Facebook. Need we say more?

The recent initial public offering of Facebook shares has generated an incredible amount of discussion, much of it around the perceived injustice of having an IPO price at $38 per share and subsequently plummet in value. To be sure, there were irregularities that exacerbated the situation (a delayed opening, lack of timely trade confirmations, curious timing of analyst earnings reviews, etc.), but our take on things is considerably more sanguine.

It may be instructive to consider the purpose of an IPO in the first place: to raise funding for a company and/or its selling shareholders.  That means the investment banks are compensated on how much cash was rasied as a result of the IPO.  Indeed, that is true whether you are selling a house, excess items on Craigslist, or other shares you own in any other company – you strive to raise the highest amount possible by selling at the highest price possible.  Measured on that criterion, the Facebook IPO was a smashing success, raising over $16 billion for Facebook and its shareholders. The fact that the price of Facebook shares have dropped from the initial value of $38 only goes to prove just how great the underwriters did at raising the most dollars for their client.

Notice how the underwriters are not as concerned with two other items: 1) the investor who buys shares after the IPO, and 2) the price of the shares after the IPO.  True, an underwriter whose IPOs consistently drop in value right from the get-go will have a hard time selling shares to the institutional investment community in the future, but that concern is secondary to its primary task.  If retail investors in Facebook are disappointed in the price of shares after they bought them, it is probably worth revisiting the basic economic tenets of a buy/sell transaction in the stock market: a buyer makes a purchase convinced that the shares will go up in price, and said person buys them from another selling the shares because they have a similar conviction that the share price will drop.  Someone will be wrong.

Looking at Facebook IPO, those sellers were insiders: folks with years of experience and information about Facebook.  Who were the buyers after the IPO? Let’s just call them” people without that information.”  Yes, there was a 171-page offering document available for investors to gain more information about Facebook.  Did any of the secondary buyers read that? Doubtful. In other words, we had informed, institutional insiders selling shares to uniformed retail clients.  Could it really have gone any other way?

We don’t buy shares in IPOs of any ilk (let alone ones so eagerly-anticipated) precisely because the economics of the basic transaction tend to be clouded with the emotion and hubris of the Big Event.  Do we miss out on the one-day “pop” of those IPOs that go “well” in the eyes of the press? You bet we do.  But we will also miss the heartburn of the next “Facebook”  – and, trust us, “Facebook” will be the moniker of disappointing IPOs for a generation to come.

Bad News?

JP Morgan’s sudden confession of a $2 billion loss on a “synthetic credit portfolio” last night was the talk of the morning for many reasons, not the least of which was the ammunition such a mistake gives the regulatory push in Congress.  We are not a big holder of the stocks of international money-center banks for precisely this type of risk: if the CEO has no idea about his/her company, how can we?

However, we are often perfectly happy to own the bonds issued by these same banks. Why? Perhaps the chart below can show this better than we can describe things in writing. The graph shows a bond we own for many of our clients (JPM 5.125% 9/15/14, in white) and JPM common stock (orange line).  At the end of the day, as galling as JP Morgan’s confession was, it was the stock that took it on the chin, while the ability of JPMorgan to pay its debts as they come due was deemed unaffected by the markets.

Remember, bad news for a stock may not be bad news for the bonds – and that’s why bonds probably have a place in your portfolio.

Payment at the Pump

In a recent article released by The Economist titled “Feeling Perky: The economic impact of high oil prices,” the cause and potential effects of high oil prices are generally explored.  Many of us are currently experiencing the impact of high oil prices on our wallets and the dread of seeing the illumination of the fuel light.  Some of us drive relatively fuel efficient automobiles such as hybrids and are therefore less impacted by recent increases in gasoline prices.  On the other hand some of us require the use of a SUV, truck, or maybe we just enjoy cruising down the highway in our 1984 Mercury Grand Marquis.  Whatever the reason we are stuck paying the $70+ tab each time we stop in to fill up the tank, and by now some of us are becoming disgruntled.  This begs the question, why have fuel prices risen so drastically and what can we expect from here?

As the article mentions, recent news media chatter has blamed a large portion of the rise in oil prices on oil “speculators.”  In response Obama has rolled out new legislation in an effort to stop these speculators by increasing penalties for market manipulation.  Another explanation for the rise in oil prices is increasing global demand on a fixed global supply.

According to the article, the most likely explanation for rising oil prices is simply that demand is outpacing supply.  Increased demand can be seen in the transition of oil exporting countries into oil importing countries.  These new oil importers are now adding to the load of the diminishing number of oil exporting countries.  In essence there are now more people at the Thanksgiving table, but we still have the same 3 pound turkey.  The effects of rising oil prices are most likely modest at a global level, however we (U.S.) are not concerned with global GDP (Gross Domestic Product) we are concerned with U.S. GDP.  As the article mentions, U.S. GDP will be affected more than global GDP because the U.S. is paying the higher prices by importing oil.

As the article explains there is no easy way out of higher oil prices for two reasons.  First, other sources of energy production are more expensive relative to how much energy is produced.  Second, the cost of transitioning to a new fuel source is high.  So what does it all mean?  The article states that for the economic boom to continue developed and developing nations will need an energy source that is abundant, cheap, and efficient.


Source article: http://www.economist.com/node/21553034