2006 Valedictory

Thursday, December 21, 2006 | | 0 comments »


a small venture beyond markets...


Over a decade ago this scribe was the sorry civil servant handling hundreds of replies to lobbyists peppering Her Majesty's Treasury with demands that the UK's overseas aid budget be increased. He saw all manner of arguments, laid out in exhaustive and voluminous detail - including a particularly sincere one from a prisoner in Long Lartin advocating human culling. Some circumstances are indeed self-explanatory.

But the best and most effective letter by far ran two lines:
"Dear Chancellor,

You know the arguments in favour of increased aid and greater debt relief - do the right thing.

Sincerely,"
In a year like 2006 which witnessed
cash-for-honours allegations; abandonment of bribery investigations because selling fighter jets to the Saudis is for our own good and more important than the rule of law; blank refusal to negotiate; sponsorship of holocaust denial circuses; religious and cultural demonization; dogma; inflexibility; non-respect of sub-judice; speeches of authority made by the knowingly ignorant; assignment of skill rather than luck to most outcomes; arguments that the Royal Family is worth it to UK plc economically; wilful omission of facts; the hard sell; double-standards; skin-saving (or other) white collar fraud/theft; getting away with it because it is possible; and not-my-problem syndrome
it would have been an equally striking request as well as an admirably distilled philosophy. A small, naive wish of this writer is that its spirit is applied more often in 2007.

Season's Greetings, Best Wishes and see you in 2007 (end-year celebrations permitting).

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The next president of France (maybe) Nicolas Sarkozy is also joining in the fun and doing a Baht. Some quotes from his latest speech:

  • the euro's level is "a serious economic error"
  • it's "making European labor expensive and the labor of the rest of the world cheap."
  • "the dollar will have become so cheap that we will have to go and make Airbus in the U.S."
  • it's "pulling wages down"
  • "I won't be the President who allows the Americans a monopoly with an all-conquering dollar."
  • "I want a strong currency supporting a strong economic policy"
  • "We cannot continue to preoccupy ourselves with an inflation which competition has eliminated without concerning ourselves with unemployment, purchasing power and growth."

Of course, canvassing is one thing, governing another: France is still - this has been fact checked - a democracy. That Mr Sarkozy's socialist rival, Mme Royale has a similar position makes it that much more euro-bashingly interesting.

It's all coming to the boil just nicely.

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Thai Capital Controls

Tuesday, December 19, 2006 | | 1 comments »


In September Capital Chronicle posted about the Thai coup arguing that blind pursuit of returns by investors ignoring context would, sooner or later, prove dangerous.
So it has. Buoyed by an arbitrary military intervention last September, foreign direct investment (FDI) poured into Thailand in the hope that "stability" would boost economic prospects. The baht rose to its highest level since, ah, the 1997 Asian Crisis.
Key exporters lobbied for intervention. Arguably in the absence of those inconvenient fetters of balancing democratic interests they have swiftly got their wish. In one fell swoop Tarisa Watanagase, governor of the Thai central bank and a military appointee, has punished FDI with a severe wedgie and hit upon a potentially inflammatory beggar-thy-neighbour depreciation wheeze.
Competing Asian exporters will not be impressed; and if this subsequently proves the thin edge of the wedge of a round of regional tit-for-tat currency manipulation the previous YouTubed post on the vagaries of form may not look so flippant.

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Fetch

Monday, December 18, 2006 | | 0 comments »


Baseball fans, look away now.

Form has a funny way of abruptly turning 180 degrees; and when I get around to writing about equities going into 2007 it will be tempting to apply that principle.

In the meantime, it was nice to see it alive and well today as India beat South Africa for the first time in South Africa in a Test match. India had lost – miserably and embarrassingly - all the preliminary one-day games and looked to have no chance. Yet they crushed the hosts comprehensively.

A microcosm of that about turn in form came with two balls from trash talking South African quick bowler Andre Nel to man of the match "Gopu" Sreesanth. Naturally, Indian fans have had a field day with this on YouTube.

Laugh? I nearly cried.




NB: Where on earth were the SA supporters? The stands are practically empty...

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Since iSoft announced on 17 October that it was in talks that might lead to a takeover, dealings in more than 1% of the company’s share capital have had to be declared under rule 8.3 of the City Code for Takeovers and Mergers. These make interesting reading insofar as the information allows some limited conclusions.

Take Laxey Partners, for example, self-described as
“a global active value investment management company that pursues one strategy: it actively seeks to close the valuation gap between the share price at which an asset trades and its intrinsic value.”
The regulatory announcements show Laxey holding 0.8% of iSoft, or 1.9m shares. They also show Laxey must have held almost 10 million shares at 17 October. In between they have sold the difference at prices between 32.3p and 47p. iSoft trades at 56p as this is written. In cash terms Laxey are around £1.5m lighter. Panic selling (perfectly understandable)? Or actively closing the valuation gap?

On the other hand, there is New Star Asset Management. They currently control a short interest of 7.1 million shares or over 3% of iSoft equity. They held about 9.3 million shares short on 17 October more than likely sold at much higher prices. However, on visible dealings they have lost almost £730,000 since; and for every penny rise (or fall) in iSoft their holdings move £71,000. Complacently sitting on an overall profit? Or quietly confident there is more downside to come?

On balance, what is visible shows institutions holding significant longs. Capital Group, a US mutual is especially notable for it has bought its 1.96% pretty near the trough (if that is what it was); Barclays is essentially a net 4.1 million shareholder trading a portion of its holdings on iSoft volatility; HBOS is an iSoft banker and holds over 10 million shares; HBK Master Fund, a hedge fund has 12.7 million shares; and Sisu Capital another 8.3 million (no further detail available, unfortunately, on these two).

Significant shorts like New Star and, to a lesser degree, TT International (2.1 million shares) as well as the chancers lurking just below the 1% threshold may want to reconsider their positions. iSoft cannot survive without a deal; but with a market dominant install base throwing off cash like an annuity, products of some promise, operational improvements and a sector growing at 11% CAGR a deal is likely. Sentiment is improving and closing over 4% of iSoft capital in an in-demand market will boost the equity significantly. All the institutional long holders know it.


NB: The writer holds a financial interest in iSoft plc

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Anyone reading and believing the AFX news wire interpretation (written by Simon Duke and the first off the press I have seen) of these results should be forgiven if they think the end is nigh. Mr Duke appears to have a short interest in the shares given his choice to rehash old shock and awe language regarding the dangers of bankruptcy; and to mention only the exceptional operating costs and not the related exceptional credits in his article. Ah, well.

Despite this scribe retaining a long interest, here is a more balanced appraisal for those who appreciate the iSoft context. These results are operationally impressive (break-even post-exceptionals) for a firm faced with overwhelming bad press and in the midst of wrestling with the previous regime's accounting cash hole. Cost cutting is ahead of schedule; and, for a firm who Mr Duke and many others doubt as viable, it has mitigated the top-line impact of its plight well.

The balance sheet is still very weak (expected) with the new financial borrowing facilities heavily drawn (ditto); and cash outflow is large but not as large as feared. It is even perversely encouraging.

