Knight Capital and High Frequency Trading Making Markets Skittish
Stock-Markets / Financial Markets 2012 Aug 03, 2012 - 12:12 PM GMTBy: Bloomberg
Dinakar Singh, founder of $4 billion hedge fund TPG-Axon Capital, spoke with Bloomberg TV’s Erik Schatzker and Stephanie Ruhle on “Market Makers” today, saying that investors are scared and are paying a lot for safety. Singh said that the commodities “super cycle” is over because of falling Chinese productivity and profits—and that profits are improving the most in Japan.
Singh went on to say that he sees growth in the chemical, health-care and aerospace industries and likes Sirius XM and W.R. Grace. He also said “we are bearish on some financials, U.S. regional banks especially” and that he is betting against telecom stocks.
Singh on Knight Capital and high frequency trading:
“All of these things -- markets being skittish, having some moments where machines are driving the system as opposed to people for lots of reasons, liquidity being very patchy – means that things move crazily. That makes it both easier and tougher to make money. Easier because I do not think it has ever been simpler to look at something and say I cannot believe it is trading here. And at some point have a high conviction of that unless the world ends, I’ll make money. It is also never been harder to emotionally withstand what you have to withstand along the way. You might believe in great value for a stock when it is going down 15% in one day. You start thinking about all of the things that you might have missed. In some ways, the guts part of the business has gotten harder.”
On the current environment:
“For us, we pick stocks. That is how we make money. More and more, everyone has become more emotional in markets. We get scared by headlines and we all start acting the same way whether you are a CEO or a consumer. Jobs do matter. I think when you look at the U.S. in the last number of months, our view coming in this year is that people got too excited. There was a bounce back from last year and some good weather but it was going to be a slow gradual sloppy messy restructuring without a big recovery. Things have reversed. I think people are getting too pessimistic…I think ultimately consumers and CEOs are reading the same headlines and scared. I think you are seeing a cyclical or temporary step down. We do not think there one should expect a big bounce, but there won’t be much of a plunge either. It feels like the numbers are crummy but they will probably stay this way for a while. The fiscal cliff is a real issue. I think you're seeing an impact right now.”
On how to play this market:
“People have gotten scared and they’re paying a lot for safety. On the safety side, people like dividends in safe industries. So Verizon is trading 18 times earnings because people want safety and a good dividend. There are companies like Time Warner Cable that we think are just as defensive but they did not happen to pay a dividend, they have even better cash flow, but they traded as a result much less well last year. For us, big opportunity. So media and cable that’s very cash flow rich and where we think management is going to turn that spigot on and turn it into a dividend or buy back machine that makes sense. Sirius, Time Warner Cable, companies like that. On the cyclical side, not everything is terrible. There are some sectors where we think there is good structural growth and balance sheets will be put to work. Some chemical companies are very good restructuring candidates. Aerospace suppliers. Aerospace is in the middle innings of a very long term upgrade cycle.”
On whether financials are a good buy:
“We are bearish on some financials, U.S. regional banks especially. Not because they are bad but because they are not going to make a lot of money. I don’t think people have factored through how much their earnings will get hit with rates being so low. We see earnings going down sharply for regional banks. For the global money center banks and securities firms, they are going to be volatile, but the bad news is out there right now and there are some good things to look forward to. The old way of making money used to be mergers, advisory, underwriting. Markets are going up and down every 13 seconds. None of those happened, but they settle down and they happen again. If the market settles down, you will see a big wave of mergers pop up and that will help. I think people are overstating things right now on the bad side.”
On China:
“If you look at China specifically, multiples had really collapsed…You have two general types of companies. Big, state-owned companies that people don’t trust and private companies that people really don’t trust. There isn’t a lot that trades at big multiples anymore. I think if you can find cases where there is real growth and they can pay cash back to you, you’ll make money.”
