Today we have very heavy news flow. The market was up strongly in the morning because of the Warren Buffet’s investment in Bank of America, but that Euphoria quickly died down after the German market had a large drop mainly on the news that there are some chinks in the European bailout of Greece. There were also some rumors of possible downgrade of Germany which were promptly denied by the rating agencies. Here is my take on some of the big events that have transpired since yesterday
- Warren Buffet Invests $5 Billion in Bank of America – Berkshire Hathaway which is run by Warren Buffet has bought $5 Billion of preferred shares in Bank of America(BAC). The preferred shares will give a dividend of 6% annually and Buffet also gets warrants which give him the right to buy 700 million BAC common shares at $7.14 over the next 10 years. BAC shares and the market moved higher on this news as this provided the market with confidence that BAC may not be in such a bad situation as its stock action over the last few weeks has been indicating. But I don’t think you can read too strongly into the buffet buy and would not recommend people following Buffet into buying BAC stock. Buffet is mainly buying because he has gotten a sweet heart deal which you and I cannot get. Preferred shares are different than common stock which you and I buy on the stock exchange. The best way to think of Preferred shares is that it is like perpetual debt which just pays interest. In some dire circumstances the board can suspend the interest and the company does not have to pay back the investment, that is why it is treated like equity. So buffet gets 6% a year in interest and with the warrants he also gets all the possible upside on common stock. Nevertheless his investment does have a risk if BAC becomes insolvent, so the information we can take is that Buffet at least thinks BAC has a very low probability of going insolvent.
- Greek Bailout faltering – I believe this event was really the big mover of the day and caused a reversal of the rally due to the Buffet news. In order to bailout Greece and other European nations in trouble the Europeans have created a common fund called the European Financial Stability Facility(EFSF). The weaker countries can get funding from the EFSF. The problem arising is that Finland which is one of the European countries contributing money to the EFSF wants collateral from Greece to get some protection in case Greece later defaults on the money lent by Finland. This is very circular because the only way Greece can give this collateral is from money it borrows form other European countries. So Finland is asking for protection at the expense of other European countries. This caused a big sell off in the German market since this increases the possibility that as the largest and most financially healthy country in the EU, Germany may have to bear a bigger cost of the European bailout. The bailout is already very unpopular in Germany and with these added burdens it will make it even more unpopular. So overall the risk in Europe has increased somewhat and that is why our markets also fell.
- Unemployment Claims – Unemployment claims rose to 417K last week but the Department of labor made a special note that 8.5K was due to the strike by Verizon workers. So the real claims data has been pretty stable near the 400K level. This corresponds to the economy creating around 100K jobs per month. So far at least this data point is not indicating a strong contraction in the economy.
- Steve Jobs retiring – Sadly, it appears Steve Jobs health has deteriorated to the point where he cannot serve as Apple CEO. Apple stock is not reacting strongly to the news as I think the market had already been anticipating this could happen sometime this year. I think Apple will do okay for the next few years based on its current product road map but I think after that the lack of Steve Job’s genius will be felt. Unlike other very large $100 Billion+ revenue companies, Apple has very few product lines, so Steve could personally be involved in every aspect of Apple’s products. Apple also creates commodity products, unless you have a creative genius as your CEO it is not easy to keep making fat profit margins in commodity products.