UnThreaded | Threaded | Whole Thread (4) | Ignore Thread Prev | Next
Author: junkman02 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35392  
Subject: Price-Risk versus Information-Risk Date: 3/24/2009 4:32 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 6
A couple weeks ago, when uncertainties about then triple-rated GE's future were heightened, their debt was being priced lower by the bond market to yield as much as 10% (for the obvious reason that the market was already discounting possible ratings cuts). Now that those cuts have been confirmed and GE has been whacked by the rating houses (down to AA+ by S&P, and further down to Aa2 by Moody's), the bond market is expressing its approval of both of those moves by pricing GE's debt higher than before. Does that make sense?

Well, actually, it does, according to observers like Justin Mamis. (Cf, his The Nature of Risk) There he argues, “Information serves to relieve anxiety.” (Ibid, p. 28.) What has happened is the usual trade-off between price-risk and information risk. When investors knew less, they were willing to pay less. When investors know more, they are willing to pay more. But this has to be asked: What is the “more” that they know now that they couldn't have been known then? The impending rating cuts were obvious. The bond market, by its pricing, said so, and the least bit of comparative work done with yield-curves by the would-be investor would have confirmed the "correctness" of that pricing, as well as suggested the correct way to have bet that investing situation. (And that's all investing is, making bets, one after another, in a disciplined, data-motivated manner, about things that can never be fully known but whose participants, the human beings on each side of a trade, i.e., the sellers and buyers, are fairly easy to read, which is why the psychology of investing matters more than numbers of investing and why shrewd market observers like Mamis are worth reading.)

Have GE's financials materially changed? Has the economy materially changed? Uncertainties about both still abound. The major difference is that before the would-be investor in GE's was being offered a bit of a price discount to assume information risk. Now that the supposed information risk has been removed, the discount has been removed. Thus, the would-be investor in GE's (or any issuer's) debt has to ask: Which is the better time to buy? When there seems to be information-risk, or when there seems to be price-risk? How each person answers that question is for each to decide.

One minor comment: It still takes a 3rd order polynomial to plot a trend-line for a yield curve of GE's debt, instead of the 2nd order that is more typical of a normal yield-curve. And the short-end is very steep for reasons that would need to be explained. But the easy, obvious bargains of past weeks are gone. And whether buying then, or now, makes sense is still a matter of uncertainty that can be reduced, but not resolved, by proper due-diligence (and, of course, proper position-sizing).

Charlie

PS Yes, I do realize the Fed and Treasury's quantitative easings have an explanatory role in how GE's debt is currently being priced, as also the company's own actions to bolster balance sheets by selling assets, etc. But the main point of my tale hold true. "Price-risk vs. information-risk" plays itself out, time and time again, in all markets, because it is human beings that make markets, and people don't change.
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Print the post  
UnThreaded | Threaded | Whole Thread (4) | Ignore Thread Prev | Next

Announcements

Pencils of Promise - Back to School Drive
"Pencils of Promise works with communities across the globe to build schools and create programs that provide education opportunities for children."
Post of the Day:
Saul's Investing Discussions

Why Did I Buy a Bunch of PFIE Today?
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Community Home
Speak Your Mind, Start Your Blog, Rate Your Stocks

Community Team Fools - who are those TMF's?
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and "#1 Media Company to Work For" (BusinessInsider 2011)! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.
Advertisement