On whether Japan is a better buy:
“Some of my favorite stock stories are in Japan. The Japan-China comparison is pretty interesting. The place where you have seen the best profit improvement in the world is Japan. China is the only index that has gone down. Profit margins are falling because costs are going up…In Japan, they’ve had a brutal headwind from the yen and yet they have restructured pretty aggressively so profit margins for the Nikkei have gone up and are now about there with the S&P. People do not expect that… Japan Inc. was a disaster 15 years ago. Today, there are stocks we like with low multiples that are paying out cash and growing.”
On what stocks he’s buying and selling:
“People are paying a lot for dividends in defensive sectors, but if the dividends are not there, they were not paying a lot before. There opportunity is to find a stock in a company where there is a lot of cash flow, people aren’t paying for it, but they will tomorrow. Sirius is an example of a stock that we love. The company nearly went bust a few years back, merged with a competitor and changed the dynamic of the industry. Take it as an example against Verizon. Verizon is a good company but trades 18 times earnings. They are paying out almost all their cash in the dividend. Sirius has double digit free cash flow yield. It is restructuring. It is going to grow its earnings because it is still recovering from a few years ago…This is a case where you are getting a much, much better deal for something that is growing and where the cash is going to turn from being in the company today and in your pocket tomorrow.”
“Health care was a terrible sector until a few months ago. Pharma stocks have been some of the best performers in the market. And suddenly they have gone into the safety category because if you want to buy dividends, there are not that many options for large cap big dividend stocks that are very cyclical…The best thing you want in this environment is a company that not only has value, but where management that will work with you to deliver value over time.”
On telecom services:
“In a hedge fund, this is called a funding short. It is not that you think it is terrible and going straight to 0, but it is priced fully and not going up much so not a very good risk reward. Within telecom services there are two categories. There are the Verizons, we get it, they trade here for a reason, but they are pretty fully priced. On the other side, there are other companies that are legacy telecom companies where the dividend is a very high, but business really is eroding. It is priced well today because of a high dividend, but it is not sustainable. When you look around the world, a lot of high dividend stocks in Europe are not trading well because people are looking at them and saying I get it. I have a dividend today but it might not be there tomorrow.”
On M&A activity:
“I think it is picking up. It’s better than 2008 and 2009. I think you are going to see waves of M&A. I think if you are a CEO right now, you do not make a big move because you do not know what the landscape is going to look like in six months. Europe headlines on one side—U.S. politics on the other. Six months from now, 100 days from now, we will know who is going to win the election. I think you will see some level of activity come back in. We are clearly seeing companies start to sniff around for small acquisitions and over time i think you will see bigger ones. Take the chemical sector. We are not fans of the cyclical cycle overall, there are several companies, W.R. Grace is one, Rockwood is another--where you have very low multiples and good businesses. The key is to make sure they are businesses that people want to buy. So the large strategics have good balance sheets. It is not just a cheap multiple. You’re going to get paid for it.”
On where the hedge fund industry will get its human capital:
“I think when you look at where most people have joined, most joined from a couple of areas. They’ve worked in investment banking for a couple of years and then come on over with analytical skills set and then you train them. Or they work in research and come over as well. Those are usually the two places where people join hedge funds from. Ironically on the prop side, I think prop desks being shut down means fewer people will be going and raising money as you start up traders. I don’t think it is going to change the supply of capital or labor that much because ironically in some ways, if Goldman or Morgan Stanley and others are aggressively prop trading, they are competing for good young guys with us. So now, if you want to do investing and you are a good young person at pick a firm, there is only one place to go. So not so bad for us.”
On whether there is still real talent left on the sell-side:
“I think so. When I look at firms like Goldman Sachs, Morgan Stanley, CS, etc., the people there are still terrific. The prop trade business has always had their own complexity but these firms make a lot of money doing their old job and they still need some very good people doing it. When you are treading stocks every day, futures and currencies every day, you need very good people who know what they are doing and frankly I think the business is going to look like it did ten years ago.”
bloomberg.com
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