Joined Jun 2, 2014
30 Blog Posts

The Facebook Rotation

Stocks themselves should not be viewed in vacuum, especially if you’re looking for a medium term hold or beyond.  What does that mean exactly?

Essentially, unless you put on a trade based on limited amount of time (Exodus plug), chart pattern, or known catalyst (earnings, product launch, governmental decision, etc.), any extended time of price appreciation should be viewed in the entire competitive landscape; not an as an individual stock.

It’s not called a “market” for some coincidental reason.

This brings me to the opportunity presented to Facebook today after they report earnings.  Traders will definitely be positioning for a big move in one direction, but there’s a larger implication in my opinion.

Let’s face it, technology earnings have been acting like Biff Loman in a job interview: the expectation bar was set very low, yet the outcome was even a larger disappointment.

Google (I refused to call them Alphabet) and Microsoft left a brown spot in the bed last week.  Apple is now down over 6% after their announcement last night.  Don’t even get me started on the court jesters over at Twitter.

Considering the sell offs happening in big tech names, there should be a high demand for Facebook’s shares if they can beat their earnings and provide robust guidance as money managers, hedge funds, and eventually the retail side to fill up their proverbial technology allocation slot.

With a robust and promising quarter, my contention is this will lead to investors to further accumulate shares of Facebook as time goes on (think at least 3-6 months).  This can just as easily be played as a trade (bear or bull), but I think the longer term risk-reward is truly enticing.

Bad report and it get drags down with the rest of tech and remains at the same level of interest to its peers.  Good report translates to Zuck and crew getting that Super Mario mushroom style boost, and new tech investors rotating into it for the long haul due to a relative attractiveness over its competitors.

Make no mistake, although Facebook may not appear as a traditional MBA defined competitor to Microsoft, in the world of fintech markets that automatically adjust one’s “tech” holdings, as well as fund managers with the same directive, these two are clear competitors in the stock market.

The OG of social media is the sixth largest publicly traded company. Who’s above them?  Yep, AAPL, GOOGL, MSFT in that order.  No doubt FB has the clout, interest, and coverage to shift major money around.  Their growth story hasn’t written an ending either.

The conditions are present for a prolonged move to the upside, and in my opinion, this is the seminal moment, even with the ultra-impressive run they’ve been on.  I’m fully aware of the risks present, with so much growth baked into the price, as well as the hecklers that’ll come out of the wood work in the comments section.

Quick disclaimer, I’ve been long Facebook for over two years and will continue to be due to its diverse ecosystem of revenue driving apps and their seemingly noble and moral attempt to “connect to world,” simply a ploy to get as many users as possible.  They come off as caring, but it’s all for profit. Genius.

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When Pedigree Goes Wrong

Here’s a great lesson for every investor: it does not matter where your fund manager, advisor, or broker went to school or what his/her last name is; doing your own diligent research, asking questions, and being insistent on details and transparency are necessary and obligatory.

Most of you know this anecdote alludes to a Mr. Andrew W.W. Caspersen, who allegedly concocted a fraudulent investment scheme. Long story short, Caspersen solicited capital from multiple institutional investors (hedge funds, pensions, charities) under the guise of his actual job, which was to advise clients who invest in private equity funds.

Instead, he conceived a sham investment fund, developed phony promissory notes, and established fake emails and websites. This was all done for the purpose to steal, at a minimum, $95M. He was successful in wrongfully security $24.4M from a charity associated with a hedge fund (not sure how that works) and $400K from a said hedge fund’s employee.

Sans his two initials in the middle name, you’d reasonably assume he was desperate to make it in the ultra-competitive world of private equity and most likely does not have the background and advantages that supposedly will set you up life.

Well, you’d be wrong. This dude went to Princeton undergrad and Harvard law.  Even more inexplicable, his father, Finn M.W. Caspersen Sr., was in charge of one of the nation’s largest consumer finance shops before it was bought out in 1998.  No doubt Caspersen, both son and patriarch, fancied checkered pants.