Philips, or whoever is supposed to be studying a tie-up with iSoft but didn't want to talk about it today, certainly ought to be encouraged. iSoft will ultimately stand or fall on its products (notably Lorenzo) but a pre-condition is a sound financial structure. Going-concern fixations in the vein of Mr Duke's are lagging indicators and do not do justice to the operational progress made in part by Bill Henry's hiring (a step it appears many iSoft watchers may not have fully appreciated) or the financial rebuilding taking place under Mr Weston. They ignore, too, the importance of the large recurring revenue element of iSoft's substantial install base.

None of which is not to deny that the firm remains on a knife-edge in funding terms. But context should still count for something; and so far this morning the share price agrees with that approach.

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Is another iSoft plc chapter about to be written?

John Wayne starred in The Man from Utah (1934) playing John Weston, a young drifter who thwarts the robbery of a small town bank thus preserving its existence.

In a strange, time-shifted parallel world, iSoft plc’s non-fictional but identically named Chairman has been more or less living that same plot line with the company over the last year.

Although it is doubtful the bonus monies paid out to the previous Chief Executive, Mr Whiston, on revenue subsequently restated (very downward) will ever be returned there is a decent chance Mr Weston will rescue iSoft from the huge cash hole it was recklessly and silently plunged into. On the other hand, one analyst rates the probability of a bankruptcy at 25%.

All may be revealed when the company announces interim results this Monday 11 December. The numbers will be interesting enough, particularly the top line and cash flow; but it is the unsubstantiated story, cited officially by Businessweek late today but broken unofficially (zero proof, see) by the FT’s Alphaville this morning, that Philips Medical Systems is in advanced talks with the firm that may add bite. It is conceivable that an announcement may come with the accounts.

In terms of potential fit, the idea of iSoft and Philips is a runner. Philips lost one channel for its relatively limited health care IT business when GE bought IDX in January 2006: GE promptly dropped the Stentor (a Philips company) imaging solution IDX had until then been offering.

Your scribe spent some time with GE Medical Systems finance and can attest that there is an incentive for Philips to join arch-rival GE in being capable of offering a comprehensive healthcare software solution (read: as in iSoft) alongside their formidable hardware line-up. Were you a potential client, which would you prefer - a bits and pieces or a single all-in-one solution vendor?

I leave you to your weekend with the trivia that, in The Man from Utah, viewers were treated to the unexpected spectacle of the Duke singing contentedly and strumming a ukulele. It would be sweet music for shareholders to see something similar from Mr Weston on Monday. Truth, after all, is stranger than fiction.

If this is a real deal, though, the Devil will be in the terms.


NB: The writer is financially interested in iSoft plc

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A post on India and globalisation is long overdue. This isn't (exactly) it. But Christmas is a time to share.


Courtesy of Australian-based Boymongoose & Nishan Selvadurai

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The Divergence Game

Friday, December 01, 2006 | | 0 comments »


You may be a bit busy today, what with the US dollar in free fall; a contracting US manufacturing sector (according to today's ISM index reading); the Fed's "preferred" inflation reading still stuck (as of yesterday) stubbornly above their 2% comfort zone; a US housing market showing signs of needing to go and have a lie down in a darkened room; and winter storms approaching the US with attendant crude prices above $62.

However, spare a thought for the US bond market as the 10 year yield dips to 4.41% whilst this is typed.

These charts have featured here before, and not that long ago. But when bonds threaten in this manner to diverge from equities and outperform the subject bears revisiting.

Exhibit 1: US 10 year Bond vs Equities (S&P 500), 1996 to 2001


Exhibit 2: US 10 year Bond vs Equities (S&P 500), 2001 to date


Have a thoughtful weekend and give Goldilocks my regards should you see her.

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Will China’s domestic demand play its proscribed role in the soft-landing “decoupling” scenario when/if American consumption demand falls along with GDP output in the next slowdown?

Much of the Chinese economic public relations image rests upon the urban areas of only seven of its provinces/municipalities whose combined population is 306 million souls*. Six of these are highly urbanised and have grown thanks in large part to massive infrastructure and/or capital intensive investments. With nearly 40% of industry state-run that is perhaps not unexpected; and at least in urban centres it can be said that a form of consumption demand exists.

Nonetheless, aggregate domestic distribution of goods has fallen since 1998; and the internal consumption market is, unsurprisingly, extremely fragmented. In rural China – 50% of the population - incomes are falling and are about 30% of the national average (which is $1,500 annually or $5,900 on a purchasing power parity basis). There are just too many farmers for what fertile land is available.

The famed export performance of China too has unexpected characteristics: 90% of it arises from the efforts of foreign owned firms. There is a striking lack of contribution from Chinese enterprises.

Exhibit 1: Foreign share of Chinese exports, 1998 - 2006

Image courtesy of La Caixa bank

In sum, it is difficult not to conclude that the Chinese economy is dominated by urban and state-led investment projects (itself a function of huge domestic savings) of which its 7 most urbanised provinces/municipalities have been principal beneficiaries. Preparations for the 2008 Olympics are a case in point; and the economic benefit from such investments has been ultimately mixed at best. Half the nation is rural and desperately poor; there is a distinct dearth of significant homegrown companies; and the export sector (with its own linkages back into China's savings rate) is in the hands of foreign companies sensitive to final demand above all.

Coupling? They must be considering proposing.

China may be a great new market (and so it's been said for over 400 years) but investment–led internal demand hand in hand with dependence on exports has limits. The balance of probability says these will be exposed in the event of a significant US downturn.


*Shanghai, Beijing, Tientsin, Guandong, Zhejiang, Jiangsu and Shangdong

Sources: World Bank; UN Development Programme; La Caixa bank monthly report for November 2006

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Dear Reader, a funny thing happened on my way to Damascus - the US dollars in my pocket started vanishing. That rendez-vous with Ananias is on hold.

Exhibit 1: GBPUSD spot rate, 2002 to date (weekly data)


Apparently, during Thanksgiving this dollar-drop was “technical” and caused by thin volumes. However, since then the celebratory carve-up continues - although the dollar is still not trading below its December 2005 troughs of $1.956 (sterling) and $1.367 (euro). And, curiously, neither recent EU or US macro data have been clear-cut enough to account for the shifts underway.

Exhibit 2: EuroUSD spot rate, 2002 to date (weekly data)


Some reasons explaining why the dollar cannot fall significantly (as in much and persistently beyond those troughs) are around: logistically it is difficult for foreign central banks to diversify their fx holdings, whatever China announces; and, similarly, there are just not enough large liquid, stable equity/debt markets like the US into which surplus capital can be diverted.

This leaves only the broader global economy to put in context. As in the previous post, the bet is how deep will the US slowdown extend; and how far will it be offset by domestic demand elsewhere (both emerging and EU economies). Which is another way of asking is this all a helpful settling cyclical adjustment within a robust global economic expansion or reflective of a profound approaching US-led global slump.

Dollar action is, perhaps more than any concrete data can explain, beginning to play out trader sentiment between these two outcomes. But it is most probable upon the vast expanse of grey in between that the pendulum will come to rest.

