Tuesday, 24 June 2008

Macro-Trends – Stock Market Dynamics – Subtly Building Bullishness?

In skittish equity markets, where volatility has been rife and bankers, analysts, CFOs and public alike seek the new bottom from which to build. It seems that with that in mind, with its own brokerage income as a beneficiary, that Merrill Lynch looks to have taken tangible and psychological steps to try and inject some confidence into investors' outlooks.

Whilst some banking analysts talk of the sector's need to create new business models – including obvious alliances & consolidations - many of the the bulge bracket banks will be reviewing how to stablise deal-flow and put some semblance of sense back into a tumultuous market that have undermined consistent company Market Capitalisation valuations and so, in turn, undermined the very basis of fundamental value assessment.

Until that is done, and a current stormy sea gives way to calmer waters, the very confidence of conventional volume dealings driven by institutional and private investors won't prevail; and that stability is required to create stable MktCap valuations that facilitate acquisitions and divestments, the very core of M&A activity and of course associated Wall St commissions
Thus we believe that by now re-categorising its stock recommendation titles Merrill Lynch is subtly seeking to help create the more buoyant market conditions which underpin its famous logo. In automotive speak, attempting to 'jump-start' the value creation engine and remove its inconsistent 'flat-spot' drops and baseless 'surging'.

Candice Browning, under the banner of “improved investment research”, has created “an absolute system with a relative twist”. In practice this means that ML is apparently demonstrating & communicating analysts' calculation transparency and putting further detail into the recommendation titles.

Critically, this now turns:

- A “Sell” ranking to an “Under-Perform” - which reflects the lowest 20% of expected performers (though this doesn't necessarily mean it will drop, it could rise)
- A “Buy” ranking stock is expected to go up at =/> 10% in price
- A “Neutral” stock is expected to hold or go up (inferred 0-9.9%)

Of course the most critical feature is that absolute 'line in the sand' drawn that will create a new fever of inter-sector competition, irrespective of the specific sector's general performance. The CEOs and CFOs of listed companies will be presumably be seeking to stay out of that bottom band to retain a good reputation.

This in itself is a catalyst for managerial focus on stock-price performance, when at a time for many industries, especially the auto-industry, is facing severe headwinds and is keen to avoid the Market's glare so as to build secure foundations for their long-term corporate futures.
investment-auto-motives believes that Merrill Lynch's new ratings system will set a new format that many of its peer research departments and brokerages will follow.

Nardelli will be glad of the reprieve that PE ownership brings, but Wagoner and Mulally will surely be scratching their heads as to how best to play-out this fundamental shift in investor perception, especially relative to their European counterparts such as Daimler, VW and FIAT.
As for the NA supplier-base, especially those corporations already in Chapter 11, this could put the cat amongst the pigeons, sharply dividing those who appear to have positive futures vs those that don't; indeed any Chapter 11 supplier will do their damnedest to reach above that bottom 20%.

What will this mean in practice?

We suggest that this ML initiative may well be the spark to set-off the new rounds (of much conjectured) alliance building and mergers & acquisitions. All players will be seeking the safe ground and looking to see how their business structures and relationships can be re-orientated to provide the best picture possible. Of course, at best it hones corporate strategy and long-term focus, but at worse it theoretically could lead to informal and formal amalgamations of those companies that present the best price/earnings picture – M&As undertaken for Wall Street's pacification.

Such an unabated hunt for paper-based valuations could result in a re-run of the conglomerate bubble of the 1960s, in which parent companies built up broad portfolios of often un-synergistic sub-holdings that invariably led to ultimate demise as the p/e based acquisition model ran out of steam.

Automotive CEOs and CFOs must resist the temptation to follow the 'paper trail' to temporary success under these new assessment conditions, instead demonstrate to analysts that their operations can be run lean and effective, with only directly synergistic couplings considered for M&A.

Wall Street may be plying on the pressure to both 'clean out' the market systemics and create a new market bottom, but VMs and Suppliers must not be tempted to short-terminism. Instead we may be on the verge of an opportunity to put into practice the new automotive business models that have for so long been diagrams and charts in industry and analysts note pads and strategy presentations.