Friday, December 12, 2014

How Was 2014? Not Bad?

Not glowing, but not bad
This was the year that stayed the course, proceeding along a smooth track with occasional bumps in the road until the bottom nearly fell in early autumn. In the beginning, financial consultants and those who dare to project a year or two down the road reminded us that stock markets couldn't repeat the astounding double-digit returns of 2013. But the markets, they said, could still manage satisfactory returns.

Now there's that bit about our rocky autumn, when markets tumbled and rumbled, and we had begun to wonder whether another crisis or period of turmoil was on the horizon. So in finance, how has the year turned out?


The year has been eventful, but it won't deserve a long chapter in financial history. For much of the period, we prepared for "tapering," the Federal Reserve's plan to pull back on "QE"(Quantitative Easing, or its efforts to ignite the economy by buying bonds, thus injecting more money into the overall supply and keeping interest rates low.) We braced ourselves (as we have done for a few years now) for the Fed's pull-back and for a sudden rise in interest rates. 

Financial advisers warned about loading up portfolios with fixed-income securities (especially those with longer terms) lest interest-rate increases would cause rampart losses. But soaring interest rates haven't happened yet (at least not in 2014), and bond portfolios haven't plunged as much as many have predicted. 

In corporate bonds, the looming 2014 story is investors' desperation for higher returns in a low-interest environment. In the hunt for a decent return, they have "chased returns" by accepting more risk. Hence, investors that heretofore wouldn't touch a non-investment-grade (or "junk"?) bond are now getting comfortable with purchases with credit grades below BBB+. They reason it's worth the risk of probability of default to get a return much higher than the paltry 1-2% returns on high-rated bonds. 

Risk-management skeptics are watching this trend closely. While the demand for more yield pushes upward the demand to invest in more corporate bonds near "junk" thresholds, it also increases prices higher than they should be on a risk-reward scale. 

This leads to investment portfolios becoming saturated with risky bonds, which, at least right now, don't appear risky, but could become a terrifying albatross in a market downturn. The skeptics say chasing yields too much by taking more risk leads to being insufficiently compensated for the risks accepted. 

Fixed-income departments, meanwhile, at major financial institutions (known in the industry as "FICC" ("CC" refers to currencies and commodities)) continue to languish. Banks have observed declining volume, so much so that they can hardly rationalize supporting FICC departments. 

They suffer, too, from the industry's migration toward electronic trading. (Equity markets and trading have experienced the same migration, too, toward computer trading.) Banks and dealers, especially those that rely on trading volume to generate profits, can no longer justify hiring and paying high compensation for rows of trading desks populated by high-bonused humans. 

Some banks have elected to withdraw from FICC; others, like Goldman Sachs, have decided they have the edge and capital to profit from sheer heft and the  massive volume partly achieved from other banks' paring down FICC units to bare bones.

MERGERS AND ACQUISITIONS: The Trends for the Moment 

Statistics show this has been a banner year in mergers and acquisitions. Big banks and boutiques have thrived. From the flurry of deals, two trends have surfaced: 

a) Activist shareholders have become forces to be dealt with. They have evolved into industry-shapers who confront board members and shareholders and exert financial will-power to get their way regarding strategies to increase a company's share price. No company is off limits, whether it's Apple or Herbalife, as we've seen in the last two years. 

When they "get their way" or successfully convince board members or big shareholders their financial strategy will work, that results in a barnyard of M&A activity--a sale of assets, a sale of divisions, a separate spin-off to existing shareholders, a proposal to acquire another company, or a proposal to sell the entire company. 

b) We appear to be in a financial era where selling off unwanted, lagging, money-losing or unrelated operations (subsidiaries, fixed-assets, product lines, e.g.) seems a viable financial strategy to boost a company's market value (or share value). This would be the antithesis of the momentous era of conglomerates (in the 1960's and certain periods thereafter). (Credit Suisse has identified over 25 global companies that are now considering or have announced spin-offs, asset sales of significant size, or divestitures.) 

Reflect back, for a moment, to those periods in financial history when diversity in product lines, businesses, and investments ruled corporate strategy. Corporate finance theory supported diversifying assets to reduce risks. Management practice stipulated that a struggling, declining business unit could be offset by another less-correlated, growing business unit. 

Now corporate strategists (and M&A advisers) have promoted a different tactic: Get lean, streamline operations, and focus on what you do best--which means, too, become less diverse. The strategy has spurred some M&A activity in the last year, most notably H&P's announcement to split into two smaller companies (a consumer-products company and a cloud-computing, software company for a corporate clientele). The sale of PayPal by eBay was another well-known divestiture during the year. 

Be watchful, however. M&A trends toss and turn. They depend on investment opportunities and cash reserves held by large companies. They also depend on prevailing fads and financial maneuverings, banks' willingness to finance mergers, and regulators who worry from the sidelines that the careless financing of deals might be getting out of hand. 

HEDGE FUNDS: Who's Shutting Down Now? 

Hedge funds and their industry are hurting. Funds big and fall have disappointed investors; funds here and abroad have shut down in stunning numbers. 

Let's give an example. The S&P equity index, through October, was up 11% in 2014. The HFRI index, an example of hedge-fund performance among multiple strategies, is up only 2%. Investors must wonder why they would share significant profits with hedge-fund managers who have under-performed a basic market (minimal-cost) index. 