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For the market neutral, or negative, the story of Saul on the road to Damascus may be beginning to resonate. Whilst perhaps not yet struck blind by a bolt from the blue and converted, doubters can not help but be surprised by the strength in equity markets.

The economic story supporting markets is foremost about ample liquidity. Secondly it concerns the rise of Asia as an aggregate industrial power capable of developing internal domestic demand. Lastly there are the commodity exporters. Whether this mix is defined as a “new paradigm” as advertised or as a new twist to an old economic story does not really matter. It is what it is: generous liquidity -> global growth -> low inflation -> low rates -> generous liquidity.

How long that circle will continue is not knowable. However, that most large economies are peaking/have peaked is clear (Julius Bär's latest thinking on that illustrated below). On the other hand, whether 2007 will be a mid-cycle correction rather than a recession is unfathomable.


Exhibit 1: Image courtesy Julius Bär. Sign indicates shorter-term outlook.


Consensus, though, is for a mid-cycle correction and equities are cheerfully, and somewhat maniacally, pricing this in. Equities also appear set to enjoy some real-time support from seasonal strength through to end Q1 2007. In this situation eager "complacency buying" may prove to be the largest impoverishing threat, especially for retail investors.

Fetch me Ananias.


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M: “I want you to take your ego out of the equation”
James Bond: “So you want me to be half monk, half hitman”

Casino Royale

As it happens, that is an apt description of those of Her Majesty's Treasury (HMT) officials charged with monitoring government spending departments. It's also decent philosophy for equity investors.

On 17 November Casino Royale opens. Notably, this episode of the Bond saga has a starring role for an official of HMT, portrayed by Eva Green. And Ms Green puts on a first-class performance as a Treasury woman. Or at least as it might be imagined by those Treasury men whose favourite lunch time activity remains the strolled tart-of-the-day spotting contest in St James' park whilst en route for a pint at the Two Chairmen public house.

But why quibble? Ms Green brings long overdue glamour to HMT's work. There was always the thrill of working behind bomb-proof curtained offices; the mystery of ancient wall safes whose combinations have long-been forgotten; the warren of below-ground rooms from which historic items are periodically retrieved and displayed in HMT's entrance hall (swords were a favourite during this scribe's tour); and, not to be forgotten, the excitement of preparing and delivering ministerial briefings (exemplified by useful contributions from the Foreign Office such as describing a visiting overseas finance official as being “tall for an Asian”).

Now the world knows, too, that HMT personnel also hit the streets. Thanks, Ms Green. Even your correspondent can say, without remotely risking running foul of the Official Secrets Act, that he had occasion to enter the MI6 building south of the river (with the Bond theme tune running through his head and his heart beating quicker). Nice views.

Unfortunately, Ms Green lets the side down in one respect. She falls prey to “agency capture” for HMT-style monkdom is not for everyone (especially when compared to Bond-style monkdom).

A good controller - and investor - must maintain a careful detachment. Just never apply this to making a Bond film.

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Quantifying and assessing the impact of potential economic shocks is an inexact undertaking. Going the whole hog and assigning them a probability whilst cloaked in the garb of academia, though, makes the exercise much more impressive. And often more inexact.

In 1987 this scribe had an undergraduate course with an internationally known historian and expert on Nazism and contemporary European politics. Deeply knowledgeable, the professor opined that Germany would not be reunited in his lifetime (he was a young chap then). Well, he's still breathing and junior readers may need to google historic artefact “the Berlin Wall 1989” for more information. A forecast, expert or not, hazarded upon a chaotic (as opposed to linear) environment is a hostage to fortune.

Which is what makes reading the Oxford Analytics Global Stress Points table (above left, click for larger image) such wonderful entertainment. Released in January it from the start contained a mix of de facto events not warranting a probability rating (“civil war” in Iraq pre-dates 2006, and just how much more nationalist could Mr Putin's regime be?) with standard tabloid fare (dirty bomb, avian flu, oil shock). There is also a 4am-and-the-beer-keg-just-ran-dry choice (“collapse of the euro”); and anyone who has spent more time than they care to recall reading about avian flu will wonder how the “scholar-experts” came up with a 55% likelihood of it hitting this year (it must be an interesting formula).

Nonetheless, two overlapping items merit special attention: an “oil price shock” and a “US strike on Iran”. It is curious there is no “Israel strike on Iran” option for the Israeli government has been talking openly about it since 2002 with an eye to conditioning sympathetic listeners to such an eventuality.

In either event, timing a US and/or Israeli strike as a function of Iran's point-of-no-return in acquiring nuclear bomb-making knowledge (but not the weapon itself) has brought the matter to a head: if the 2007 Global Stress Points table carries similar scores for a strike as in the 2006 edition then the “scholar-experts” will be rating the likelihood of the risk too low.

And if ever an international diplomatic triumph was required it is on this issue.


NB: All graphics courtesy of the AON Political Risk Map commissioned in association with Oxford Analytics

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One US odds maker put the over/under line for the first three-day takings of the new Borat! film at $11m. This is the comedy in which Borat praises President Bush’s “war of terror”.

Under normal circumstances a foreign filmmaker taking the proverbial piss on American patriotism like this might spell commercial US disaster. However, the production ended up taking well over $26m in its first three days.

Democrats were forecast to gain 15 seats and control of Congress by most professional pundits in yesterday's US mid-term elections. The Borat result was an unscientific anecdotal reason to take the over; and so it has proved with Dems taking the House, as this is written, with a shade over 20 seats added (and it may finish with over 30 net adds). The Senate, somewhat unexpectedly given the few constituencies (33 of 100) contested, is within 2 seats of Dem hands also.

The result most desired by the markets is gridlock, thus preventing the emergence of grandiose legislative plans - ie no change keeps current trends as is. Unfortunately, that inexplicable expectation is a pipe dream: divided government has nearly always proved cheap as both sides act as spoilers to the spending plans of the other.

So expect a period of fiscal restraint should the Republicans cling on in the Senate; and coupled with anti-war sentiment it may be the Pentagon that ends up taking the brunt of said restraint, albeit over time. That appears likely to translate into a significant fiscal drag on the winds currently helping sail the US economy.

Of course, Democrats might end up taking both Houses. That sharpens the focus on more than dwindling war funds and simple control of the legislative agenda: it brings into stark relief the potential Dem agenda items of minimum wage hikes, protectionist measures and drug price-controls. The extent of their impact on the slowdown that is approaching (anyway) is more difficult to gauge; but it does not look positive.

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Can’t a fellow spend a few days away relaxing without the Government of Canada reneging on a tax promise? Those royalty trusts really tied the income portfolio room together, man.

Slings and arrows; and nonetheless a break in the Cévennes was a fine idea. Trees, balmy weather, good walking, trees, autumnal colours, happy children, trees, friends, wine, trees, roasted chestnuts (ah, thanks to those trees) and so on.

Also it was an excuse to check out the timber plantation opportunities (did I mention the trees?) Jeremy Grantham keeps banging on about in his quarterly letters (free registration required).

Sustainable forestry is of course bio-friendly, touchy-feely, oxygen producing and soul-soothing. Cash, on the other hand, is liquid and unconstrained by the vagaries of green politics (cross-reference Canadian tax politics). It’s not certain this scribe’s environmental credentials will be enhanced by the choice at hand: more study required.

