Two Ways to Lose Money
Thursday, October 24, 2013
Charles Rotblut, CFA
AAII Journal Editor

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Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 49.2%, up 2.9 points
  Neutral: 33.2%, up 4.4 points
  Bearish: 17.6%, down 7.3 points

Long-term averages:
  Bullish: 39.0%
  Neutral: 30.5%
  Bearish: 30.5%

Take the AAII Sentiment Survey »

The financial services industry seems to have an endless reserve of ideas for how to make money for itself at the expense of investors. Among the latest of these ideas are an investment in a football player and bonds paying coupon payments with additional bonds. Oh boy....

The first is a tracking stock by Fantex Brokerage Services based on Houston Texans running back Arian Foster’s future earnings. He currently ranks fifth in total rushing yards; a hamstring injury he suffered in last week’s game lowered his season-to-date rank. Last year, Foster signed a $43.5 million contract, which included $20 million in guaranteed salary. Part of this guarantee was a $12.5 million signing bonus.

Fantex wants to sell 1.055 million shares, priced at $10 per share, in a tracking unit tied to 20% of Foster’s future income. Specifically, it is tied to Foster’s future earnings derived from his persona as a football player. If he should do something else, such as write a children’s book or become a musician, those earnings would be excluded. If Foster’s earnings diminish enough in the future, the tracking stock may convert into Fantex Inc. Platform common stock. Foster’s stock will trade on Fantex’s website and the company hopes to sign up other athletes in the future. A regulatory filing has been made with the Securities and Exchange Commission, and the company is waiting for the SEC’s approval.

There is a long list of questions to be asked, with the biggest being: What is Foster’s future earnings potential? The average career of a NFL player is about three years, but Foster is in his fifth year and has so far displayed all-star talent. Running backs, on average, peak at age 27, but some remain very good players after this age. Injuries, however, are a real concern and are unpredictable. How marketable Foster is to national advertisers and what his career will look like after he is done playing is also questionable. Forecasting the future earnings of emerging companies like Telsa Motors (TSLA) and Twitter (TWTR) requires a tremendous amount of guesswork; forecasting Foster’s future earnings is even harder.

New York University professor Aswath Damodaran attempted to calculate the fair value of Foster’s stock and came up with a price of $6.11 per share. He then adjusted his calculations to factor in injury probabilities and determined a fair value of $5.07 per share. The details behind his assumptions are on his blog; it’s an interesting analysis from both a valuation and a football perspective.

The second new idea is the re-emergence of pay-in-kind (PIK) toggle bonds (also called toggle notes). These bonds allow the issuers to make coupon payments either with cash or bonds. The Wall Street Journal said these bonds were originally created in 2005 to fund the purchase of Neiman Marcus Group by private equity firms. This week, a different private equity firm issued $600 million in PIK bonds to help finance its recent purchase of Neiman Marcus.

PIK toggle bonds offer higher yields, which can make them appealing to investors in a low-interest environment. The Neiman toggle notes pay a 0.75 percentage point premium to the 8% interest on its other bonds, while giving the retailer’s new owners the option of issuing additional debt instead of using cash to fund interest payments, according to The Wall Street Journal. This is akin to taking out a home equity loan from your mortgage company instead of writing a check to pay your monthly mortgage payment. The lender lends out more instead of receiving his scheduled interest payment.

PIK toggle bonds are good for private equity firms who use the flexibility to withdraw cash from their portfolio companies or at least want to avoid committing more cash to a portfolio holding. It exposes the bondholders to an increasing level of risk, however, which is why the popularity of toggle notes plunged during and after the financial crisis. The extra yield you receive may be more than negated by the much higher risk of default. Companies financially strong enough not to need PIK notes don’t issue them.

More on

The Week Ahead

Approximately 125 members of the S&P 500 will report earnings next week. Included in this group are Dow components Merck & Co. (MRK) on Monday, Pfizer (PFE) on Tuesday, Visa (V) on Wednesday, Exxon Mobil (XOM) on Thursday and Chevron Corp. (CVX) on Friday.

The Federal Reserve will hold a two-day meeting, starting on Tuesday. The meeting statement will be released on Wednesday afternoon. Because of the government shutdown and the September jobs numbers, no changes in monetary policy are expected.

The economic calendar includes a mix of current and delayed reports as federal agencies try to get caught up. Monday will feature September industrial production and capacity utilization and September pending home sales. September retail sales, the September Producer Price Index (PPI), the August Case-Shiller home price index, the October Conference Board consumer confidence survey and August business inventories will be released on Tuesday. Wednesday will feature the September Consumer Price Index (CPI) and the October ADP Employment Report. The October Chicago PMI will be released on Thursday. Friday will feature the October ISM manufacturing survey and the October PMI manufacturing index. The Labor Department’s October jobs report, which was originally scheduled for release on Friday, will be delayed until Friday, November 8.

Two Federal Reserve officials will make public appearances on Friday: St. Louis president James Bullard and Minneapolis president Narayana Kocherlakota.

AAII Sentiment Survey

Pessimism plunged to a 21-month low and optimism rose to a 10-month high in the latest AAII Sentiment Survey. Neutral sentiment rose.

Bullish sentiment, expectations that stock prices will rise over the next six months, rose 2.9 percentage points to 49.2%. This is the highest level of optimism registered by our survey since January 24, 2013. It is also the fifth time in the past seven weeks that bullish sentiment is above its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged, rose 4.4 percentage points to 33.2%. This is the first time in three weeks neutral sentiment is above its historical average of 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, plunged 7.3 percentage points to 17.6%. This is the lowest pessimism has been since January 12, 2012. (It was also at 17.2% on January 5, 2012.) Bearish sentiment has now been below its historical average of 30.5% five times in the past seven weeks.

This week’s readings almost replicate the readings of January 12, 2012: bullish at 49.1%, neutral at 33.7% and bearish at 17.2%. While history does not always repeat, it is interesting to look at. Bullish sentiment was above average for 15 out of 16 weeks from December 15, 2011, through March 29, 2012. This optimism was accompanied by a 16% rise in the S&P 500.

Pessimism has fallen by a cumulative 16.0 percentage points over the past two weeks and is now at an unusually low level (more than one standard deviation below average). Bullish sentiment is right at the top of its typical range. These readings come as the S&P 500 is within striking distance of its best calendar-year return since 2003. Rising stock prices, better-than-forecast third-quarter earnings and economic growth are keeping individual investors optimistic. Concerns about slow economic growth, stock valuations and the lack of a long-term fiscal solution have not gone away, however, and remain front and center for some individual investors.

This week’s special question asked AAII members how, if at all, the latest federal budget agreement is influencing their six-month outlook for stocks. Responses were mixed. The largest group of respondents (41%) said it was not influencing their outlook. Some of these members said they are more focused on corporate earnings and the economic backdrop or simply take a long-term view toward investing. Nearly 21% of respondents said they are cautious. Concerns about another standoff occurring in January or February was the primary reason why, though some respondents also thought the latest agreement merely postponed the date for dealing with debt reduction and other fiscal issues. Nearly 18% said they are bearish, with some fretting about a market pullback occurring in the first quarter and others frustrated with the lack of progress on fiscal issues. About 9% said they are now more optimistic.
Here is a sampling of the responses:

  • “No change. I invest for the long haul.”
  • “I am pleased—Not at all. I think the economy is the most influential factor in determining the direction the stock market takes.”
  • “I’m bullish for the next three months, and then I’ll wait and see.”
  • “The agreement was nothing more than another ‘kick the can down the road!’”
  • “I would probably be bullish if the clowns in Washington had actually been able to pass a budget.”

» Take the sentiment survey