Many publications and articles have written about Caspersen’s pedigree and privilege, as if these were perquisites to succeed in his career field.  No one can argue that his background and lineage would get anyone through the door and at a desk, but as we’ve seen time and time again, it ends at the chair.

What intrigues me so much, as someone who loves the financial world and has a legal background, is his motive.  The brief says the illegally obtained funds were used to trade options, yet his Tiger and Crimson schooling were no match for the highly complex and intricate options market—Caspersen lost most of it.

This doesn’t satisfy me in answering his intent.  My personal opinion is that he obtained illegal insider information, of which he’s much more likely to have access to as opposed to most, which he believed to be reliable. However, the situation did not play out as he expected.

Human behavior can be best understood through incentives.  Yes, this is a blanket statement, but it gives us a framework to better understand why people commit moronic, criminal, or even fatal actions.  This is the reason why, with everything equal, I’d take the manager/investor who came from a less illustrious background because he or she has a large incentive to succeed.

Or, our actions could be driven by genetics… turns out Caspersen Sr., right before he took his own life, was being investigated for sheltering tens of millions of tax dollars.

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A Not So Valeant Effort by ValueAct

The amount of monetary and mental pain being absorbed by Bill Ackman and his Pershing Square investors due to Valeant’s current free fall has been well documented.

But what about other hedge funds who have stayed overnight in this hotel? Articles have been disseminated that have scrutinized Sequoia’s oversized position.  As a side note, Sequoia’s fund managers were supposedly Buffett disciples.  Nothing about Valeant screams a typical Uncle Warren investment.

This brings me to another large hedge fun, ironically named ValueAct, which as of its most recent 13F filing manages around $14.5B and has a 10.5% position in Valeant. This, by any and all measures, is a very important, successful, and massive hedge fund that has the ability to move markets.

I say ironically named because there are minimal fundamental financial metrics or strategic and operational catalysts related to Valeant’s, past, present, and (highly questionable) future.

While Valeant has seen greater than 10% YOY revenue growth in each quarter since Q4 2010, partly due to controversial price hikes, earnings have been erratically bipolar due to cost-trimming initiatives, as well as Red Bull fueled acquisitions leading to massive amounts of leverage and debt payments.

Relating to the strategic and operational paradigm of Valeant’s, despite a handful of their commercialized products that deserve praise, others aren’t necessarily giant leaps for mankind; including toe nail fungus relief, contact solution, and acne medicine.

Moreover, their polemic pipeline doesn’t scream massive innovation, with glaucoma treatment being the brightest star. Notice how R&D hasn’t been mentioned, merely the lack of it is implied.

Turning the attention back to ValueAct, if attractive financial ratios and business catalysts are not present, what other “value” drivers do they see? Maybe it can be found in their February 4th investor letter, wherein Jeff Ubben alludes to one of their investing strategies:

“We look for opportunities where a company can remove intermediaries that distribute, resell, install, service and maintain their products. In the case of a company with diffused customers and limited internal resources, the “middlemen” can be extremely helpful.

However, this help comes with a cost as the middlemen need to get paid, extracting economics from the industry.”

Fair statement and clever approach, except that Valeant has become the poster child for middlemen via specialty pharmacy Philidor. Then, Ubben goes into saying this about Valeant and their management team:

“At Valeant, we will continue to help the company navigate out of the storm of pundit criticism, short seller allegations, and management turmoil. Today, with CEO Mike Pearson on medical leave and the ongoing board investigation of Philidor, a lot seems uncertain.

However, we believe much of this will be resolved in 2016 as the team delivers operating results and cash flows. The Ad Hoc committee will report the facts, the crisis will move behind us, and the company will chart a new path, having learned lessons from the events of 2015.”

2016 hasn’t necessarily gone off without a hitch. This is what the public knows (with more surely to come): Valeant withdrew earnings forecast last night, delayed the 2015 10-K filing, suspiciously their CEO J. Michael Pearson came back from a three month hiatus of pneumonia, and canceled an analyst call that was to be scheduled after yesterday’s close, but canceled it after the media discovered it.

Shout out to Bluestar who wrote about Valeant and shorted this, and caught the next potential misdeed- discussing 2016 operations with a limited amount of investors and not in the public domain. Read his Valeant posts if you haven’t yet.