NB: No, I did not make up the name of the wine; and lest Seigneur d'Arse wishes to complain, a rose by any other name would smell as sweet. Really.

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A brief foray into an area tenuously linked to investing, but footballing numismatics will enjoy it...

When Ulster Bank put George Best on it.




Some North American readers may be labouring under the assumption that Freddie Adu, fine young fellow he may be, is the original child footballing prodigy. Let the clip below disabuse you.



Bring your Pelés, Cruyffs and Maradonas, stick them in the Northern Ireland team this man had to play in and then make your comparisons.

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Spot the Elephant

Thursday, October 26, 2006 | | 0 comments »


Those hoping for something in the vein of Elmore Leonard were disappointed by the 25 October Federal Open Market Committee (FOMC) press release.

Despite the presence of the right mix of economic elements necessary for a thriller there is no doubt as to the bland authorship. The statement is clearly their own work, copied around the table (a few times) for agreement before release. Unemployed skilled ghostwriters up and down the USA remain glum: they too could have left all options on the table but at least given us all a nice ride on the way there.

Style, of course, is one matter, content another. Some commentators argue the FOMC’s actions do not matter much. Indeed, that its power is perceived as key to most investors is odd given a demanding fiscal environment outside its control (particularly those elements of which are politically driven) and a US sovereign debt market dominated by foreigners.

In mitigation to this general obsession with the FOMC and its fixation on “contained inflation expectations” here is a small, graphical comment.

Exhibit 1: Spot the elephant


Yet the release remains a bestseller in financial circles.

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From a former pension-concerned Xeroid colleague, this definition of a hedge fund found within the Ownership Profile of the Investor Relations section of the Xerox website:

Hedge Fund Definition

Hedge Fund investors have the majority of their funds invested in some sort of market neutral strategy. Notably, the term 'hedge fund' is both a legal structure (as opposed to a mutual fund) and an investment style. Nearly every firm that uses a hedge fund or market neutral style is legally organized as a hedge fund (and thus only open to accredited investors). Many are offshore funds that are unregistered, have no investment limitations, and are not subject to disclosure regulations. The common element is that any long position taken in a specific equity is offset by a short position in either a merger partner (risk arbitrage), an 'overvalued' member of the same sector (long/short paired trading), a convertible bond (convertible arbitrage), a futures contract (index arbitrage) or an option contract (volatility arbitrage). Because of the idiosyncratic nature of these investors, the fundamentals of their portfolios are not indicative of their investment styles. Thomson Financial categorizes these portfolios based on its specific knowledge of the their historical investment behavior.

Are you confident your pension trustees' / managers' holdings in certain “legally structured" hedge funds are deployed as described above? Apparently those investing with Amaranth were.

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FT.com launches a new service next Monday called Alphaville: instant market insight.

Currently on a dry pre-launch run (and already under scrutiny from rivals) the service, in broad terms, pushes two themes - its timeliness and its added value commentary (which also has a daily interactive aspect).

The FT/Alphaville team, led by Paul Murphy, has envious resources, contacts and experience at their disposal; and that combination has the potential to turn Alphaville into a precious tool for market followers.

The site deserves a close look.

I received, unfortunately, no recompense (pecuniary or alembic) for this plug....but Alphaville did say something nice about Capital Chronicle this morning.

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Set hedonics to one side. Suspend, for a moment, argument over what ought to be included or excluded. Instead, just consider a picture of your preferred, consistently calculated end-user US inflation measure – usually the CPI, PCE or the GNP deflator.

Such a survey reveals year-over-year inflation still hopping an upward trend, even with today’s positively received core CPI pause. Overlay a Fed Funds plot and the argument that this cycle’s hikes began a year too late gains weight.

Exhibit 1: US Fed Funds vs CPI and PCE (year-over-year % change), 1970-2006 ytd (recessions in pink)


“Too late” because the Fed is now pressured to cap inflation whilst a slowdown gels. Global liquidity has braked sharply since 2005 – one herald of a downturn - and is an indicator with a circa (but variable) 2 year lead over the S&P500.

Exhibit 2: Global liquidity and the S&P 500, 1975-2006 ytd


As this is written, European markets and US futures are rising strongly on the CPI core data. This reflects a belief that the ideal outcome of slower economic growth culling inflation is panning out. Under this view the Fed also gets to cut thereby touching down softly.

But the Fed wants to see core inflation fall, not merely pause; and at 2.5% yoy (PCE) and 2.9% yoy (CPI) it is still well above the bank's 1% to 2% target.

There is no way the Reserve will cut on this data; and the longer the rising trend is in place whilst the Fed holds the greater the risk a simple downturn becomes recession. On the other hand, a premature cut might look a good call for a while but ultimately risks further arousing a fertile (though currently resting from his exertions) inflation bunny.

That may only defer an even uglier choice.

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NB: The author holds iSoft plc equity

Upon being told this scribe lives near Grenoble some people do a double take and reply, “What?! Cher-nobyl?” Much the same mystified why-would-you-want-to reaction takes place when people chance upon iSoft plc shareholders. Welcome to my world.

To sketch some context, iSoft is The Major Supplier of hospital software in the UK (60% of revenue) where they have no sizeable competitor. Earlier this year former management was caught cooking the books. The company has enjoyed bad press since, and carried the political can (partly justified) for implementation delays and gremlins on the largest non-military IT project the UK has seen. iSoft came close to financial death as a result, and is yet a hospital job.

Thanks in large part to its non-implicated, newish and well-connected Chairman (John Weston) it has put the beginnings of a survival platform in place. Nonetheless, long-term shareholders have been badly singed, and the firm needs to recapitalise its balance sheet in order to deleverage and stave off a liquidity crisis.

At today’s AGM permission will be sought to issue equity. It’s likely that before year-end iSoft will then either make a rights issue, an open offer, or some combination involving perhaps an open offer and a conditional placing.

The choice is important. Rights issues are typically followed in the UK by underperformance for up to five years. Open offers, contrastingly, enjoy outperformance.

Exhibit 1: Rights issue vs Open offers, ex post performance


Graphic from Ngatuni et al, p 43 (see sources, below)

It is tempting to conclude that the choice of financing determines the subsequent performance. In fact, the choice reflects the underlying context of the company; and this context drives ex-post performance. The “context factors” include such things as director’s interests, growth prospects, degree of financial distress, appetite for rights, anticipated use of funds and so on.

An isolated, financially distressed iSoft may not have enough shareholder support for anything other than an aggressively discounted rights issue, and the volatility of its equity supports this outcome. However, the company may not be as isolated as it seems. In this morning’s pre-AGM statement Mr Weston referred again to trade and financial company interest in iSoft. Gleacher Shacklock and Morgan Stanley have been appointed advisors and discussions are opening.

This might be interpreted as is a sign of confidence in the company’s inherent worth (most notably its install base/UK market share) and implies both non-shareholder investment demand and, possibly, eventual refinancing on gentler and more confident terms than some analysts anticipate.

On the other hand, it might not: what form the re-financing takes and who participates are, in the shorter term, crucial.


