A History Lesson From 2006 and 2007

It was obvious by late 2006 that the real estate bubble was beginning to deflate. Leveraged speculators were starting to get into trouble and the housing market was slowing down. With all the leverage in the system it was a certainty that the collapse would be massive. Let me refresh your memory if you forgot: 108% no money down mortgages, liar loans, janitors getting $500,000 mortgages, no doc, no problem.

Despite the writing on the wall the market steadily climbed through late 2006 and all the way until the summer of 2007. There were some hiccups during the year when a number of subprime lenders collapsed but the market recovered quickly each time. There were some bigger hiccups that Summer when problems began to surface at larger banks but the market still did not not put in a high until October of 2007.

By October of 2007 the problems were painfully obvious. The economy was slowing and the real estate bubble was quickly deflating. Shouldn't the market have realized this instead of making new all time highs? Isn't the market a discounting mechanism? What was the reason the market kept climbing?

The answer to this mystery was quite simple. There was a boom happening in M&A, LBO and share repurchases. The supply of stock was quickly shrinking. It seemed like every other day there was a massive share repurchase, LBO or M&A announcement.

I remember this period very clearly because I was short. My saving grace was that I bought SPY leap puts when the VIX was at 10 so it allowed me to weather the market going against me. While this trade turned out to be the trade of my lifetime it was a grueling experience. Knowing for certain that the economy was collapsing, yet watching the market go against me every day was painful. If I were managing OPM at the time I likely would not have been left with much money.

This period ingrained into my head the power of share repurchases and cash M&A. The market was able to shrug off subprime companies collapsing, banks running into trouble and a slowing economy. It wasn't until the economy choked off the M&A and share repurchases that the market collapsed.

I was reminded of this experience in the past week as TrimTabs reported that there was nearly $100 billion in cash M&A and share repurchases in the last 2 weeks. Than on Friday it leaked that Wal-Mart, the nations largest retailer, was having one of their worst starts to a month ever. The main culprit being the payroll tax hike. The market dived at first but by the end of the day the Dow was up.

I don't believe a collapse is imminent like I did in 2007, even though there are no shortage of imbalances and risks. The reason I tell this story is that if the share repurchases and cash M&A continue at the recent pace it is likely to trump any fundamental factors.


vitfinance said...


Josh Heller said...

I thought I was a genius being short in 08 but I turned back to bullish at 1200 (just before the big leg down) and had my head handed to me.  I'm curious where did you flip back to being bullish and why that level?  

I feel that the market going up each day (recently) is unsustainable but I'm not wildly bearish today.

Tsachy Mishal said...

I turned bullish a few days after TARP was rejected. S&P 950ish. Early as usual

Jeff Schmitt said...

I worked in M&A during 2006 and 2007. The difference then was deals were getting financing at 6x-8x EBITDA vs a max of about 4x-5x in the past. I

Josh Heller said...

The lesson I learned is that it is okay to be neutral.  Up until then, I would always be bullish or bearish, never neutral.  I still would have been early but (maybe) could have minimized losses by being neutral from 1200-1000 and nibbling on the way down instead of being aggressive fast.

Tsachy Mishal said...

I agree that the deals we are seeing now are not nearly as egregious as what we saw in 2007.

Tsachy Mishal said...

It took me  a long time to realize that its ok to do nothing or do less at times. Was one of the biggest improvements in my trading/investing. Easier said than done. Took me nearly a decade to learn that one

Shubh Desai said...

Hi Tsachy,
Still hold VOD? Do you know why is it dropping? Still a value? Any thought on adding it more.

Tsachy Mishal said...

Its my largest position