This post shouldn’t be interpreted as bashing ValueAct, Pershing Square and Ackman, Sequoia, or any of the other powerful hedge funds. More so, it should be a warning and reminder to all of us that individual stocks can be freaking dangerous.

Say what you want about them, but you cannot doubt that these are all brilliant people, with all the financial resources and quant brainiacs at their disposal, whose success we all hope to achieve. That’s the scary part of Valeant heading off a cliff like that dude on his horse in The Revenant.

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Don’t Believe The GDP Headline

The wonderful, and at the same time deceitful, aspect about math is that if you know how the inputs move the outcome, you’re able to shape a particular outcome.

The revised Q4 2015 GDP number, which was upwardly revised to by 0.3% to 1%, does not paint as pretty of a picture that the hawkish Fed heads (cough cough Mester, Williams, Lacker, and George), out of touch politicians, and financial media would want you to believe.

This is the equation for GDP, utilizing the Expenditure Approach:

GDP = C + I + G + (X − M)

C stands for personal consumption expenditures; I stands for private investment; G stands for government spending; and (X − M) equals net exports, i.e., exports – imports.

Here’s where the math gets fun. Inventories, which is baked into private investments due to businesses incurring the costs to produce a good, turned out to be higher than originally estimated.

Per the WSJ and all other business media outlets, “U.S. businesses pared back inventories much less than initially estimated in the fourth quarter.” Translation: Inventory levels increased higher than we thought.

Is this a result of businesses building up stockpiles for an increased demand, or they haven’t sold as many of their goods? Look no further for the answer in the revision to personal consumption, or the consumer.

Consumer spending increased 2% in Q4, but that’s lower than the initial 2.2% estimate. It’s also lower than the Q3 annualized projection of 3%. I thought the Fed told us lower oil prices would lead to higher consumer spending?

I’m here to tell you people are spending money! Seriously, think about the last time you went on spending spree and throwing out money like 50 Cent at a strip club.

Lastly, imports fell lower than initially forecasted, revised down to 0.6% vs. 1.1%. These are foreign made goods that were purchased domestically. So again, spending was actually lower.

Getting back to our equation…Increase in private inventories will drive GDP up, but businesses are not selling as much because consumers aren’t spending but that’ll move GDP down. However, with less imports than thought (again spending not happening), net exports increase, which drives up GDP.

Make sense?

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Try To Think Rationally

I’m fully aware that the title of this post is almost impossible to act upon when it comes to the stock market. Yet, it is vital to display this characteristic if you ever want to make money in the market, especially in (seemingly) perilous times, akin to these past couple months.

You’ve got to be aware and remember that when it comes to money, two of the most primal human emotions are at play: fear and greed. And to zero in on your mindset even more, others may wonder whether one plays a bigger role than the other.

Well, one definitely does and it’s fear. Renowned behavioral psychologist and Nobel Prize winner in Economic Sciences, Daniel Kahneman, author of “Thinking, Fast and Slow” (great read on how the human mind process information and acts upon it, namely in times of stress) has confirmed this supposition.

He posits that people are generally loss averse when it comes to money decisions; i.e., losses hurt a hell of a lot more more than gains. You see this in sports. Ask any coach and they’ll tell you that losing the championship hurt much worse than the euphoric feeling of winning the championship a couple years back.

With that being said, as of my time of writing this, since January 14th of this year, when things got extra dicey, we currently stand being up 1.35%. That may surprise a lot of people due to all the doom and gloom you hear on TV and read online (occasionally in print as well).

By no means is this a referendum on bears to proclaim that we’re in a bull market that’s about to rip to the upside, or vice versa. My point is that, unless day trading is your forte, you cannot base your portfolio and investment decisions on every day movements.  You will get scared out of them all the time.

I’ll be the first to admit, it’s happened to me multiple times. Whoever says they haven’t, whether their positions were bullish or bearish, are either lying to you or do not have enough experience to tell you any sort of advice.

