming the government is going to collapse rather than reporting that all will be well. Don’t take this as a statement that a government shutdown in the US won’t happen; I’m just saying it is unlikely to happen.

A US government shutdown is likely to lead to a widespread risk-off move in equities and a rally in bonds (which was counter intuitive considering the situation) if the market reacts the same way it did in 2011.

Final thought: Keep an eye on market movement leading into the Monday deadline as well. If the market is pricing in a more bearish scenario than is necessary, you may have a trade on your hands. 

p.s. I think it is interesting to note that in 2007, Senator Obama voted not to increase the debt ceiling for President Bush’s administration. He also fought to de-fund the Iraq war. Funny how the tables have turned: the Obama administration’s debt ceiling increase is being voted against and US politicians are trying to de-fund Obamacare (doubt that will work).

Until next time,

P.B

Toronto GISA-Blog Contributing Author

High Frequency Trading ... Friend or Foe?

Technological innovations have had such a tremendous impact on all of our lives over the last few decades, I often wonder; do people ever stop to appreciate how far we have come? Already, my smartphone has become a mandatory tool in maintaining my connectivity with the world, that the very thought of having my battery die short makes me want to cry. Yet just 5 years ago, many of my friends (myself included), were very content with a clamshell as long as it could text, and play a slew of fun polyphonic ringtones. And I will be the first to admit that I laughed when Steve Jobs introduced the iPad back in 2010, thinking the last thing the world needed was an oversized iPhone. I would have never guessed the devastation I would come to face 3 years later when some punk stole my iPad 2 right from under my nose at a Starbucks (seriously watch your stuff next time). However, despite the leaps and bounds technology has had on consumers, it has also had a tremendous impact on the financial industry as well. Rendering what was once reserved for a PHD graduate, a trusty HP 12c calculator, and a fun filled afternoon on a trading desk, into soulless  server that can shoot off trades quicker than the speed of sound. Welcome to the world of high-frequency trading.

 

So what exactly is it?

 

High-frequency trading, or HFT, consists of ultra-high speed security trades automated through an algorithm (algos to for the tech savvy) designed to follow a particular investing strategy. An HFT trader has the capacity to take on a wide range of positions within fractions of a second, bringing with it the capacity to turn a quick profit, eons ahead of any traditional market maker. Typically, these millisecond transactions work off of very small profit margins, but when they are run on a bulk basis, it makes the practice potentially lucrative.

 

The history behind high-frequency trading can be traced back to at least 1998, when the SEC first authorized electronic exchanges to compete in the market, enabling anyone with basic computer and internet access the chance to participate in marketplaces like the NYSE. Fast forward to about 2009 and add a few different iterations of HFT models, and you’ve got a 164% jump in daily volume on the NYSE thanks to the financial industries newfound love for HFT trades.  Today, the practice has lost much of its accelerated growth and popularity, but HFT’s still account for a quarter of trades in the Canadian equity market, and just around half of trades in the U.S market.            

What are some of the strategies?  

Well aside from the traditional arbitrage opportunities we always read about in text books (i.e. Foreign exchange rate, FRA, or even exchange mispricings just to name a few), some of the other popular strategies used in high-frequency trading include the following:

-        Index fund rebalancing

o   Many mutual funds and ETF’s replicate particular indices (aka index funds) which require frequent rebalancing and adjustments in order to stay aligned. High-frequency traders utilize algos that can anticipate a stock price increase caused by block orders from large institutions rebalancing or adjusting their index funds, and exploit their speed to purchase securities ahead of the market.

 

-        News-Based trading

o   A news-based trading strategy involves algos which scan news feeds for key words and general market sentiments to predict increases in prices for various securities, and once again utilize their speed to buy and sell to slower market participant

 

-        Low-Latency strategies  

o   These strategies involve using faster and more efficient technologies (I.e. microwave technology has a faster response time when traveling great distances vs. fiber optic cables) to beat out slower market participants (including other HFTs) in any one market strategy. 

So what’s the downside?

Stamen visualization of  one minute of bids and offers on March 8, 2011.

