Here Come the Capital Raisings…

Dear Reader,

The number one rule in investing is that markets never do what you expect them to, when you expect them to.

A good example is what’s going on in the US market now.

‘No one’ expected stocks to collapse more than 30% in a month, the sharpest fall in stock market history.

Having said that, my mate and fellow Rum Rebellion editor Vern Gowdie did say to get out of the market completely in January, before the virus hit the fan and spread like wildfire around the world.

But in general, no one saw this coming.

The panic low for the decline in the US was on Monday, 23 March. The market subsequently enjoyed its sharpest rally since 1933. But the general view was that it was a ‘dead cat bounce’. That is, a bear market rally.

We were going to ‘re-test’ the lows, was the consensus view. The market cooperated for a few days. It lulled people into a false sense of security.

Then, overnight, it ripped higher.

The S&P 500 surged 7%. The Dow Jones Industrials added a massive 7.7%, while the NASDAQ jumped 7.3%.

That re-test of the lows didn’t really work out, did it?

That’s not to say it won’t happen. It’s just not going to happen when most people expect it to.

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Knowing that you don’t know is a powerful weapon

Look, I’m not saying it’s easy figuring out this market. It’s all but impossible. But what you shouldn’t do is think you have it figured out.

The best option is to go into it completely ignorant. Knowing that you don’t know is a powerful weapon. By all means have a view, but don’t hold onto it too tightly, because it’s probably wrong.

With that in mind, let’s have a look at the S&P 500. As you can see, it’s now trading close to the 61.8% retracement level of the Feb/March crash. These are often important technical levels where markets will run into resistance.


Rum Rebellion

Source: Optuma

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So that’s the first level I’d be looking at.

But I’m not looking much beyond that. It’s a case of taking it one day at a time.

What I would say though is that rallies of such magnitude as you saw in the US overnight are not particularly healthy. They’re more characteristic of bear market rallies than bull markets.

Companies using opportunity to raise capital

What you can be sure of though, is that companies will take advantage of this window of opportunity to raise capital. A few are already in the process or have wrapped up.

Cochlear Ltd [ASX:COH] got in first. Then there’s been Flight Centre Travel Group Ltd [ASX:FLT], Webjet Ltd [ASX:WEB] and Oil Search Ltd [ASX:OSH] to name a few.

As prices rise, there will be more.

Unfortunately, many of these raisings will only go to the ‘big end of town’. That’s because recent rule changes mean the annual limit on the issue of new shares to non-shareholders (without needing shareholder approval) has increased from 15% to 25% of existing capital.

Moreover, it used to be that you couldn’t do a pro-rata share issue of more than 1–1 without shareholder approval. That’s now increased to 2–1.

In other words, you’re likely to be diluted should any company you own raise capital.

Take COH’s surprise $800 million institutional raising. It went into a trading halt when its shares last traded at $168. It offered the new shares at $140 a share, a rather large 16.7% discount to the last traded price.

COH paid JP Morgan a $20 million ‘underwriting fee’ for the job, meaning that if it couldn’t place the new shares, it would have to take them itself.

It needn’t have bothered. Within 24 hours, the deal was done. London-based fund manager Veritas received an allocation of $304.5 million, a massive 34% of the total raise.

In fact, demand for the raise at that price was so high that JP Morgan increased the offer (to fund managers, not existing retail shareholders) by $80 million.

Existing retail shareholders got a measly allocation of $50 million, around 5.5% of the total raise. There is zero chance all will be able to take up their maximum allocation of $30,000.

Yep, good old capital raisings: In a panic, they are great for investment banks. They can scare boards into setting very low prices to ensure the deal gets away. The banks then get their fund manager mates into these fire sales, in the expectation that they will be rewarded with brokerage business down the track.

As I said, it’s a sweet deal…for the investment banks.

Another example of these fire sale prices is the WEB raising. It last traded at $3.76 before going into a trading halt. It did a capital raising at $1.70. The share price closed at $2.47 yesterday, a 45% premium to the raise price.

So keep this in mind if your company comes knocking for money. Just follow the lead of the investment banks. Don’t be spooked out of not taking up your (measly) allocation.

Mass capital raisings are usually a sign that we are close to a bottom.

Whether that is the case or not this time around, I don’t know. It really all depends on how politicians manage the economy from here.

The sooner we can relax the social distancing rules, and get people back to work, the better. As I wrote yesterday, the longer the shutdown continues, the tougher the recovery will be.

Chris Mitchell wrote a similar sentiment in The Australian yesterday:

Like the need to “flatten the curve” so our health system is not overwhelmed, the public is largely taking on faith the language of the government’s economic ministers. This includes phrases that suggest the “economy will come roaring back” when we “get to the other side”.

Economists also supported flattening the curve, but are concerned at the unprecedented nature of the challenge governments are facing. There is no precedent for deliberately putting large sections of national economies to sleep. Or for imagining these can be reawakened at will like Sleeping Beauty.

Indeed. There is also the issue that the virus will come back when we relax the rules. The fear of this alone is enough to suggest the economy won’t come ‘roaring back’.

It’s likely to be a stop-start process.

So if the market rally continues, take it with a grain of salt. Settle for picking up shares cheaply in a capital raising…if you can.

***

PS: Keep your eye out later today for a brand-new report on the state of play from your Rum Rebellion co-editor Vern Gowdie. In it, Vern will update you on how he sees this downturn playing out.

Regards,


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Greg Canavan,
Editor, The Rum Rebellion

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Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own. Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts. At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates. Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.


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