So what does someone do? There a couple options, which are dependent on whether you have a money manager or if your account is self-managed. Buy and hold sounds myopic and simple, but we as humans, are not wired to withstand the pain that comes with it. Very few can take the medicine.

First off, if your account is self-managed, I highly encourage you to “stress test” your strategies i.e., come up with different levels of hypothetical losses (10%, 25%, 50%, etc.) and whether you believe you can withstand seeing various levels of unrealized losses, and what you will do in times of market panic.

Additionally, you must have some sort of medium term thesis as to where the market may go (ranging from 3-6 months, no more though) and confirm that your selected strategy will match that thesis. If you can’t come up with one on your own or are simply unsure, find and follow a source that’s transparent with his or her recommendations (hint: highly unlikely this person will be on CNBC).

What happens if the tide goes against you after a reasonable amount of time, not day to day? Then you must reassess that thesis. Any good investor has a general belief and sticks to their guns, but does this in a disciplined manner.

This means that you will encounter losses, but minimizing them must be in the plan. The amount of losses you think you can take will be determined by your risk profile (age, reason for funds, disposable income, family situation (married, have kids, taking care of parents/siblings), etc.)

Realizing the actual risk profile of one’s self is no easy task, but it’s so important. I thought my tolerance was high; but when the crap hit the fan, turns out it wasn’t. And that’s okay… I’ve balanced that out by taking on more risk in my brokerage account and being much more conservative in my Roth IRA.

Second, if a money manager is being used, ask them what their actually strategies are to help achieve your financial goals and what the plan is if the market falls by x%. Honestly, if they cannot explain it in a clear and concise fashion, take the cash somewhere else or have it self-managed.

Anyone can learn the basics and will probably beat 90% of “professional managers” as long as your plan is simple, easy to act upon, and cost/fee conscious. I mean, studies have shown monkeys randomly picking stocks have done better than the average manager. Seriously, no joke; google it.

Not one sane person acts upon a service that they don’t understand. Tell me someone you’ve ran across that’s had their house painted in an unknown color, and I’ll show you a maniac.

The point of this post is that whatever you do, stress test your pain tolerance and have an actionable plan in place, based on your risk tolerance and profile. To sum it up, your money should be managed in a method that allows you to sleep at night. Plain and simple.

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Learn Credit Spreads

Some of you supposed eight figure account stock mavens love spouting out the phrase, “the bond traders are the smartest people in the room”, or “credit leads equity.”  This is all true, and I am not here to argue with that.

What I am here to do, for the more novice and honest market participants, is to explain what exactly credit spreads are, how to interpret them, their current condition, and what they may tell us about future market moves.

I’m not calling bull or bear; I’m simply providing you with an unemotional approach that should only be a minor part of you complete macro and micro analysis.

First, what is a credit spread? Many of you will hit up Investopedia, which says “The spread between Treasury securities and non-Treasury securities that are identical in all respects except for quality rating.”  Then you’ll Google Treasury security, and then quality rating.

Here’s what to know. Treasury securities are theoretically and as close as you can get to a risk-free investment, and it’s a safe haven for a risk-off environment. Thus, for you religious enthusiasts, the reason Fly has been calling TLT (20 year+ Treasuries) the Ark.

A non-Treasury security could be a corporate bond, which is a little riskier, and a junk/high yield bond which is even riskier than the other two.  Quality rating is simply an [allegedly] independent rating of the level of risk found in the security.

When comparing spreads, both securities have the same maturity, meaning the time period when the principal amount of the bond is due.  A bond is simply a loan with interest.  Hence, Bail BONDSm       an for you vagrants. They have a high interest rate here because there’s a high risk with the criminal. Make sense?

Next, how should one interpret the spreads? As a side note, never analyze or try to paint a picture in a vacuum. Look at the trends, and try to make a story of it.  Moving on, remember this: The higher the rating, the lower the return, but the safer the asset is, i.e., less likely to default.

In turn, widening, or increasing, spreads suggest there is growing anxiety about the ability of a riskier borrower to pay off their interest and principal payments, while narrowing, or decreasing, spreads indicate a confidence in that the borrower won’t be a free-loader and default.

