Wednesday, 8 October 2008

Macro-Level Trends – Financial Markets Contortion – VW (momentarily) at #1

As the over used euphemism 'contagion' spreads across the globe, this week undermining Europe's banking sector and more sharply spreading concerns throughout Asia, so regional regulator's have sought to pull more and more economic levers to calm the raging storm. The Fed's landmark TARP initiative comes in the wake of previously failed Treasury & Federal Bank ad hoc efforts, the ad hoc approach used to avert the risk of encouraging further 'moral hazard'. Now TARP has been followed up with a major US rate cut - timed with a similar global-wide central banks strategy - which together try and both provide 'lubricating' liquidity and improve business investment confidence as Large Cap Cos and SMEs face their toughest operating challenges yet.

Since the ripple-effect (or rather tsunami-wave) washed across to Europe, national governments have had to look selfishly to their own level of exposure and associated economic risk. Euro-skeptics like the UK's re-emerged, experienced and vocal Norman Lamont (ex Conservative Chancellor of the Exchequer) commentating on the noticeable fractures appearing within the Euro-Project, as individual national governments seek their best nationally-biased defensive economic plays at this critical point of the storm.

Germany has perhaps come under the heaviest criticism for its policy and regulatory reaction, not at all surprising given its role as as the central promoter of the EU ideology from the earliest days. Encouraged by the success of its own re-unification in 1989 it touted the economic advantage of strength in numbers via cross-continent unification. That has for the most part been proven true, EU expansion and value creation apparent for a decade, but conversely and controversially, just prior to the brink of the sub-prime credit-crunch in August 2007 Germany appeared to gain 20/20 foresight. It started to build its own economic defense barriers across national-industry via M&As (eg Schaeffler-Continental) and seemed to rouse quiet but powerful political pressure. Done so to maintain and strengthen an implicit corollary that holds-together intra-national business confidence; that political will obviously focused on the formally separate, yet endemically close-coupled, multi-tiered banking sector.

That sentiment of comradeship in the national interest to manage risk has been most apparent with recent banking sector consolidation including Deutsche's buy-into Postbank, Commerzbank's takeover of Dresdner and Commerzbank in turn assisted by Allianz. This latter kinship derived from the insurance company's free-cashflow dominant business model that underpins its own and associates' Balance Sheets. However, comradeship does not include illogical self-sacrifice, as seen with peer-group aversion to Hypo-Real Estate. Those with most complex and opaque Balanced Sheets (even with apparently 'solid' underlying assets) are rightly recognised as a step too far, at any price, given the possibility of internalised domino-affect decline that would only de-stablise the sector and nation's economic base furthermore. Thus Merkel's Government and the Bundesbank have had to, like its US and UK peers, step into the breach to ease capital market, industrial and national tensions.

Given German historical 'sozial-democratish' leanings the possibility, indeed probability, of proactive governmental intervention, whether invisible or explicit, has always been recognised by its capital markets. Even with Merkel reigning over a grand co-coalition of CDU-SPD encouraging progressive 'lassaiz-faire' economic attitudes the onset of previously potential, and now realised, hard times effectively re-set the German psyche; especially so at the main Frankfurt DAX Bourse.

And since the intervention policy templates to stem market losses & possible collapse were being effectively set by the US and UK market participants were aware enough to recognise Berlin's probable moves. And having seen the SEC and FSA essentially ban short-selling to avoid the driving-down of the market, although regarded not such an issue in Germany with less Hedge-Fund and Speculator action (given the 'Vulture-esque' repute), it was always a realistic early option to execute as was aired a couple of weeks ago

Thus, the sharp momentary 55% intra-day spike in VW common stock, following the 27% leap on 18th Sept, could be viewed as surprise, both in terms of time-lag and ferocity.
(As widely reported, the spikes are the result of off-setting contra-buy strategies from those who'd previously shorted the stock, but had to cover their positions when the expected decline didn't actually eventuate).

But given the 'awareness' of the general market to the probability of a short-sell ban it's interesting to note trader's mass behavior. Although there was a generally controlled contra-buy wind-up, each trader will have been trying to double guess the timing of eachother's buy movements and relative positions in such a sensitive market. Yet ironically, as seen in the US Great Depression's short-sell ban, a mass of traders trying to cautiously avoid over-paying can paradoxically post-pone many buys resulting in market rush which unsurprisingly spirals price.
Of course although market theory posits informational transparency for all, the reality (even with nano-second quick price information services) cannot illustrate the psychological 'moods and modes' of all VW shorting participants. Thus the wrong double guessing other trader's actions by the majority of trading mass may have generated the ferocity.

Additionally, given that Porsche Holdings SE holds (presently) 35% of the company's stock and the State of Lower Saxony holds 20%, there is only 45% or so available as free-float. It is estimated that a third of this available equity (15%) was previously being shorted, given the poor outlook for the auto-sector; the remainder held by passive ETFs (Exchange-Traded Funds).
What's interesting is that the bourse itself didn't step-in to halt VW stock trading when it was so obvious that market reaction and rapid stock rise was wholly due to extraneous factors, not the core earnings outlook fundamentals or other incoming information game-changers. Given this weeks hellish market drops, and the very contrast to mass-index behavior, one might well suppose that the bourse operators momentarily turned a blind-eye given the corporation's powerful influence on the dour DAX and Eurostoxx indices.

The previous expectancy of a significantly lowered VW stock price that short-sellers were banking on would have played favourably into the hands of Ferdinand Piech and Porsche Holdings SE given their stated intention to buy 51% or so of the company by month-end. So the shorting ban must have infuriated Piech who is keen to extol the potential synergies between VW (specifically Audi) and Porsche, aswell as recognising that the markets would have boosted Porsche's own stock-price for having obtained such a sizable additional stake in VW AG for such relatively little expenditure.

Thus the remarkable rise of VW's Market Cap value, widely reported as now the world's #1 automaker beating Toyota, will be recognised as essentially fatuous and a result of very contorted market dynamics. Yes VW has been the automotive darling of capital markets maintaining a very valuable upward traction of over 50% valuation YoY to date, but given the very specific, short-lived driving-factors that saw the stocks spiking, it is fundamentally irrational to expect VW to maintain such a climb in the long-run, even if as is probable many of the short-sellers who took-on the contra buys keep buying to defend the own considerable present exposure.

Indeed general 'long-play' investors beyond the ETFs will seek to see a valuation-drop to get back in the game and benefit from a soundly based re-growth period as VW introduces the all-important 6th generation Golf, a core revenue contributor given its #1 standing in Europe and its high potential as the catalyst for capturing the new CO2 literate 'diesel progressives' segment of US mass-market.

As for Piech and Porsche Holding's ambitions for VW ownership, could he be brewing an alternative ploy that involves the Hedge Fund owners of that all important 'over-paid' 15%?