Hedge-fund managers argue they offer less volatility on returns (and many statistics prove that), but the argument hasn't been persuasive enough to keep some funds from closing or some of their investors from demanding redemption. 

The better known funds with decades of a track record or those that have (share we dare say) diversified into many opportunities and operations will survive. Citadel, the fund and the firm, and Bridgewater, the fabled fund in Connecticut, come to mind. 


Banks have become stifled by financial regulation, often frustrated, sometimes claiming that regulatory compliance distracts them from trying to find ways to achieve reasonable profits and returns with fewer business lines and surging capital requirements. JPMorgan, for example, announced during the year the thousands it has hired in regulatory compliance and billions it has invested in compliance technology. 

For banks, it was the year to respond to "MRA's," or "Matters requiring attention" from regulators. Stroll the corridors of bank headquarters and listen to executives discussing liquidity ratios and liquidity requirements, stress tests, leverage requirements, and definitions and requirements of "SIFI's," strategically important financial institutions now saddled with even more strenuous regulations. For big banks (Citi, JPMorgan, Goldman Sachs, Wells Fargo, et. al.), it's the new normal. 

Now more than ever, a big bank's board is faced with a nearly impossible challenge: How does the bank achieve returns on capital of 10-12% with reduced leverage, reduced risks, and increased capital requirements and much of that capital invested in compliance activity? Stay tuned. 

BITCOINS: What happened? 

A year ago, a fuss, a fury and an infatuation with Bitcoins swamped business headlines. Some said it would be the investment opportunity of the decade; others swore that Bitcoins, its payments system, and its increasing values would supplant foreign-currency activity or perhaps credit-card payments and some factions of the banking payments system. Proponents argued that investors, traders, large corporations and even consumers would be foolish to ignore the trend. 

Much of the glow of Bitcoins has dimmed, especially after a few Bitcoin-related companies imploded and became mired in legal turmoil. The volatility of the value of Bitcoin, at unacceptable levels, also proved too much for many investors or payments-users. Many were discouraged by the secrecy that surrounds the system and by the complexity in explaining how value and Bitcoins are derived or created. What was valued at over $1,000 a year ago has now dwindled to just over $300. 

Bitcoins haven't disappeared. The desperate urge to get into this profit-surging game before it's too late seems to have dwindled. Meanwhile, the puncturing of an apparent fad gives regulators a chance to catch up, understand the system and consider how to regulate it appropriately--an advantage regulators didn't have when other complex financial instruments were bombarding the markets in the 1990's and 2000's. We assume, of course, regulators haven't shelved the phenomenon for the time being, too. 

ALIBABA: Touchdown on U.S. Soil 

Who knew much about Alibaba before the company decided to plant itself (at least in the way of doing an IPO) on American soil? The company's IPO at the New York Stock Exchange, one of the biggest ever and involving a roomful of stalwart underwriters, might be called the industry's deal of the year. 

The company propelled itself onto U.S. capital-markets terrain with its $25 billion offering and a market valuation around and about $200 billion, threatening to go head-to-head with Amazon, eBay, Google and any digital enterprise on these shores. By becoming a household name in homes from Nevada to New Hampshire, it achieved its biggest milestones (becoming known and talked about). In the board rooms and senior suites at Amazon and Google, they now much take a peek at what's hovering over their shoulders from China. 


Business schools are like the marathon runner who doesn't give up. They adjust and push ahead and change gears. They continue to try to stay relevant. MBA curricula everywhere are tweaked and massaged. Occasionally at some schools, the course outline is overhauled and many have instituted online courses to supplement the case approach, lectures, group work and problem sets. 

Business schools, even the best ones, tag along following trends in business and capital markets, riding the coattails of free enterprise's every move. They are more willing to scrap what doesn't work more than, say, their counterparts in law or medicine schools. And they embrace new topics that hardly existed as a discipline just a few years ago. 

Business schools now sponsor courses in digital advertising, data analytics, venture financing, financial regulation and electronic trading. Just about every year, they redesign core courses, subtracting something, adding a few, rethinking what the consummate MBA graduate should master before landing on the doorsteps of Morgan Stanley, Microsoft, McKinsey or Pepsico. Many top schools require MBA candidates to spend time overseas in projects, internships and courses of study. 

Yet they never feel they've caught up. They worry, too, that tuition costs will deter top students. So they spend perhaps too much in resources to accommodate students with state-of-the-art facilities (to help students justify tuition payments and opportunity costs in not working). In some places, those facilities architectural gems. Schools such as Yale, Wharton, Michigan and Stanford (some of them Consortium schools) have built sparkling campuses to attract students and faculty. Those that haven't (Columbia, e.g.) are hustling to do so. 

The year expires with markets trying to interpret the impact of the late-2014 plunge in oil prices. Markets gyrate now and then, even in December, trying to evaluate whether such a decline prices is good for consumers and companies or bad for large energy companies and whether what's bad for energy companies has greater impact than what's good in other sectors.

Some will say, let the markets gyrate a little, when we never expected fuel prices to have dwindled so low. Not a bad thing. 

And not so bad a year. 

Tracy Williams

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