Kass: 2014 vs. 1989

After digesting Tuesday's post-close news regarding Twenty-First Century Fox (FOX/FOXA) withdrawing its bid for Time Warner (TWX), I wrote the following:

UAL Redux?

Has the M&A bubble just burst with the withdrawal of Twenty-First Century Fox's bid for Time Warner? Does the broken proposal have adverse consequences for the broader market? These questions will be asked by many investors tonight.

Remember on October 13, 1989, there was a mini market crash after the breakdown of the leveraged buyout of what was then UAL Corp. (arguably caused by the Association of Flight Attendants pulling out of the deal). The arbitrage community was hit badly; some larger arbs even went out of business.

Not only did the U.S. stock market fall by about 7% in one day (and the transports dropped by more than 12% in two days) but the junk bond market also collapsed.

A mini Black Swan then -- and possibly now.

After Jim Cramer read the above post, he suggested that I should craft a column on why 2014 will likely be different than the 1989 mini market meltdown.

Jim has a wonderful idea, and he is 100% correct that conditions in 2014 (economic, interest rate, etc.) are indeed different than 25 years ago.

So without further ado, here is my follow-up to Jim Cramer's suggestion that I might explain why 2014 is different than 1989, when the UAL leveraged buyout was aborted, and why it is not a given that this year's stock market might fall in reaction to the abandoned M&A deals of Sprint (S)/T-Mobile US (TMUS) and Twenty-First Century Fox/Time Warner as deeply as it did 25 years ago.

There is always a temptation for talking heads (myself included) to make simple observations and conclusions, as it makes for exciting press and exposure. My cautionary remarks in "UAL Redux?" could have been taken incorrectly, and my intention was not to be sensationalistic. What I meant to suggest is not that the market would fall 7% to 10% as it did in 1989 but rather if history rhymes, the failure of the two takeovers could produce some market indigestion.

As I have written in the past, there are ample reasons to be concerned that the markets are somewhat overvalued.

Many of the conditions (especially of a monetary kind) that led to the UAL buyout being terminated, however, are not apparent today.

The most important difference is that back in 1989 monetary conditions were extremely tight: The yield curve was inverted, the condition of the junk bond market was tenuous, and prices were under extreme pressure. By contrast, today (as seen in the chart below) monetary conditions are extremely easy, and the yield curve is positively sloped.

Moreover, while junk bond yields have backed up, they have declined only modestly relative to the rally in prices and still remain at near-record absolute yields.

The second difference is that the Twenty-First Century Fox/Time Warner deal isn't even being financed with high-yield bonds; it is being financed by cash and stock. UAL was all junk.

The third difference is that the regulatory environment today under a Democratic administration is different than it was under Bush's Republican administration in 1989.

Finally, monetary conditions were being tightened aggressively back in 1989, even before the UAL buyout was announced. The yield curve was already inverted, and rates were much higher than they are today.

In August 2014 interest rates are at or near record low levels (at most maturities) and are not likely to rise by much in the period ahead, thanks to the kindness of the world's central bankers.

Jim, thanks for the advice to clarify why the markets are likely behaving better than expected today.

The reality is that the conditions in 2014 are far different than in 1989.


This content originally appeared on Real Money Pro on Aug. 5 and Aug. 6.

At the time of publication, Kass and/or his funds had no positions in the stocks mentioned, although holdings can change at any time.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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