With major markets back at the levels of 1999, stocks may look like a bargain. They’re probably not.
The casino economy is ending, but the world’s stock markets are still jumping like balls on a roulette wheel. Indexes have plummeted to multiyear lows and leapt in recent days on news of the survival of the world financial system. But the prospect of a drawn-out recession has rapidly sobered investors, culminating in Wednesday’s stunning 9 percent decline in the Standard & Poor’s 500-stock index.
Stocks are supposed to offer high returns to compensate for high risk, so the last decade of flat equity performance – despite its periods of heady highs – creates a problem for investors. Pension funds and other asset managers with long-term investment horizons typically invest most of their assets in stocks. With the stinging losses they’ve suffered, they’ll be tempted to pull out. Recent large withdrawals from stock mutual funds indicate this may have already started.
Historically, selling after a market has plummeted has usually proved to be a big mistake. But stocks do look cheap. The ratio of price to expected 2008 earnings – a gauge of their value – for almost all major market indexes fell last week, according to Société Générale. That is unusually low by recent measures, although a few gray beards may remember the single-digit price-to-earnings multiples of the 1970s.
Additional bait for investors is the low Federal Reserve benchmark funds rate, at just 1.5 percent, and the prospect of falling rates in Europe and emerging economies. Easy money buoyed equity markets after their 2001 crash, and might do so again.
But cheap shares generally get cheaper when profits fall and growth prospects dim. That’s exactly what’s in the cards. A global slowdown is just beginning. Tight credit around the world is set to squeeze consumer spending, corporate profits and investor enthusiasm for risky assets.
Even after the post financial crisis recession ends, central bankers may prove less stock market friendly in the next decade, keeping rates higher than during the last. They should be, since low rates spawn asset price bubbles like the one in the housing market that is still popping.
That means, despite the recent market routs, true value opportunities in the stock market may remain scarce. And, if big investors do decide to take their money and retire to the sidelines, the recent punishing slides may not be the last.
CIT’s Dividend Magic
CIT Group is resorting to financial juggling. For the second time this year, the company — one of the nation’s largest commercial lenders — is issuing shares in part to finance the payment of dividends on its preferred stock, which indirectly allows it to make payments on its common stock. This makes little sense, other than as an optical trick to distract investors.
For years, CIT raked in nice profits by lending to small businesses. But its expansion into mortgages and student loans at the top of the market ended in disaster. It raised $1.5 billion by selling common and preferred stock in April. It just announced plans to raise an additional $8 million.
CIT cannot pay dividends on its preferred stock if its so-called fixed charge ratio, a measure of how comfortably operating profits cover fixed financing expenses, goes below a threshold that it is currently nearing. It barely exceeded that threshold as of June 30. And, if it skips paying dividends on its preferred stock, the company can’t pay any on its common stock either. So CIT is using the proceeds from its common stock sales to pay dividends on the preferred, which has the added benefit of allowing it to continue paying dividends on the ordinary shares.
Suspending the common stock dividend would be smarter, though it might panic some investors. But asking them to buy new shares — and essentially finance the dividends they receive — is not exactly a calming prospect. A variant of this, more popular among European companies, is to pay dividends in the form of stock rather than cash. This involves fewer steps than issuing stock to pay dividends, but is equally illogical. Both dilute earnings per share. Cutting a slice of pizza in two doesn’t make it any more filling.
In any event, this hasn’t blinded investors to CIT’s problems. The company has lost almost 90 percent of its market value in the last year. Shareholders would be better off in the long run if its chief executive, Jeffrey M. Peek, spent more time sorting out CIT’s core problems or finding a buyer than playing games with its dividends.
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Don’t Be Rushed Into Buying Stock
By IAN CAMPBELL and ROBERT CYRAN
16 October 2008
With major markets back at the levels of 1999, stocks may look like a bargain. They’re probably not.
The casino economy is ending, but the world’s stock markets are still jumping like balls on a roulette wheel. Indexes have plummeted to multiyear lows and leapt in recent days on news of the survival of the world financial system. But the prospect of a drawn-out recession has rapidly sobered investors, culminating in Wednesday’s stunning 9 percent decline in the Standard & Poor’s 500-stock index.
Stocks are supposed to offer high returns to compensate for high risk, so the last decade of flat equity performance – despite its periods of heady highs – creates a problem for investors. Pension funds and other asset managers with long-term investment horizons typically invest most of their assets in stocks. With the stinging losses they’ve suffered, they’ll be tempted to pull out. Recent large withdrawals from stock mutual funds indicate this may have already started.
Historically, selling after a market has plummeted has usually proved to be a big mistake. But stocks do look cheap. The ratio of price to expected 2008 earnings – a gauge of their value – for almost all major market indexes fell last week, according to Société Générale. That is unusually low by recent measures, although a few gray beards may remember the single-digit price-to-earnings multiples of the 1970s.
Additional bait for investors is the low Federal Reserve benchmark funds rate, at just 1.5 percent, and the prospect of falling rates in Europe and emerging economies. Easy money buoyed equity markets after their 2001 crash, and might do so again.
But cheap shares generally get cheaper when profits fall and growth prospects dim. That’s exactly what’s in the cards. A global slowdown is just beginning. Tight credit around the world is set to squeeze consumer spending, corporate profits and investor enthusiasm for risky assets.
Even after the post financial crisis recession ends, central bankers may prove less stock market friendly in the next decade, keeping rates higher than during the last. They should be, since low rates spawn asset price bubbles like the one in the housing market that is still popping.
That means, despite the recent market routs, true value opportunities in the stock market may remain scarce. And, if big investors do decide to take their money and retire to the sidelines, the recent punishing slides may not be the last.
CIT’s Dividend Magic
CIT Group is resorting to financial juggling. For the second time this year, the company — one of the nation’s largest commercial lenders — is issuing shares in part to finance the payment of dividends on its preferred stock, which indirectly allows it to make payments on its common stock. This makes little sense, other than as an optical trick to distract investors.
For years, CIT raked in nice profits by lending to small businesses. But its expansion into mortgages and student loans at the top of the market ended in disaster. It raised $1.5 billion by selling common and preferred stock in April. It just announced plans to raise an additional $8 million.
CIT cannot pay dividends on its preferred stock if its so-called fixed charge ratio, a measure of how comfortably operating profits cover fixed financing expenses, goes below a threshold that it is currently nearing. It barely exceeded that threshold as of June 30. And, if it skips paying dividends on its preferred stock, the company can’t pay any on its common stock either. So CIT is using the proceeds from its common stock sales to pay dividends on the preferred, which has the added benefit of allowing it to continue paying dividends on the ordinary shares.
Suspending the common stock dividend would be smarter, though it might panic some investors. But asking them to buy new shares — and essentially finance the dividends they receive — is not exactly a calming prospect. A variant of this, more popular among European companies, is to pay dividends in the form of stock rather than cash. This involves fewer steps than issuing stock to pay dividends, but is equally illogical. Both dilute earnings per share. Cutting a slice of pizza in two doesn’t make it any more filling.
In any event, this hasn’t blinded investors to CIT’s problems. The company has lost almost 90 percent of its market value in the last year. Shareholders would be better off in the long run if its chief executive, Jeffrey M. Peek, spent more time sorting out CIT’s core problems or finding a buyer than playing games with its dividends.
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