To be honest it really depends which side of the fence you stand on. Many advocates see high-frequency trading as a means of: increasing market liquidity (smaller bid-ask spreads and higher trading volume), decreasing price volatility, improving market resilience (shown to improve mini crash recovery), and increasing price efficiency (shorter pricing anomalies due to lightning quick arbitrageurs). On the other side many individuals criticize high frequency trading for: removing many traditional market makers from the industry, creating additional credit risk (difficult to monitor and control leveraged positions), and its potentially devastating market impacts due to system failures or infrastructure glitches. Glitches have been the main attributable force behind some of the more recent high profile problems with high frequency trading such as: Facebook’s IPO, the Flash Crash 2010, and Knight Capital’s $389M loss back in 2012. This has led to increased pressure on many regulatory boards to step up, and enforce stronger compliancy and standards for this segment of the industry.

Well, despite the heat from many recent events, it is sufficient to say that like or hate it, high frequency trading is here to stay (at least until the next evolution in trading happens, but who knows how long that could take). I guess the real questions we should start asking ourselves is, is it too late to learn how to code?    

 

Until next time, I remain your friendly neighborhood blogger,

Jon

Raider of the Lost Company, Carl Icahn

Over the past few months you may have heard Carl Icahn, Michael Dell, Dell, Silver Lake, or even heated battle, uttered from any one business news site in any random order. If you’re anything like me two things immediately jump to mind. First, those cheesy yet iconic “DUDE… you’re getting a Dell” commercials from back in the day, and second, “People still buy Dell’s?” Well before I get ahead of myself on this clash of the titans, or worse, risk offending the Dell constituency of the blogosphere (seriously, they do offer great computers at great prices), I think it’s important we start with the basics.

So who exactly is Carl Icahn?  

Carl Icahn, or Uncle Carl as one of my classmates loves to call him (we'll get into that soon), grew up in the very humble Far Rockaway neighborhood, in Queens New York. In 1957, Icahn earned his degree in philosophy from Princeton University, and soon after continued his studies at the New York University’s School of Medicine, where he dropped out before graduating. In 1961, Icahn went to Wall Street and landed his first gig working as an entry level stockbroker at Dreyfus & company. Seven years later, he bought a seat on the NYSE and started his own brokerage firm; Icahn & Co.   

The story really starts to pick up in the late 70’s, when Icahn began his quest as a shareholder activist and started taking large stakes in companies such as Tappan company, Marshall Fields, and Phillips Petroleum. However, the deal that really launched Icahn to super-stardom was his takeover of Trans World Airlines (TWA) in 1985. Shortly after his acquisition of TWA, Icahn helped drive up profits through improved efficiencies, and made the organization profitable in 1987 and 1988. Icahn then brought the company private through a share repurchase program which also helped gain back his initial $440 million investment and then some change ($29 million to be exact). However, shortly after taking the company private competition began to intensify among the airline industry and complicated costing structures hindered TWA’s profitability. In 1992, TWA filed for Chapter 11 and Icahn left the following year with $190 million worth of travel vouchers under the condition that they were not to be sold through travel agents. Without missing a beat, Icahn started lowestfare.com where he unloaded his small country worth of tickets, and then went on his way to take large positions within companies such as: RJR Nabisco, Time Warner, Motorola , Netflix, and Herbalife just to name a few.

So what makes the Carl Icahn approach so special?

To be honest, the strategy is fairly straight forward:

• Step #1- Find a valuable corporation through the Graham and Dodd method for valuation (Depressed prices shown though : poor P/E ratio, high dividend yield, stock price below book  and/or net current asset value). 
• Step #2- Buy a up a large stake in the organization (Usually around 10%). 
• Step #3- Try to either: elect a new board of directors, achieve a divestiture of assets, or straight up break up segments of the organization and liquidate.
• Step #4- Stand your ground and maintain a bad-ass, no compromise, no negotiation demeanor with existing board members, shareholders, or anyone else who gets in your way.
• Step #5- Let the stock price appreciate or receive a very generous greenmail offer and cash out. 

But the easiest strategy of all would be to follow Uncle Carl on twitter (@Carl_C_Icahn) and hope you can snag a ride on the “Icahn Lift” before anyone else.     

So what exactly happened with Dell and Silver Lake?