Which brings us to today, and what two important credit spreads are showing us.  The first compares investment grade corporate bonds vs. Treasuries, and the second is high yield corporate bonds (which are riskier than investment grade) vs. Treasuries.























You’ll notice that these generally follow a similar pattern. However, when one diverges from the other, this can produce actionable objective signals to implore.  For example, I wrote a post in early-mid November saying that the high yield spread was diverging (showing a different pattern) than the investment grade spread. Two to three weeks later, all the rage was high yield collapsing.

What has recently caught my attention is the divergence on January 22 of the high yield spread and investment grade spread. Where the high yield spread actually fell and has slowly began to creep up, the investment grade spread has been consistently increasing.

This could signal a few things, but what I’m taking from this is that credit fears are not merely contained in these highly levered oil and material companies found in the junk bond bin. It appears that the qualms and worries have trickled into investment grade credit.

My personal take is this divergence should be factored in when determining how much risk is currently in the market. While I’m still long a handful of equities, my cash level is around 45% and has been like this for a couple months. I will continue to tread lightly, and this confirms my current stance.

Finally, I ran a quick comparison of the one year return of CROP (investment grade corporate bond ETF) and HYG (high yield corporate bond ETF). HYG is down around 13.5% while CORP has only been down 6%. In turn, CORP seems to have some room to drop. The actionable trade out of this is to consider buying puts (or bet against) on CORP; I will be initiating this move in the next day or so.

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If Presidential Candidates Were Stocks

With the Iowa Caucus recently complete and the looming New Hampshire primary, I began to ponder how each presidential candidate would be represented in the current stock market. This isn’t the most exact science below, and full disclosure, I’m apathetic when it comes to politics.  I vote on issues; not on candidates.

Additionally, it’s laughable and frightening that one of the individuals listed below will become the most powerful person in the world in nine months.  This is the best we have to offer as the United States?

However I digress. If you have any recommendations or observations, or don’t agree with my choices, list in them comments section below.  Remember, this is America.  We have democracy and open dialogue (cough cough North Korea…).


Ted Cruz (27.6%) 8 Delegates- Restaurant Brands International, the owner of Tim Hortons, because he’s Canadian.

Donald J. Trump (24.3%) 7 Delegates- Oh the ways I could go with this…He undoubtedly possesses a quality that is found in all stocks: volatility. That being said, with Chyna (extra You’re Fired), once thought to be a beacon of hope but now a death spiral– this man is Alibaba.

Marco Rubio (23.1%) 7 Delegates- He’s billed as having all the qualities and potential a candidate could want, but is unable to separate himself from the soberingly talentless pack. Like Gilead, a company with such strong revenue and earnings growth as well as a robust pipeline, Rubio seems to trip over his own feet like just like Gilead and their stubborn buybacks and refusal to make an acquisition.

Dr. Ben Carson (9.3%) 3 Delegates- This sleepy, dull, lackluster medicine man exemplifies Eli Lilly quite well.

Rand Paul (4.5%) 1 Delegate- As a Kentucky senator, it only feels right to associate himself with Suntory Holdings, the Japanese manufacturer and owner of Jim Beam. I’m sure that one makes some of you depressed, learning that a supposed “American treasure“ (not my words, believe me ) is owned by a former World War II enemy.S

Jeb Bush (2.8%) 1 Delegate- Despite the household familiar political bloodline, this was a tough one, mostly due to the fact how boring W.’s younger brother is. Jeb must be a real knucklehead if his brother won two presidential terms. That being said, he is formally dubbed Yelp.

Carly Fiorina (1.9%) 0 Delegates- I’m taking the easy way out on this one, Hewlett Packard.

Chris Christie (1.8%) 0 Delegates- His uprising and subsequent downfall is just like Twitter’s; he was all the rage but peaked too soon, now he can’t catch a bid.


Hillary Clinton (49.9%) 22 Delegates- I was going to go with Tyson Chicken due to her notorious connection and windfall of profits trading cattle futures with James Blair and Red Bone in the late 1970’s, but I’m going with Wal-Mart here. She’s not going to win a popularity contest, but you can’t deny her history of success and achievements. However, they (and her) better be careful because they’ve got tough competition.           Also, they’re both from Arkansas.

