HYBRID VIGOR VOL 2 ISSUE 20: Get It Right The First Time

Everyone seems to want to know if I think we’re going to have a Triple Crown winner, now that American Pharoah has won the Preakness. My short answer—I haven’t a clue, but I think it will be clear very early in a very long race. If American Pharoah makes an easy lead, it will be almost impossible to catch him. More likely, several of his rivals will try to box him in, the way they did with Smarty Jones, who looked even more invincible in the Derby and Preakness than American Pharoah has. It should be interesting. One thing is nearly certain—American Pharoah will be a bad bet. Not only will he be trying to do something the last eleven horses to win the Derby and Preakness have failed at (not counting I’ll Have Another, who missed the Belmont due to injury), but tens of thousands of people will be buying $2 souvenir win bets on him, knocking his odds below fair value.

As you know from reading this space, I try to link convertibles to real-world events. Just as the first quarter-mile is likely to determine the outcome of a mile-and-a-half race, a convertible’s trading tone often gets determined by its first day. Priced correctly, leaving a point or so on the table for buyers without making an issuer feel cheated, the bond is likely to outperform its underlying shares as well as many other bonds. Priced too aggressively, it will be a tough sell until its valuation becomes too persuasive to ignore. And in today’s market, that’s not going to happen very often.

The chart we now show in the Ugly 20, the average HARP from week to week, can be used as a pretty effective gauge of market richness. The current trend suggests that if new issuance doesn’t pick up over the next month or so, we could be heading into another rich July that’s exposed to a sharp falloff like last year’s. So let’s hope for some reasonably priced deals over the next few weeks while we wait to see if American Pharoah can pull it off.

By the way, just like everybody wants to know what the “buzz” is on other desks, you can expect the “buzz” horse for the Belmont to be Materiality, who conceded a lot of experience in the Derby and broke horribly from the gate, only to finish an impressive sixth, if there is such a thing. My guess is that betting him will be like buying a bond that you know the momentum guys are trying to buy—the price is unlikely to be fair value. But just because some people overpay doesn’t mean they can’t make money if they get the underlying stock and trend right enough. Similarly, Materiality may turn out to be good enough to win the Belmont. It will be fun to see.

(This is the cover letter for the subscription-based weekly Hillside's Hybrid Vigor newsletter. For a complete copy, please contact John Anderson at + 1 (646) 712-9289 x 107).