Well, the long and short of it is, Dell as an organization has been faced with some rather staggering drops in sales over the past few years (a 72% drop in quarterly revenue was reported in August 2013). Michael Dell, company founder and CEO, decided Dell was due for some restructuring and partnered with private equity firm Silver Lake Partners to buy back the company. Their plan was simple, take Dell private, re-shape the business model back to its core values, and hopefully save the company. Seems like a no brainer right? Well, that is until Uncle Carl, the company’s second largest shareholder, saw the $13.65 share price offer and told Dell and Silver Lake to go fly a kite. Icahn saw much greater value for Dell and countered with an offer for $14 per share and a warrant for the right to purchase future shares for under $20 within certain conditions. Well from there the saga continued, and after a long summer which included many heated debates, tweets, and a few offers, Icahn had enough and folded under Dell’s final offer for $13.88 per share and a dividend payout.  

So what’s next for Icahn? 

According to Icahn’s twitter account he’s spending quite a bit of time and money investing in Apple, and has even suggested a larger scale share re-purchase program with Apple CEO Tim Cook. One thing is for sure, given the lackluster response from the street following Apple’s launch of the 5s and 5c, Icahn’s presence make’s this story all the more interesting.   

I hope you enjoyed this short but sweet posting on the legend that is Carl Icahn. If you have any questions, comments, or even suggestions for my next blog posting don`t hesitate to leave a comment or contact me directly (institutegoodman@gmail.com).

Until next time I remain your friendly neighborhood blogger,

Jon


Sources

Kroll, L, and A. Dolan, K. Forbes 400 Richest American. Forbes. Retrieved Sept 14, 2013, from  http://www.forbes.com/profile/carl-icahn/

Loth, R . The Greatest Investors: Carl Icahn. Investopedia. Retrieved Sept 14, 2013, from http://www.investopedia.com/university/greatest/carlicahn.asp

Salpukas, A. Icahn on T.W.A. Woe: 'We're at Crossroads'. The New York Times. Retrieved Sept 14, 2013, from http://www.nytimes.com/1990/02/10/business/icahn-on-twa-woe-we-re-at-crossroads.html?pagewanted=all&src=pm

Icahn Enterprise L.P. . Retrieved Sept 14, 2013, from http://www.ielp.com/

Ponzio, J. The Graham and Dodd Method for Valuing Stocks. Seeking Alpha. Retrieved Sept 14, 2013, from http://seekingalpha.com/article/44626-the-graham-and-dodd-method-for-valuing-stocks

Vardi, N. Michael Dell: We Are Going Back To Our Roots Taking Dell Private. Forbes . Retrieved Sept 14, 2013, from http://www.forbes.com/sites/nathanvardi/2013/09/12/michael-dell-we-are-going-back-to-our-roots-taking-dell-private/

 

 

 

 

 

Hello and welcome...!

Hi!

My name is Jon, and I will be your communications officer for this upcoming semester at the Goodman Institute of Investment Management (GIIM). As part of the Goodman Institute Student Association (GISA), I am profoundly dedicated to helping the student body advance both as students and professionals within the financial industry. That is why we decided this year, to create the official GISA blog and twitter account. Our objective with creating and implementing these new tools is to help keep GIIM students up to speed on the financial industry in a fun and efficient manner.

GISA Twitter Account (@GISA_blog)

Twitter has quickly become one of the financial industries preferred means of staying informed on hot topics and trends taking place. The GISA twitter account will cover one post every weekday, on what is making headlines on the street. In essence, if you needed to know one story before calling it a day, the GISA twitter account has you covered.   

GISA-blog (www.gisa-blog.blogspot.com)

The GISA-blog on the other hand will consist of a weekly posting on a more detailed topic relevant to the industry. Topics may include but are not limited to: economics, political impact on markets, important people, and financial trends. In your life long pursuit of success, we hope that the blog will help push your knowledge and understanding of finance that much further.   

We need you!

In order for this initiative to truly be a success, we need your help, not only in reading and following but also in collaborating. If you have an idea, opinion, or even suggestion (yes that includes any platen grammar or punctuation mistakes I will inevitably make) I would love to hear from you. You can reach me by email (institutegoodman@gmail.com) or even in the hallways at school.  
 
I look forward to a wonderful new school year, and most of all getting the opportunity to meet and work with you all.

Until then I remain your friendly neighborhood blogger,

Jon   

Left: Jon GISA VP, Right: Ahmed GISA President