Bernie Sanders (49.6%) 21 Delegates- I’m going with Microsoft here. A once old, crotchety, cantankerous man has come out of nowhere to find surprising success.

Martin or Mike O’Malley [couldn’t remember his first name…] (0.6%) 0 Delegates- Insert any highly levered, debt up to the chin small capped oil company.

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Facebook Is King, Twitter A Hipster Doofus

After Facebook’s crush job on earnings Wednesday night, Zuck might as well just have walked into the Twitter headquarters and dropped the mic.

However, he didn’t, because he is an awesome CEO who is focused on his company, and Jack Dorsey wouldn’t have gotten the message; he was probably vegging out with a sherpa finding his inner consciousness.

Before I get all high and mighty, let me say that I have invested in Twitter before.  Facebook has been a holding of mine for a while and will continue to be, but as a refined millennial, I conceptualized the POTENTIAL value of Twitter.

After Facebook’s earnings release last quarter, I posted about why Facebook is still a buy. I do not intend to change that thesis. One of the reasons I said FB was still a buy was its focused company leadership, especially Mr. Zuckerberg.

When I first started investing, the whole idea that the CEO and executive leadership made such a strong impact was a bit romanticized and overblown, and nebulous at best. After studying and reading about successful companies, it’s clear that leadership is key. The problem is that leadership is extremely difficult to gauge.

It was a lazy thought of mine to underestimate what a CEO brings, because in hindsight, it’s a tough characteristic to measure. There’s no P/E, cash flow, or public comps. As I’ve learned from Jeff Macke, someone who is widely recognized and respected in the financial world, some CEO’s just have “it.”

As I said in my prior post, Facebook has focused on mobile and now is champion of that domain. Messenger increased Facebook users increased by almost 50M and Messenger by 100M. And they’re still growing.

After some quick searches and calculations, with a global population of around 7.4B and internet users coming in around 3.1, Facebook has about 51% of the world’s internet population as a monthly active user.  That’s mind boggling.  However, their potential market is still 49% un-captured and perpetually growing. Zuck has a plan to expand that market size.

This is the important part of the post where I compare the King and the Hipster Doofus.

Zuckerberg’s pet project is internet.org. That’s his plan to get everyone in the world on the internet. Do you know why he wants to do this? Yes he wants to come off as a humanitarian, but this guy is not altruistic. It’s because everyone in the world is a potential customer!

Dorsey’s pet project is trying to run two separate companies. I should stop here and point out that I admire him and could only dream of the achievements Jack Dorsey has had. He has created and founded two tremendously innovative and successful companies that offer unique products.

The problem here is that he doesn’t focus and obsess over one or the other. How is that Twitter still only has 300M users, and Instragram already has 400M and growing? Laughably, you can use Instagram as a platform to get on Twitter, which would piss me off as Twitter’s CEO.

Also, let’s look at the social media ecosystem Twitter has acquired. They got ahead of the video game with Vine, only to let SnapChat to organically grow faster and have much more mass appeal, despite Twitter’s user base advantage. Additionally, what have they done with Periscope? That fad lasted about 10 days.

A quick breakdown of Facebook’s ecosystem:











And don’t get me started on monetization. When you compare Facebook’s and Twitter’s earnings and revenues it resembles Frost’s “The Road Not Taken” (hint: Facebook’s  made all the difference). If you don’t understand that metaphor, for the love of whoever you pray to, pick up a book.

Here’s a free suggestion for Twitter on how to make money, and barely do anything. Act as an advertising platform between a spokesperson and their followers.

Example: If Nike pays LeBron James $50M a year for endorsing their shoes, have him send a Nike Tweet his followers. Once LeBron does this, Nike pay Twitter a small % of whatever. That’s much more targeted advertising, and you don’t need a fancy algorithm.

What it comes down to is laser focus (extra Adderall) and freakish obsession with your company; Zuck sees Facebook as his one and only true love and Jack views Twitter as a fling he wouldn’t even give Uber fare to.