Sources: Ngatuni, Capstaff and Marshall, Long-term Performance Following Rights Issues and Open Offers in the UK (1986-1995); Kortewg and Renneboog, The Choice between Rights-Preserving Issue Methods, 2003; Armitage, The Proportion Underwritten and the Reaction to Share Issues, 2000.

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Equity and bond prices have had a particularly strong positive relationship since 1980. Which is normal – quiet, uneventful macroeconomic growth sees equity and bond gambol, hand in hand on a flame of desire, upwards.

Since June 2003, though, the two have been falling out and equity has gamboled alone ever higher. Where is the love?

Such splits are not unknown. Spats (negative correlation) typically occur when uncertainty and doubt creep corrosively between the lovebirds. What are more unusual are long term separations.

Exhibit one: SPX and US 10-year bond yield (inverted), 1995-2000 (click for larger image)


The period 1996 to end 2000 was especially difficult for the couple. The movement of one explained less than 40% of the movement of the other. In the preceding 15 years they’d hung out together over 75% of the time. In particular, they grew apart from late 1998 as Mr Equity’s substance abuse problem (liquidity) began in earnest following a series of confidence-sapping encounters involving Asian currencies, Russian debt and the cleverest hedge fund ever.

Exhibit 2: Global liquidity (Foreign Official Assets Held at Federal Reserve Banks) and the SPX, 1971 to date (click for larger image)


Abruptly, from 2000, it became more difficult for Equity to get high. By the end of the year liquidity dealers were even raiding users and Equity got the withdrawal shakes. But Ms Bond seemed to be making a new life for herself and by 2003 was a world away from the sad withered creature she had been in 1999.

Exhibit 3: SPX and US 10-year bond yield (inverted), 1995-2000 (click for larger image)


In a desperate gamble to get her back - and himself in a Good Place - Equity went back hitting the liquidity with a vengeance in 2002. For a time it was like old times for the couple. Sweet. Yet quickly Bond found it harder and harder to keep up with Equity. And when, by 2006, he had taken to giving her odd looks whilst humming wistfully “Don’t cha wish your girlfriend was a freak like me?” (stay on topic, right click) she knew something had to give.

As did observers who knew, thankfully, Equity had begun easing off the liquidity. They just hoped the process wound down gently so everyone could get back to normal. HIOBs.

Sources: Yahoo Finance; Statistical Supplement to the Federal Reserve Bulletin; Federal Reserve Archival System; Federal Reserve Economic Data (FRED); Market uncertainties and stock-bond correlation, Dr F Bulthaupt, Q1 2004, Dresdner Bank

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PartyGaming update

Wednesday, October 04, 2006 | | 0 comments »


UPDATE to recent posts (1, 2, 3) on UK gaming stocks:

Many visitors here are looking for guidance on the prospects of UK gaming stocks prospects, particularly PartyGaming (PRTY).

Some things are clear for them; the US is 75% of rev and 50% of custom - they are losing good clients; the massive $500m revolver negotiated last time they reported is surely subject to review by lenders; it will be very difficult to raise replacement debt on favourable terms; or tap markets for fresh equity without a large discount; they have already cancelled the interim dividend, not as good a sign as they have spun it; and, bar Presidential refusal to sign the Senate bill (chance would be a fine thing), it is unlikely recovery will be quick. One glimmer of hope is that they are now, ironically, takeover targets from big US casino operators.

However, the risks of this sector are now plain to see (even to those who did not read the PRTY prospectus) and outweigh the immediate odds of white M&A horses charging to the rescue.

Let the dust settle.

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Simon Jefferson, guest contributor, writes...

I go to parties, sometimes 'til 4.
It's hard to leave when you can't find the door.
It's tough to handle this fortune and fame.
Everybody's so different, I haven't changed.
Joe Walsh, Life's been Good (to me so far)


For dedicated market watchers there are simply dozens of indicators around to spook or cheer the Bull or the Bear. For more casual observers like myself the best I can usually mange is the business news of my chosen rag and just keeping my eyes open; it's amazing what you can pick up from just walking around - never to be repeated offers, empty stores, increased vacancies etc.

One of the most striking things I have come across is the current advertising campaign of Saxo Bank in Copenhagen Airport (and other global sites). Saxo are keen to let us lose fortunes (probably with a helpful loan from them) - I refer you to their tag line:
"Dollar Drops, You earn – simple as that! Learn to trade FX like the pros. It's easier than you think."
Well, if was really that easy. But for every winner there is a loser.

All of which brings us nicely to the subject of hedges. Not the green things bordering your estate but those paragons of rectitude whose whole ethos was to "diversify risk" and whose publicity scam has been "Trust us, we're diversifying risk, we don't need regulation or some busy body sticking their nose in”. This is a lie. Not a half-truth. Nor economical with the actualité. It is a lie.

Many if not most "hedge" funds are taking big time-gambles with your and my money: witness the demise of Connecticut-based Amaranth Advisers where $6.5bn has apparently been lost from a fund "worth" $9.5bn at the beginning of August. So good were their controls and so well was the risk diversified that a 32 year old trader in Calgary was able to blow the lot.

Over here pension funds are piling in and the Financial Services Authority even wants such funds to be available to the public.

You really couldn't make it up.


NB1: Simon Jefferson is a widely-travelled and experienced finance professional; and he's cautious these days.

NB2: [Editor adds] Saxo are not alone. I have seen both HBOS plc and Société Générale aggresively touting leverage (CFDs in this case) to the general public in recent months.

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Update: A PartyGaming plc shareholder / potential shareholder? This may interest.

And the improbable moves closer to reality, pending Presidential signature. Monday morning expect the UK gaming plc's to take a serious spanking.

Senator Frist's legislation may be vague (poker sites appear to have room for argument on the basis that it is subject more to skill than chance); it may not amend the equally vague (for non-sports wagers) 1961 legislation; it may be close to unenforceable for the financial institutions it is aiming at; and it may be a violation of WTO treaties (there is talk of a pro-gaming legal challenge). But it looks like it will become law on signature plus 270 days unless President Bush sends it back (don't bet on it).

And that will make operations a great deal more complicated for the UK's gaming sector.

The text of the amendment can be found here, on pages 213 to 244.

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There have been a few unexpected referrals to this site but none more so than the google search for “chopstick market in Turkey” which returned CC in top spot.

Initially, this was nearly reason enough to short Google. Then, downtime and curiosity begged the question, just what could possibly be so interesting about chopsticks as to merit a google? The Top Five CC answers reveal an unsuspected richness to the utensil's character belied by the words "chop" and "stick":

  1. Chopstick etiquette in China demands that the palm face down or else the diner will be considered vulgar (source, Wikipedia).
  2. Japan consumes 200 pairs of chopsticks per capita per year (source, Washington Post).
  3. Singapore Medical Association members Leung, Poon and Lo considered death by chopstick from both “a clinical and cultural perspective” in their published paper Chopsticks and Suicide (source, Singapore Medical Journal 1995 vol. 36, no. 1, pp 90-91).
  4. In a gesture to environmentalists, China imposed a 5% export tax on chopstick producers in May this year. Exporters responded by raising prices 30%
  5. Reacting to these developments, a spokesman for the Japan Chopstick Import Association (yes, really) said, “We are not in an emergency situation yet” (source AP).
To the recent emailers with the kind words about the site, apologies. This is the last time chopsticks will be studied (even if the Mercantile Exchange establishes a contract for them).

