Editor's Note

07/13/2007 12:00 am EST


Howard Gold

Founder & President, GoldenEgg Investing

July 12, 2007

Summertime and the trading ain’t easy.

Investors have been humming that tune since a month ago, when concerns about higher interest rates sparked a sell-off in stocks.

During that time, the Dow Jones Industrial Average and the Standard & Poor’s 500 have bounced up or down, depending on the day’s news.

On Tuesday the Dow plummeted 148 points on fears about the subprime mortgage market. On Wednesday, it rebounded 76 points on hopes for good corporate earnings reports.

Unless Thursday’s trading—when the Dow broke out into all-time highs—marked the beginning of a new rally, it seems as if investors can’t make up their minds whether the glass is half-full or half-empty.

The markets’ big fall Tuesday was prompted by reports that Standard & Poor’s and Moody’s were reviewing their credit ratings on billions of dollars in bonds backed by subprime-mortgage loans. Many of those loans are likely to be downgraded, although as S&P’s chief economist David Wyss told the Nightly Business Report Tuesday, that represents a mere 0.01% of the total mortgage market.

The near-collapse of two Bear Stearns-sponsored hedge funds that made leveraged bets on subprime mortgages sent a chill through world markets last month. Everybody knows a lot of speculation is going on, and because it’s being done mostly by secretive hedge funds, nobody knows how much is really at stake, as I wrote here.

That has brought on the much-anticipated “repricing of risk,” which investors had been awaiting as long as Godot. Credit standards are tightening, and some anecdotal evidence suggests the days of practically free money may be over.

Kohlberg Kravis Roberts has quietly delayed its financing for the $26-billion leveraged buyout of First Data—a deal that attracted attention for its use of so-called “covenant-lite” loans. (Unlike traditional loans, “cov-lites” offer much fewer restrictions or benchmarks borrowers have to meet.) I strongly suspect KKR is getting pushback from potential debt buyers.

Meanwhile, JC Flowers, another private-equity firm, is threatening to pull out of a $26-billion deal to buy Sallie Mae, the student-loan behemoth, citing possible legislation that may cut some government subsidies to student loans, the Financial Times reports.Things like this happen when people start getting cold feet.

Maybe that’s why there’s been a rush of high-profile new deals recently. Blackstone Group (NYSE: BX), fresh from a rather tepid follow-up to its much-hyped initial public offering, last week announced that it would buy Hilton Hotels (NYSE: HLT) for $20 billion. Bell Canada also said a group led by two private-equity firms would buy it for $33 billion—the biggest buyout ever—while nursing-home owner Manor Care (NYSE: HCR) said Carlyle Group will acquire it for $6.3 billion in cash.

Prominent figures have begun reassuring the market. Charles Prince, chief executive officer of Citigroup (NYSE: C) told the FT that the party isn’t over for private equity.  “As long as the music is playing, you’ve got to get up and dance,” he said.

And John Snow, formerly cheerleader-in-chief for the US economy and now chairman of Cerberus Capital Management, told The Wall Street Journal that even though “the market has lost some of its buoyancy,” he expects its massive buyout of Chrysler to go through.

Meanwhile, KKR, whose chairman Henry Kravis has declared that we are in the “golden age” of private equity, sneaked in its own filing for a public offering on the eve of the July 4th holiday. Apollo Management and even Carlyle Group reportedly may be preparing IPOs as well. Hedge-fund operator Och-Ziff Capital Management Group has filed for an IPO, and others may be waiting in the wings.

When the smart money talks up deals with their mouths—but buys insurance with their wallets—investors should pay attention.

But they shouldn’t overreact. From all I’ve seen, the danger of a meltdown or contagion of the kind we saw with the collapse of Long-Term Capital Management in 1998 is pretty remote.

The fears of higher interest rates that caused the sell-off a month ago have eased dramatically as the ten-year Treasury now yields close to 5.1%. (Treasuries actually benefit from subprime worries as investors gravitate to quality.) And private equity funds have massive war chests ready to spend on big deals.

Meanwhile, the corporate merger & acquisition wave continues (on Thursday Australia’s Rio Tinto bid $38 billion for Alcan), while companies like ConocoPhillips (NYSE: COP) and Johnson & Johnson (NYSE: JNJ) plan massive stock buybacks.  Corporate earnings could be surprisingly good this quarter, as Bernie Schaeffer wrote here, economic growth is pretty good and Federal Reserve chairman Ben Bernanke thinks core inflation is well-contained. That, and reasonable valuations, make a good case for stocks.

Fear is battling greed for the hearts and minds of investors—or at least investors who pay close attention to the market’s daily gyrations. When there’s bad news about subprime mortgages, it’s the end of the world. When a good inflation report crosses the wires, we’re in Paradise.

The truth, of course, is somewhere in between. There are always things to worry about in the markets and in the world. That’s why responsible advisers and commentators continually stress long-term planning and broad diversification.

Aside from reducing your exposure to the riskiest asset classes, as I recommended here a few weeks ago and making sure your overall allocations are in line with your strategy, most of us should go to the beach or the ballpark, have family barbecues, play golf, go hiking—do anything except watch CNBC and listen to Bloomberg radio.

It’s summertime, and the livin’ is easy—even if the trading isn’t.

Comments? Please email us at TopProsTopPicks@InterShow.com.

Howard R. Gold is editor-in-chief of MoneyShow.com. The opinions expressed here are his own and do not necessarily reflect the views of InterShow.

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