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AIG Flips Icahn The Proverbial Bird $AIG

In a shocking display of executive and leadership gumption, AIG did not bow down and kiss the ring of Carl Icahn and John “Puerto Rico” Paulson.

Rather than adhere to the demands of Uncle Carl to break apart its three main insurance businesses by spinning off both its mortgage and life insurance business from the property-and-casualty business and creating three separate companies, CEO Peter Hancock decided to pull the old switcharoo.

AIG Leadership’s Plan

In a feeble attempt to appease Mr. Give Me Three Seats On Your Board, Hancock and his BOD’s decided to sell off AIG Advisor Group, their broker-dealer network, to Lightyear Capital and PSP Investments.  AIG will also be spinning off and IPOing 19.9% of United Guaranty, the mortgage insurance biz. As time passes, AIG will sell off the rest.

Also, Hancock decided to “return” $25 billion to all shareholders (insert Bailout and TARP thoughts) through dividends, and of course buybacks, which Jeff Macke would highly approve. Moreover, over the span of two years, there will be $1.6 billion of cost cuts, most likely in the form of trimming jobs.

Please note, all jokes and sarcasm aside, please read his piece on buybacks you’ll learn a lot; I for one did.

Lastly, and probably most confounding when you put it context to the activist’s demands, is the $67 billion market cap mega insurer is reorganizing its business reporting structure into nine divisions. Here’s the kicker… They claim it’s to “better track operational performance.”

Icahn’s Plan

I’m not going to sit here and defend Mr. Icahn, though I do enjoy how he calls out all the big shots of finance like he’s Stone Cold Steve Austin. Lord knows he’s pulled fasts ones on just about everyone involved in Wall Street (dead or alive).

However, splitting into three business units vs. nine divisional structures, some of which may become part of a legacy portfolio, (whatever the f$%k that means) makes much more practical sense to me.  We like math at iBankCoin, and three seems more manageable than nine.

Icahn’s plan, and I hesitate to say this, seems much more shareholder friendly in the sense that with two spun off companies, current AIG shareholders receive something real and tangible in return, rather than some made up buyback.

With all that being said, there’s one, albeit, significant, implication and outcome of Uncle Carl’s plan that makes me side with him: the prospective elimination of the Significantly Important Financial Institution (“SIFI” or for the unwashed, ‘too big to fail’) label.

Per his October 28, 2015 letter to Hancock, Carl posits that “Each would be small enough to mitigate and avert the SIFI designation by splitting into three separate units.”

For those who are not as financially attuned, by being designated as a SIFI, you have to hold a ton of capital reserves, which decreases the amount that could be distributed to shareholders or used in capital expenditures, and lowers your return on equity, net income divided by shareholder equity. On top of that, you have tons of regulatory and compliance issues to deal with.

To add actual credence and credibility to Icahn’s plan, about two weeks ago, MetLife spun off its U.S. life insurance unit, which happens to be the America’s largest life insurer.  Someone must’ve listened to Uncle Carl; will AIG?

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Mainstreet Explanation of How Oil is Driving Stocks

In my introductory post, I mentioned that a major reason I wanted to start writing and blogging was to explain seemingly confusing financial issues in a simple manner. My hope was that people, who are neither financially savvy nor knowledgeable, could learn a thing a two.

Truth be told, I don’t believe I’ve done a good enough job focusing on this and have let some readers down. With that being said, many of you have probably seen on the Today Show or heard on your local news broadcast that “markets are down, primarily because of low oil prices.”

The problem with these statements is that it gives no insight as to WHY this one of the main influencers of this recent drawdown. In this post, the end goal is for the everyday financial lay(wo)man to understand why oil is driving the equity markets.

It would besmirch Fly and Bluestar (you don’t see these two with common thoughts that often) if I didn’t mention that their posts have inspired me to write this, and have educated me on this topic. This article differentiates itself by appealing to Mainstreet.

It is essential to understand the following concepts and relationships when trying to decipher the current oil crash (or any asset class in general):

1. Credit (or debt) that is issued (or lent) losses its value as the asset, which was used to support the issued debt, drops in price. I realize that this may sound elementary to most, but it’s important.