Enjoy the weekend.

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"What we care about is GDP and earnings growth of emerging market companies. Who cares if they are small now, the real question is can we make money off of emerging market growth? Are emerging market stocks cheap right now? How about addressing these much harder questions?"

This is a new comment on an old post. The post in question argued that emerging - and emerged - markets are worth considering from a human development perspective and not merely on the basis of GDP and (by implication) earnings data. Market size did not necessarily matter: economic, political and social development did.

Exhibit 1: Updated chart of selected country data (right click, new tab for large image)


Implicit was the idea that country stability is worth a great deal when investing in emerging economies.

Take the example of Thailand. Until the military intervention this month it had been democratic for 15 years. The journalists say this was a coup based on disagreement over the policy employed against Muslim insurgents in the south of the nation. On the one hand sat the traditional power of the army arguing jaw-jaw. On the other sat the Prime Minister arguing war-war.

Investors may be happy the army lost patience with democratic processes (jaw-jaw being the vastly superior option) but in other circumstances the absence of the rule of law might have been catastrophic for portfolios – and more importantly – for the well being of Thais.

Taking account of the principles represented by events such as the Thai coup is - or should be - an integral part of the answer to the questions posed in the comment. In this case the principle is that the Thai military will intervene in politics when it decides it needs to.

GDP and growth rates can never be the whole answer. Systems - political, legal, social and economic – have greater impact for a populace. And for banal investors seeking returns also. If they can simply be spat out of the pram at will we should all be wary.

NB: As for specific answers to the questions (which are not the hard ones in my view): emerging markets are not in a vacuum and (generally) are highly vulnerable to the US slowing down. But if you think that’s just not going to happen, the Thai shipper (to stick with the Thai example above), Precious, has a nice little niche market, appears historically cheap and, when not having its ageing freighters impounded as unseaworthy, generates good cash from the shipping trade between China and the Mid East. May the force be with you.

Looking beyond imminent US or Chinese cyclical downturns, and if the commenter wants less risk, South Korea is promising, particularly financial services to an ever more prosperous population.

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Site additions: Recent Comments

Wednesday, September 27, 2006 | 1 comments »


Since the site moved to the new beta blogger platform many of its older posts have been inexplicably re-indexed by a number of economics/finance aggregators and readers. These posts now appear "new" despite carrying dates (sometimes) over a year old. In some cases they have attracted comments.

The long and short of the matter is that so future comments do not remained buried, a "Recent Comments" box (courtesy of Storago.com) has been added in the right column. A few comments have been copied and pasted into this new system so it initially does not look lonely but it is otherwise automatic.

There are a couple of bugs, but with some luck these will be ironed out soon (ie I have asked someone for help).

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The German ZEW economic sentiment indicator posted a much worse than expected decline this morning (it is at -22 versus an expected reading of –9) to sit at its lowest level since January 1999.

The survey behind this indicator is answered by a sample of German financiers. Its predictive value of German GDP and service activity is not helpful; but it is a solid, if volatile, indicator of German manufacturing activity 2 quarters out.

If predictions of recession have not been posted here this year it is because there is so much of it about in the press generally and history shows it to be a guessing game. But for the record (and doubtless this is going to come back to bite) the model used here covering the United States flashed red on all fronts for the second quarter '07 on the basis of various August monthly data releases.

The financial sector of Europe’s main economic engine also is now anticipating a US downturn from Q2 2007 and expects German export manufacturing to suffer as a consequence.

How much this is a reflection of US expectations leading - falsely or otherwise - international expectations remains to be seen.

Exhibit 1: ZEW Indicator of Economic Sentiment



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Conclusion:
Still worth looking at - but with a proviso since 2006.

As China moves in 2006 to being a consistent net exporter of steel its influence over an important driver of the Baltic Dry Index (BDI) – iron ore for steel production - grows. But China’s massive growth in steel output has come in large part though government intervention. This, to some degree, is distorting the underlying freight rate picture.

To what degree is key. The level and volatility of the BDI is influenced not only by total commodity demand but also by fuel costs, seasonality, fleet numbers, route bottlenecks and sentiment. These additional factors should temper conclusions about the relevance of China’s steel activities on the level of the BDI.

Discussion:
The BDI has in the past been helpful to assessing global economic activity. It is, after all, a reflection of real prices paid to ship production inputs across the globe. Since March this year the index has been on a tear, rising 70%, or 1,750 points.

Exhibit 1: BDI vs 10 Year US treasuries, 2002-2006 ytd


Hang on – aren’t we supposedly on the cusp of an economic slowdown? If 10-year treasuries still lead the BDI (as in Exhibit 1) a dip in the BDI is around the corner. Some other indicators also suggest this may be the case - drops in crude prices, widening US credit spreads, inversion of the 10 year vs 3 month US yield curve, a flat S&P500 versus the prior six months and the Chicago Fed’s National Activity Index all signal below trend growth in the US, the main driver of the global economy.

Meanwhile, though, the BDI marches up.

Some explanation for its rise lies in the summer heatwave in Europe. Several nuclear reactors - in Spain, France and Germany - were shut down or operated at reduced output because the waters cooling their cores were too warm. Increased thermal coke was shipped to fire the power stations plugging the energy gap. However, thermal coke is only 18% of the total dry bulk trade; and these incremental shipments, a fraction within that, cannot account for most of the BDI’s increase.

But huge steel production by usual suspect China, demanding impressive quantities of iron ore imports, might. China’s imports of iron ore represented 13% of total dry bulk trade in 2005. Given that in the half year 2006 Chinese iron ore imports jumped 23% that share has at least held steady and probably risen.

Chinese steel production has correspondingly accelerated. To June 2006 it churned out 35% of global output and has become a consistent net exporter of steel since the start of the year. Which is essentially the same time period over which the BDI has counterintuitively taken flight.

Exhibit 2: Chinese imports & exports of steel, 2000-2006


Image courtesy of the Iron and Steel Statistics Bureau

Unfortunately, China’s steel output is not entirely demand led. A recent study by the American Iron and Steel Institute and the Steel Manufacturers Association argued that China’s production has been driven by WTO violating trade protections and subsidies. While both organisations might want to consider the relative shades of kettles and pots much of what is alleged rings true.

If so, China is in effect artificially boosting freight rates on an unprecedented scale (by having become the largest iron ore consumer and steel producer). Having saved non-sino steel producers from their own chronic overcapacity through large imports over the period 2000 to mid 2004 China is in danger of joining the bane of the industry. And possibly just in time for a trough in the global economic cycle.

Exhibit 3. Global steel production – demand led? Incremental growth is practically all Chinese
Image courtesy of the Iron and Steel Statistics Bureau

Clearly, China is but one factor at work on BDI freight rates alongside fuel costs, ship numbers, seasonality, sentiment, port and route traffic, and global commodity demand / GDP changes. But it is there and is becoming more politically thorny now the country is a net exporter of steel: how does a nation employing over 2 million in steel production* realign its output with demand without social turmoil - and without provoking WTO trading partners?

