My Year In Review

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By Allan Sloan
Tuesday, December 26, 2006

It's getting to be the end of the year, and that means it's time to keep myself intellectually honest by reviewing everything I've written for the past 12 months to see where I went wrong. I own up to factual mistakes with corrections throughout the year, but today I'd like to talk to you about my analytical mistakes. I'll also venture a prediction or two about what I expect in 2007.

Let's start with one of my favorite topics: General Motors and 89-year-old billionaire takeover artist Kirk Kerkorian, who for a while was GM's biggest individual shareholder, with a 9.9 percent stake. Captain Kirk had sold a piece of his GM stake in late 2004, and I expected his GM voyage to end this past January with a hefty loss.

Instead, the captain rebuilt his stake on the cheap and managed to get GM to add his adviser, Jerry York, to its board, where he stayed only briefly. GM became one of the year's hottest Dow stocks, much to my surprise. Surprising me further, Kerkorian set aside his ego (and 18 months of intense labor by York) and jumped ship last month, selling all his GM shares and essentially breaking even. Captain Kirk would have done better financially by putting his money in Treasury bills -- but he wouldn't have had anywhere near as much fun.

Speaking of fun, Warren Buffett has seen the value of his huge gift to five charitable foundations of Berkshire Hathaway stock increase substantially. On June 26, when he committed to donate 12.05 million Berkshire B shares, the stock was worth $36.7 billion. As of Friday, it was up to $44.1 billion.

I didn't expect Berkshire -- in which I own a substantial stake through Newsweek's 401(k) plan -- to rise 20 percent in six months. In fact, my columns about Buffett's gift, which will be transferred in stages, assumed single-digit returns.

For that matter, I didn't expect the stock market as a whole to do nearly as well as it's done this past half-year. Remember the spring swoon? But given how much of my net worth is invested in stocks, I'm sure not complaining.

Part of the market's second-half run has to do with private-equity takeovers, which I should have seen coming. According to Dealogic, such deals have accounted for 28 percent of the dollar value of takeovers announced in the United States this year, up from just 3 percent five years ago. This trend promises to continue -- at least until the inevitable problems set in.

Before I talk about those problems, a language point. As part of my campaign to excise euphemisms from business-news stories -- hey, I'm a recovering English major who never studied business in college -- I've decided to call private-equity deals by their old name, "leveraged buyouts." LBOs are takeovers that involve a lot of borrowed money, known to financial types as "leverage."

The key to the LBO -- excuse me, private equity -- boom is that credit is available on ultra-liberal terms. Commercial banks, investment banks and hedge funds (which, as you probably know, are largely unregulated investment pools supposedly restricted to big investors) seem to be competing to see who can make the riskiest loans on the worst terms for the lender.

Money is pouring into LBO funds and hedge funds, which produced better-than-stock-market returns in the early years of this decade. All this money is looking for a place to go. And a lot of it is going into buyouts.

I get the feeling that I've seen this show before. And I have. It's eerily reminiscent of the junk-bond bubble of the late 1980s that imploded in the early 1990s.

When junk -- non-investment-grade debt -- was an obscure financial backwater, pioneering junkmeisters could actually do serious analysis before deciding what deals to back. But when junk became popular, so much money wound up chasing so many deals that underwriting standards collapsed. This happened shortly after "junk" became known as "high yield." You see a parallel here?

In a wonderful irony, this year the boring old U.S. stock market is likely to outperform the average hedge fund. And that will happen in 2007, too, if stocks have a decent year.

How can I say this when hedge funds have had a far better recent track record than U.S. stocks? In a word, fees. If the S&P 500 returns 12 percent in a year, a big player can net 11.95 percent (or more) by owning the index in some form. But if a player pays a hedge fund or LBO house the standard asking price of 2 percent of assets annually plus 20 percent of the profits, the equation changes. The assets in which the money is invested have to earn 17 percent for the investor to earn 12. That's a big hurdle to overcome.

I never studied business in school, but I've been observing it in real life since 1969, when the Charlotte Observer assigned me to cover real estate and then added banks to my beat. Along the way, I've learned enough about numbers and credit -- and have seen enough up-and-down cycles -- to know that markets swing to excesses. And those excesses are staring us in the face in 2007.

But for this week, let's give worry a break. To all of you, a happy, healthy and successful New Year.

Sloan is Newsweek's Wall Street editor. His e-mail is sloan@panix.com


© 2006 The Washington Post Company

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