England, General Motors and the Stock Market
May 26, 2009
Posted by Jody Eisenman | Filed under Uncategorized
As the market took a breather last week, investors focused on 2 major issues. The first was the country of England (also known as the United Kingdom or UK when you include Northern Ireland, Scotland and Wales) was being reviewed for a possible downgrade of its’ debt. Like the USA, the UK has had a AAA rating on its’ debt since it was rated about 40 years ago. A “AAA” rating means that they can generally borrow at very low rates, which is convenient when you carry massive deficits. The ratings agency Standard and Poors reiterated the rating, but downgraded the medium term outlook to negative from stable. Such a downgrade in outlook is frequently a prelude to an actual ratings downgrade. S and P believes that the UK debt will equal its’ net income in the immediate future. The problem is that this could lead to a downward spiral which could have a severe negative impact.
To understand this, imagine that you as an individual was forced to borrow money to survive. Your credit is first rate, so your interest rate on borrowing is low. However, if you borrow too much as a percentage of your income, your creditors now think you less than a prime risk. Therefore, they raise your rates. So, at the very time you are in heavy debt, your creditors are increasing your borrowing costs. This, in turn, could further increase your debt, which could lead to further rate increases. Therefore, relating this to the UK, investors are afraid that this will lead to an ever increasing negative situation. However, since the UK debt/income situation is roughly similar to the US, many investors are fearful that this could happen here as well.
The second major ongoing situation is that of General Motors. As discussed previously on this blog, GM is on the verge of bankruptcy. President Obama is basically trying to persuade (rather forcefully) the GM bondholders to accept 10% of the new company in a plan of reorganization. The problem with this is twofold:
1. A 90% approval rate by the bondholders is required. As many bondholders are individual investors, I think this will be logistically difficult to accomplish.
2. The president is taking the unprecedented step of changing corporate law. As any student of economics knows, bondholders have seniority over stockholders, and secured bondholders are above unsecured bondholders. However, the Gm plan gives 4 times as much equity to the United Auto Workers, even though they hold less debt and they are unsecured. Naturally, the secured bondholders are very reluctant to agree.
Meanwhile, GM stock went thru a yo-yo move which is typical of our current markets. GM opened the month of May trading around $1.80. When it became apparent that getting approval was going to be difficult, the stock traded down, and started the week at $1.09. However, on rumors that a deal was imminent, the stock rocketed to as high as $2.24 on Friday. When it seemed that rumors of this supposed deal were premature, the stock cratered, ending the day at $1.42. Although I have not traded GM, I do think that the ultimate value of GM stock is probably a lot lower than the current price. Why? Because the current plan calls for GM to issue an incredible 60 billion more shares to creditors. What should the stock trade at? Well, if you look at the market cap of its’ competitors, they range from a high of $199 billion for Toyota to a low of $10 billion for Fiat. Ford is at $15 billion and Honda is at $52 billion. Even if one assumes that in a reorganization that GM is worth even three times as mich as Ford, you are left with a stock price of 45 billion/ 60, or $.75. Even this seems like a stretch to me. If no deal is made, there is a good chance that the stockholders will be left with virtually nothing. Where do you think the stock will be then? Of course, there is always a chance of some unforseen event that could change the whole picture. It goes without saying that trading in GM stock is extremely speculative and not for the faint of heart.