In the meantime BDI readings should probably be interpreted with a bit of care.


* A 2001 statistic, the most recent found. Since then China's steel production has tripled. Employment numbers have doubtless balloned too.


Sources: Goldman Sachs Global Investment report, March 22 2006; Iron & Steel Statistics Bureau; ABN Ambro Thailand Transportation coverage, August 2006; Qingfeng Zhang, A Comparison of the United States and Chinese Steel Industries; Review of Maritime Transport 2005, UNCTAD

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Note to subscribers

Thursday, September 14, 2006 | 3 comments »


In order to add improved functionality (notably, "Categories") to the site Capital Chronicle is being migrated to the new blogger beta platform. A secondary effect of this is the entirely new look (because re-coding the old look under the new system is making voluntary euthanasia look attractive).

The whole transition ought to take a couple of days only.

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RJH writes...

Codascisys (CSY) demerges at the end of the month. Looking over the financials, sector and management commentary one wonders why.

Demergers in the UK were rare before the 1980s at which point they were encouraged via tax incentives in order to break up inefficient (allegedly) conglomerates.

Market capped at £128m CSY is hardly worth the bother on that rationale although management claim Coda and Scisys are very different animals. The broader argument they offer is that value gains will come through better organisational and incentivisation focus. And of course two boards eliminates difficult discussion over which business is more deserving of funds.

Still, this looks fairly thin logic for a business selling at 20 times earnings. Science Systems removed Coda from the-road-to-nowhere when they bought them from Baan 6 years ago. Growth since has been steady; financially, the company has net cash [for those who still look at balance sheets, the £19m long-term liability is deferred income]; and key ratios have moved up over the last 3 years from an already decent base in 2003. Together things have not been too bad and, despite management claims that operating costs will remain as is, it is hard to believe there won't be increased margin pressure from the split.

On the other hand, the demerger looks likely to increase the odds of a re-merger or bid with/from third parties. A Scisys potentially market capped at circa £35m looks especially vulnerable: in 2003 Vega plc sought to buy them but decided not after completing due diligence. They may regret that seeing Scisys turnaround since.

If so, this scribe advises them to consider early action. Academic research* reveals that the smaller bits of small company demergers outperform the broader market by 27% over the following 780 trading days (the other bit outperforms by 9% but after a very poor first year).

Which, assuming the end-September interims are sound, points investors towards accumulating Scisys equity post-demerger.

*Thomas Kirchmaier, The Performance Effects of European Demergers, May 2003 (Centre for Economic Performance, London School of Economics and Political Science)

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RJH writes...

PartyGaming (PRTY) released strong interim results this morning which have been overshadowed by the arrest of a second gaming executive, Sportingbet's Non Executive Chairman Peter Dicks, in the early hours. An initial hearing will be held for him at 09h00 US eastern and 14h00 UK time.

PRTY is exposed, theoretically, to the United States 1961 Wire Act under which Mr Dicks, like Mr Carruthers of Betonsports before him, has been detained. 'Theoretically' only because the US 5th Court of Appeal ruling in 2002 that the 1961 Act does not apply to online bets on games of chance like PRTY's online poker rooms (as opposed to sporting events) has not been tested in the US Supreme Court.

Rather, the threat of new anti-gaming legislation is what looms over PRTY. Although this scribe sees that outcome as improbable (hard to table an anti-gambling law ahead of other Senate priorities, strong pro-gambling lobby, chances of passing legislation governing moral conduct doubtful) it is possible and would crush PRTY given that 75% its revenues come from United States. Political moods do change, hence the group's furious non-US acquisition activity.

Whatever its chances of making the books, the legislative threat from the US is not going to diminish: there has only been one year since 1999 when proposed anti-gambling legislation has not been framed (last year). And as inviting to investors is the potential opportunity to buy PRTY on these threats (or maybe even shortly after Mr Dick's hearing) owning the equity would not be stress free.

But with great growth, ferocious cash cow characteristics (negative working capital), a market leading position and cheap equity yielding 5% many will take the gamble and, like a brave (or is it caught-in-the-headlights?) quarterback, stay in the pocket.

Unlike the scrambling and heavy selling in June and July by the founders, Chairman, Chief Executive, Finance Director (entire stake), and General Counsel / Company Secretary.

Postscript: There is more nuance to the legislative threat from the US than this post sets out. Several US states have laws specifically aimed at casino games run via the net. How these can be used by prosecutors to charge individuals beyond state lines is entirely unclear. The NY Times has this article covering some of the ground.

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RJH writes...

Abbot Group is a company this scribe wants to like. Self described in its own interims today this way:

The Abbot Group is the largest offshore drilling contractor in the North Sea, one of the largest international land drilling contractors outside the Americas, operator of mobile offshore drilling units and a world leader in drilling rig design, construction and operation.
Executive Chairman Alasdair Locke has transformed and focussed the company to this end since 2001. The happy result is that the group has hit a sweet spot and operates in an environment of high demand for its services. Its sector, notwithstanding the crude-price weakness of the last week, is likely to benefit from that demand for at least the medium term (say 5 years).

Even the political outlook is favourable given the probability of Labour losing the next election: a Tory government may lead to an end of the opaque and arbitrary 'super' taxes on North Sea energy operations which Messers Blair and Brown have imposed when the spirit moved them. That would increase exploration and production activity - and demand for Abbot's expertise - further.

Further, with M&A mania well underway generally, interest from larger suitors (Halliburton, for example) is not unimaginable.

Yet Abbot's transformation is having a cost. Key ratios have declined year-over-year since 2003 and look set to again for the full year 2006.

Exhibit 1: Selected liquidity, profitability, productivity and solvency ratios


The assumptions used for 2006 are that the balance sheet remains as per the interims; full year sales match the 2005 interim vs 12 month split; and that full year EBIT matches the 2005 run rate, plus 10%.

Combining the first four of these ratios via the Z-score formula of Edward Altman, usually a bankruptcy predictor but used here as a proxy of management's performance, produces the following picture:

Exhibit 2: Abbot Group's operational / managerial performance as per its Z-score


Any result over 2.9 is safe; results between 1.23 and 2.9 suggest caution.

The conclusion is that Abbot is a leveraged bet with a vastly expanded asset base (particularly over the last two years) but thus far the productive sales and profitability generation of that asset base is unproven.

Abbot's expansion logic is impeccable and aggressive buyers of the shares will be counting on Mr Locke and team sweating the acquisitions more than has been the case. More finicky onlookers, despite fantastic macro conditions and 2007 forecasts, may want to see actual parallel gains in internal excellence before committing.

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RJH writes...

Today's final results and commentary are a testament to John Weston and team's making the best of a bad hand. Few thought it possible; and it is the financial equivalent of the 1940 Dunkirk evacuation. These accounts are likely to be qualified by the auditors (see nota bene below) but the group lives to fight another day.