2. Most, if not all, of the major stock sell offs that are persistent and resilient are preceded by a drop in the credit markets and surrounding leverage conditions.

Why is that the case? The best explanation is that businesses need credit for capital investments, purchase inventory, and fund on-going operations. When credit dries up and banks are no longer willing to lend, these businesses are not able to perform activities that allow them to grow. This leads to lower expected revenues and profits, which are then reflected in the stock price.

How can you tell if credit markets are hurting? You look at the credit spreads. In a nutshell, these compare the interest rate provided on a risky debt instrument vs. a risk-free instrument. The higher the spread, the higher the need to be compensated for the extra risk due to the increased likelihood of that person not paying back their debts.

Think of this way… On a loan of $100,000, you are much more likely to be paid back by Warren Buffett than your old college drinking buddy who still lives in his parent’s basement. To account for that extra risk, you insist on a higher interest rate.

Now onto the discussion of oil and how it all relates to what is laid out above.

Want to impress some girl or guy you’re attracted to into thinking you’re smart and educated about worldly events and financial complexes? Repeat these three statements if the discussion of why oil has dropped so much comes up a dinner party or rave or hipster hangout:

  • There’s an oversupply, due to OPEC (mainly the Saudi’s), refusing to cut production. However, U.S., Canadian, Russian, and everyone else haven’t stopped, and now Iran has joined the party (insert snarky thanks Obama).
  • There’s a decreased global demand because of an economic slowdown; many people will rightfully point to China, but there’s a ton of economic exhaustion in other places. Just ask Super Mario of the ECB.
  • A strong U.S. Dollar aka King Dollar. Commodities are priced in U.S. Dollars. When someone wants to buy oil abroad, they have to convert their currency into King Dollars. But because King Dollar is flexing on all other ass clowns, that other currency cannot buy as much.

Oh yeah, when interest rates are raised, the U.S. Dollar gets stronger, especially in a low yield environment. This is because, again, people outside of America must purchase U.S. Treasuries with U.S. Dollars, and thus drives the demand for King Dollars. You can thank Grandma Yellen and academic minions later for exacerbating this equity selloff.

So here we are.  According to Exodus, there’s about $1.3 trillion in debt for the entire oil and gas industry, which includes drilling, exploration, equipment and services, pipelines, and refining. Some more risky than others, but still, that’s a crap ton of debt.

As the price of oil keeps dropping, the risk that a non-insignificant amount of energy companies could default on their debt increases. As I’ve pointed out in a prior post, the credit spreads in high yield (extra risky debt) really began to shoot up since mid-November 2015. The high yield credit spread hasn’t been this high since 2009. The Bloomberg US Energy Corporate Bond Index accelerated its drop just around the same time (130 to 120 today).

This has obviously spilled into all energy related stocks.  But why the general market fear and drawdown, beyond the fact that a ton of U.S. economic growth was driven by the energy renaissance in the oil patch and over 100,000 energy related jobs were lost last year?

In my opinion, Bluestar’s most recent post is spot on.  By the way, he called this in November 2014 so a major hat tip to him.

To summarize what he’s saying; a major hedge fund(s) or global banking institution(s) own and are exposed to financially radioactive oil derivatives. Because other gigantic money machines are most likely on the other side of the trade or are indirectly exposed, they’re preserving their capital in the event of financial contagion and defaults. They are not able to bid up these low stock prices because they know they’ve over extended their risk at the moment.

What is a derivative? Simply, it’s a side bet that is based on the outcome of a previous agreed upon bet. The previous agreed upon bet was that oil would keep going up, but it hasn’t.

Understand that it’s derivatives that truly speed up a credit problem, just like it did with the housing crisis in 08-09 (think of oil today like houses then, but not as risky to the financial system). There is much less regulation on these, which encourages more risk taking.

Hopefully this gives you, the average investor who checks the online or mail statement once a month, some insight and knowledge as to the dynamic between oil and the equity markets, beyond what the mainstream media will simply flash in your face and have you repeat.

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