Contrarian Indicator: CEOs?

In the current recessionary environment, if a CEO comes out to say that all is well, is that an indicator to short the stock?

On the 31st of January, after a worse than expected quarterly loss, MBIA CEO Gary Dunton came out to say that “We believe that these steps, along with reduced capital requirements resulting from slower business growth, will result in our capital position surpassing rating agency Triple-A requirements … and will allow us to continue serving the needs of our clients and investors”

February 28th, John Stomber, CEO of Carlyle Capital, reported that during the fourth quarter the company’s portfolio stabilized and generated returns consistent with our near term targets, continuing to run the business to preserve the value of our shareholders’ equity and to position the Company to meet our long run objectives of earning an attractive risk adjusted return and paying a consistent dividend in the future.

On March 12th Bear Stearn’s CEO Alan Schwartz came out to say that Bear Stearns would have a profitable 1st Quarter and that the company had a $17 billion cushion against losses.

By March 12th, Carlyle Capital is bankrupt. March 17th, Bear Stearns has been sold to JPMorgan for $240 million. MBIA while still grasping to its AAA foresees further write downs and withdraws from Fitch ratings.

MBIA

Carlyle Capital Corporation

Bear Stearns

Such a situation not only brings up a whole lot of questions surrounding the legality of issuing such statements but the very credibility of company guidance. Is this fraud? Or for conspiracy theorists, is the misinformation deliberate, to allow insiders to get out of positions beforehand?

Either way, in current conditions, it might just be a good idea to start shorting a stock whenever a CEO comes out with “good news”.

Are Unethical Businesses Undervalued?

Recently, I’ve gotten into a few arguments regarding socially responsible investing. The argument goes that by holding stock in these companies, one is inadvertently supporting the company’s actions. So buying a stock like General Dynamics, developer of the F-16 fighter jets used by the Israeli army, would be helping to enable war in the Middle East. Or a more high profile case whereby Harvard, Stanford, Yale and a variety of other funds have divested off PetroChina, purportedly supporting genocide in Sudan.

And its something thats only going to happen more often. Research estimates believe that the socially responsible investing market in the U.S. will reach $3 trillion in 2011. Shareholders will also increase the pressure on institutions to divest off unethical firms.

So how exactly does this result in unethical businesses becoming undervalued? If the trend towards socially responsible investing continues, demand for the stock of unethical businesses will decrease and correspondingly decrease the stock price. Unless the social effects of these businesses are somehow monetized in the future (e.g. Palestinians can sue General Dynamics for developing the F-16), the decrease in stock price will have no correlation with the company’s profitability and therefore result in the company being undervalued.

Unfortunately, buying the stock wouldn’t result in profits. The increasing prominence of socially responsible investing would only serve to drive down the stock price further and decrease capital gains…

However, where this might actually be useful would be through corporate bonds. A decrease in demand for an unethical business’ bonds will increase the yield, with no corresponding increase in risk premium. Socially responsible investing probably isn’t significant enough for it to be a genuine arbitrage opportunity, however it definitely does bear future consideration.

The Ethics of Investing

So far I’m keeping to schedule and have just finished reading study session one, the first four readings which are all about ethics in investing and a bit on Global Investment Performance Standards, which is also a CFA Institute creation. So its basically a lot of common sense which doesn’t make the most interesting of readings.

What I did find interesting were all the situations where employees/managers had to make ethical decisions which could have far-reaching consequences (i.e. closing down the firm). With no real experience in the industry, it kind of brings to perspective how difficult it is to make the right decision because doing the “right thing” could put you out of a job or result in your firm’s bankruptcy. Of course the above situation would only come about through one’s own incompetence and in that case, it becomes much harder to be sympathetic.

Its sort of a running theme I’ve been picking up lately whether it be Warren Buffet emphasizing the importance of honesty or my Business School’s Dean talking about how a change of focus from making money to taking care of his clients made him even more successful than before but the readings reinforced how ethical behaviour will help you in the long run by enhancing your reputation and credibility.

The general message I’ve been getting is that honest behaviour actually pays off in dollars and cents rather than just through an intangible moral currency. While I’ll like to think that I’ll always chose the ethical choice just because it is the ‘right’ thing to do, the financial incentives that seem to come along with ethical behaviour shoudl probably keep me on the right track.

So now I’ve finally finished the first study session, I’m debating whether or not to continue with quantitative analysis or start with something more interesting like portfolio management before going back. When I looked through the chapter on technical analysis, I ended up reading almost the entire chapter because it was so interesting so going through more compelling material will definitely help improve the speed at which I can go through the material, especially with my finance and marketing midterms competing for time…