Management have avoided both a cash call (so far) and a debt for equity swap; they have secured funding through 2007 (subject to conditions and at extra cost including warrant issues to lenders); scrubbed the accounts with a huge write-off relating to the Torex merger (thumping book value down to 11p/share); and protected (somewhat) their flagship product through a memorandum of understanding with CSC.

However, the path forward is still fraught with risk as the US 10k style "Risk Factors" section makes plain (a welcome change from the previous régime's idea of "need to know"). Key amongst these is the reputational impact. As the commentary says:

"...concerns surrounding iSOFT have had an impact on the propensity of customers to enter into contracts with the company. In this regard the group has revised its bank facilities providing a period of stability during which it can consider and implement a suitable long term financial strategy."
Other firms have faced similar - worse even - reputational disasters. Perhaps iSoft can draw something from the experience of ValuJet Airlines, a no-frills domestic US carrier whose attractions for passengers disappeared with the crash of one of its flights in 1996. ValuJet changed name, operating strategy and merged with AirTran Airways. The group is now arguably the leanest and best placed domestic carrier in the US.

Today's announcement makes much possible and probable for iSoft. Name changes. Strategic reviews.

And bids.

NB: A legacy of the previous regime is a lack of records of cost and activity on a contract by contract basis. The new accounting policy of the firm demands this. But in its historical absence the auditors (say iSoft) cannot confirm on a 'true and fair' basis that revenue from existing contracts is being matched correctly to activity.

The author owns iSoft plc equity but this should not influence readers into thinking that iSoft is in anything other than a very very bad way.

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RJH, back from holiday, writes...

Financial markets are linear. Except when they are chaotic.

Current energy markets in this light are intriguing. If crude is behaving linearly it theoretically ought to (sooner or later) revert to its mean. That mean since 1970 sits in the $35-$40 per barrel range (real dollars). Excluding the two oil price shocks of the 1970s puts it around $30 per barrel.

So at $70 per barrel the case seems obvious enough that the demand curve has made a non-linear (or chaotic) jump to a higher trend path. Yet the data does not quite fit this hypothesis.

Exhibit 1: Trends in the oil market since 2000. Right click to enlarge.


Exhibit 2: Assorted background data for the hardcore. Right click to view.



Since 2004 global demand has slowed. US demand, 24% of the total, has even declined over the period. Even so, supply has not kept up - most notably crude production (supply includes other elements such as natural gas plant liquids). And, above all, refining capacity has trailed demand increases. Until China increased its refining output by 1.6 million barrels per day versus 2005 global refining capacity had lost ground to demand every year since 2000.

Which suggests less a shift of the demand curve than glacial market adjustments to supply.

Yet slow though the process is, crude production and refining capacity (NIMBYism and all) are adjusting as high prices - after 30 odd years of cheap crude - attract capex. Whether this can (ever) come fast enough to match the pace of increasing demand is the long-term key to price levels.

In the shorter tem it is well to recall that oil demand can fall as well as rise. The consensus view is that 2007 will see at least a slowdown in the US economy. That would push down global crude prices.

But peer beyond and the structure of the oil markets remains the same: over 50% of the 10 year consumption growth to 2004 (a per day increase of 14m barrels) comes from 3 nations - the USA (21.8%), India (7.5%) and China (23.4%). That composition is not going to change soon.

Recovery in oil demand from any slowdown will continue to outpace the large investments required in refining and production to balance the market. It may be linear but slow supply equilibrium mechanisms favour the oil sector continuing to reward calm investors.

Data sources: US Dept of Energy's "Energy Information Administration"

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RJH writes...

Remarkable growth, remarkable cash generation, remarkable Q2 key performance indicators (KPIs) issued today by PartyGaming plc and all in a remarkably bombed out sector. Investors looking for bargains are attracted to such situations.

The bomb, the threat of US anti-gaming legislation, appears more Vanuatu than Iran-like. Not only is there too little legislative time in the Senate to read and pass the proposed bill but said bill was already being watered down. This speaks to the question is a huge gambling nation like the United States really going to put a moral "anti-scourge" law on the books?

Nonetheless, PartyGaming take the threat seriously enough to hype its duck-and-dive move of geographic diversification in this morning's KPI release. An unfortunate problem with this strategy is that half the online gaming industry's growth comes from the US. Is it conceivable that this can be seamlessly be replaced by European and South American punters as the Group suggests?

Perhaps, and the large increase (also announced today) of the group's revolving net debt facility to £500m from £200m will doubtless be key in driving this diversification objective. Last time PartyGaming spoke of the £200m facility (full year 2005 accounts) it was undrawn. Today's announcement leaves little doubt that the group has already begun to leverage up its bet aggressively.

However, similarly aggressive has been insider selling in June and July: and amongst the folders are the founders, the Chairman, the Chief Executive, the Finance Director, and the General Counsel / Company Secretary (with these last two now having nil equity interest).

Which compels consideration of just how much faith management and key personnel have in their cards on this gamble.

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RJH writes...

Until the second quarter last year US inflation expectations had been a very helpful leading indicator of equity prices. The second quarter 2005 was also when Mr Bernanke nosed in front of Glenn Hubbard and Martin Feldstein as favourite to succeed as Federal Reserve Chairman. He came as a man supporting implementation of an inflation target.

Coincidentally or not, inflation expectations fell as he became more likely to replace Mr Greenspan (Exhibit A). Yet the Chairman is not, he says, an "inflation nutter" (a Mervyn King phrase): he wants an inflation target harnessed to a policy of "constrained discretion". This would avoid, for example, killing growth as the cost of dogmatically taming prices.

Exhibit A: Bernanke Fear Factor?


Yet it is how unconstrained discretion would be in a targeted regime that intrigues. Belatedly, many equity investors have sold hard, erring on the side of caution by assuming at least some maniacal anti-inflation tendencies on the part of Chairman Bernanke.

Are they right? Rate rises impact two years hence. Given that US rates began increasing timidly in July 2004, continued rises in short-term core and non-core US inflation are probable in a persistently expensive energy context.

Exhibit B: 2% core target? Core & non-core inflation year-to-date = 4.2% and 2.4%


If Mr Bernanke's target is the often referred to core rate of 2% the hard landing scenario of overshooting rate rises is alive and well. Some economists are even increasing the volume on the stagflation thesis.

Inveitable, however, is neither.


Sources: Remarks by Governor Ben S. Bernanke, March 25, 2003; SanDiego.com business news; Briefing.com; FRED (Federal Reserve Economic Data)

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RJH writes...

Another triple witching falls tomorrow. Have things changed for cash index traders following the DAX since this post appeared here a year ago?

There are still no obvious differences in price variance at the aggregate level: the daily points range of all days versus triple witching days displays similar average, standard deviation, median, skew and kurtosis characteristics.

Since December 1990 the DAX continues to trade up on 51% of its trading days; and its triple witching day performances still outperform (click for a larger image):




The following two trading days post-triple witching may also interest (click for larger images):




Make of that what you will bearing in mind the context: a long multi-year bull run to where things stand now, uncertain. Within that, many markets have traded down circa 10% in a string of nearly consecutive declines; and it would be unsurprising to see a technical bounce from perceived oversold positions over the next trading week.

Pending, that is, more macro data.

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