Finding that Bull Market.. BOOYAH!

I read Prof Lohnuts' "recommended reading" whilst I was studying over at Olin Library.. (Yes, I study while on exchange.. shoot me..) For those interested, check out Bill Gross Sept Outlook. Good ol' Bill made a couple of salient points that got me thinking.

Firstly, Mr. Gross agreed with Jim Cramer that "there's always a bullmarket somewhere", but he opined that the delevering process of global financial markets have resulted in assets that are going up in price being "rare diamonds as opposed to grains of sand". He went on to talk about the impacts of delevering. (Anyone preparing for interviews should really be reading this) Secondly, he made a case for the takeover of Fannie and Freddie by Hanky . Having discussed the repurcussions of delevering, he commented that having the US Treasury buy these highly leveraged institutions will achieve some badly needed shoring up of balance sheets and prevent future rounds of liquidations. By the way, he's been calling for the US government to step in for a while now (see his August outlook) and this little jibe at Hank Paulson was plain uncanny.

Anyway, I believe that a bull market is up and coming - not in stocks, not in real estate - but in distressed debt investing. The math is simple. Over the last few years, debt has been so readily available that people in the US were actually giving corporate loans without any debt covenants! NO DEBT COVENANTS! Usually, when a company fails to meet certain bond covenants, the creditors liquidate the company's assets to try and salvage their loan. You can think of such covenants as "leading indicators" that a company is headed for trouble and that the creditor should take "precautionary action". With no debt covenants, the company is not in default until it literally fails to make out the next cheque! Now, when that happens, the shit will hit the fan!

With many companies facing a contraction in operating incomes due to the global economic slowdown, we have a situation where some companies are destined for doom with their creditors like deers caught in a headlight. Before I go on, let's talk about the psychology of creditors. Most of these creditors are banks, well, at least the bigger ones are. Banks have never been known to stomach much risk. Now, a simple question to ask is - What would the loan/bank manager do when they know the company is headed for the shitter?

(a) Try to sell off the debt to cut loss
(b) Sleep with the debtor to make him(her)self feel better about losing the bank's money (and most certainly his(her) job
(c) Wait until the company defaults and let the event hit the bank's balance sheet

Well, it's pretty obvious isn't it?! Do I hear someone shouting "LELONG! LELONG!"? =)

As such, there should be a glut of distressed debt coming up for say.. 20-60 cents on a dollar.. a pretty sizeable "margin of safety" (assuming that the company in question is actually a sound company hit by an economic slowdown). All it takes is some extra funding.. maybe in the form of a revolver loan and some balance sheet restructuring to see the company take off once the economy recovers. Then, these distressed debt investors, who would have cleverly taken the company under chapter 11 and creatively taken a big equity stake in the said company (process quite cheem, I'm really simplying things here), can then sell off their stake to a strategic partner, launch an IPO or cash out in some other attractive ways - making a nice return in the process.

One of the most telling signs for me was when a guest speaker on this subject matter shared that most firms in this line are in the process of hiring as they wait to ride this big wave. After all, bad times are good times for them!

Lastly, and this point is pretty short, I can't help but wonder what would happen in Singapore when TOPs are awarded and many contra-players as well as over-leveraged real estate investors have to start servicing the massive interests on their mortgages. The process of delevering is brutal. I can only hope it doesn't hit us too hard.