Bill Hester: Buyout Bingo -- A Sucker's Game

by: Bill Hester

Bill HesterExcerpt from Hussman Fund analyst Bill Hester's essay on the U.S. market:

"Buyout Bingo." "Merger Monday." At the point a trend in the market is identified with constant alliterations, it's probably about to stop working. That term "Buyout Bingo" came across the newswires recently -- an apt description of the popular strategy of building a portfolio of stocks with "takeover characteristics" and then sitting back in hopes of seeing them purchased at a premium by private equity investors.

For the broader market, the pace of private equity deals has fueled the argument that stocks represent reasonable values. The recent rise in stock prices has been helped in some part by the message that investors are taking from the number of private equity deals. Increased private equity activity must be signaling that stocks are fairly valued, the argument goes, and not until the pace of takeovers drops will stocks be overvalued.

Both of these arguments may be unreliable. Waiting for a collapse in the rate of private equity deals as an indicator to reduce stock market exposure could prove too late to avoid a downturn. The number of deals may slow, especially if borrowing rates continue higher. But the pace of deals could roll over, rather than collapse, and the deals may increasingly reflect non-economic factors that have little to do with valuation. That's Warren Buffett's take on the subject. Speaking at last month's Berkshire Hathaway shareholder meeting he pointed out that there is a tremendous incentive for private equity managers to force money into new deals, value or no value. "If you have a $20 billion fund and charge a 2% fee on it, you earn $400 million a year. You can't start another fund with a straight face until you get that money invested." So the pace of activity may depend equally on those that allocate the investments and on the providers of capital. Buffett added, "It may be some time before disillusion sets in for the people supplying the money for these deals."