Market Champagne Sits on Ice

champagne

Summer may be coming to an end, but the heat in the stock market has not cooled down, as the stock market registered its hottest August performance in 14 years (S&P 500 index up +3.8%). With these stellar results, one would expect the corks to be popping, cash flowing into stocks, and the champagne flowing. However, for numerous reasons, we have not seen this phenomenon occur yet. Until the real party begins, I suppose the champagne will stay on ice.

At the end of last year, I wrote further about the inevitable cash tsunami topic in an article entitled, “Here Comes the Dumb Money.” At that point in time, stocks had remarkably logged an approximate +30% return, and all indications were pointing towards an upsurge of investor interest in the stock market. So far in 2014, the party has continued as stocks have climbed another +8.4% for the year, but a lot of the party guests have not arrived yet. With the water temperature in the pool being so enticing, one would expect everyone to jump in the stock market pool. Actually, we have seen the opposite occur as -$12 billion has been pulled out of U.S. stock funds so far in 2014 (see ICI chart below).

fund flows

How can the market be up +8.4% when money is coming out of stocks? For starters, companies are buying stock by the hundreds of billions of dollars. An estimated $480 billion of stock  was purchased by corporations last year via share repurchase authorizations. Adding fuel to the stock fire are near record low interest rates. The ultra-low rates have allowed companies to borrow money at unprecedented rates for the purpose of not only buying back chunks of stock, but also buying the stock of whole companies (Mergers & Acquisitions). Thomson Reuters estimates that M&A activity in 2014 has already reached $2.2 trillion, up more than +70% compared to the same period last year.

Another factor contributing to the lackluster appetite for stocks is the general public’s apathy and disinterest in the market. This disconnected sentiment was captured beautifully by a recent Gallup survey, which asked people the following question:

stock opinion survey

As you can see, only 7% of the respondents realized that stocks were up by more than +30% in 2013. More specifically, the S&P 500 (Large Cap) index was up +29.6%, S&P 600 (Small Cap) +39.7%, and the S&P 400 (Mid Cap) +31.6% (all percentages exclude dividends). Despite these data points, if taken with near 15-year low household stock ownership data, the results prove sentiment is nowhere near the euphoric phases reached before the 2000 bubble burst or the 2006-2008 real estate collapse.

Beyond the scarring effects of the 2008-2009 financial crisis, tempered moods regarding stocks can also be attributed to fresher geopolitical concerns (i.e., military tensions in Ukraine, Islamic extremists in Iraq, and missile launches from the Gaza Strip). The other area of never-ending anxiety is Federal Reserve monetary policy. The stock market, which has tripled in value from early 2009, has skeptics continually blaming artificial Quantitative Easing/QE policies (stimulative bond purchases) as the sole reason behind stocks advance. With current Fed Chair Janet Yellen pulling 70% of the QE punch bowl away (bond purchases now reduced to $25 billion per month), the bears are having a difficult time explaining rising stock prices and declining interest rates. Once all $85 billion in monthly QE purchases are expected to halt in October, skeptics will have one less leg on their pessimistic stool to sit on.

Economy and Profits Play Cheery Tune

While geopolitical and Federal Reserve clouds may be preventing many sourpusses from joining the stock party, recent economic and corporate data have party attendees singing a cheery tune. More specifically, the broadest measurement of economic activity, GDP (Gross Domestic Product), came in at a higher-than-expected level of +4.2% for the 2nd quarter (see Wall Street Journal chart below).

growing faster

Moreover, the spike in July’s Durable Goods orders also paints a healthy economic picture (see chart below). The data is volatile (i.e., Boeing Co orders – BA), nevertheless, CEO confidence is on the rise. Improved confidence results in executives opening up their wallets and investing more into their businesses.

durable googds

Source: Calafia Beach Pundit

Last but not least, the lifeblood of appreciating stock prices (earnings/profits) have been accelerating higher. In the most recent quarterly results, we saw a near doubling of the growth rate from 1st quarter’s +5% growth rate to 2nd quarter’s +10% growth rate (see chart below).

eps growth 2014

Source: Dr. Ed’s Blog

With the S&P 500 continuing to make new record highs despite scary geopolitical and Federal Reserve policy concerns, the stock market party is still waiting for guests to arrive. When everyone arrives and jumps in the pool, it will be time to pop the corks and sell. Until then, there is plenty of appreciation potential as the champagne sits on ice.

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September 2, 2014 at 11:50 am Leave a comment

Stock Talk: The Value of Media in Finance

Man Speaking Into Microphones

I recently caught up with 50-year investment veteran Bill Kort to answer his questions regarding the media’s impact on the financial industry. After working for Kidder Peabody, A.G. Edwards, Wachovia, and Wells Fargo, Bill called it quits and decided to retire. Besides enjoying retirement with his wife, children, and grandchildren, Bill now also devotes considerable time to his blog Kort Sessions (www.KortSessions.com).

In a recent interview published on his Kort Sessions blog (KS), here’s what we discussed:

KS: Today, when you recommend a client take on, or increase equity exposure, what are the most common push-backs that you get? Have these changed in the past few years? If so, could you explain.

Wade Slome: “Given the events that have transpired over the last 15 years, I expect to receive a healthy dosage of pushback. Many investors have naturally been scarred from the 2008-2009 Financial Crisis, so convincing certain people that the 100-year flood will not occur every 100 days can be challenging. Regardless of the skepticism I receive, I feel it’s my duty to provide the best possible advice I can to existing clients and prospective clients. I can lead a horse to water, but I believe it’s not my job to force clients into a single investment option. At Sidoxia, we customize investment plans that meet clients’ risk tolerances, time horizons, and overall objectives.

With regard to sentiment changes in recent years, it is true that the tripling in equity market values since early 2009 has changed investor moods. Risk appetites have definitely increased. Nevertheless, cynicism is still rampant. Surveys done by Gallup show that stock ownership is near 15-year lows and despite stocks at or near record highs, ICI fund flow data shows money fleeing U.S. stock funds in 2014. With generational low interest rates, I see many long-term investors being too imprudently conservative. However, on the other hand, my responsibility is to also prevent other clients from taking on too much risk, especially if they have shorter investment time horizons or have limited funds in retirement.”

KS: When you speak with clients today, what are prominent worries do they have about their investments: The general level of the market, valuation, the economic backdrop, U.S. political issues or geopolitical concerns (all of the above)? Could you rank or tell me which concerns seem to be paramount.

Wade Slome: “In this 24-hour news cycle society we live in, an avalanche of real-time data gets crammed down our throats daily through our smartphones and Twitter-Facebook pages. As a result, the overwhelming barrage of news gets disseminated instantaneously, which in turn spreads fear like wildfire by word of mouth. In this type of environment it comes as no surprise to me that the general public is on edge. Every molehill is made into a mountain by media outlets for a simple reason…fear sells! Before the internet 20 years ago, virtually no one could find the location of Cyprus, Syria, Ukraine, or Gaza on a map – now we have Google and Wikipedia to show us or the Twitter feed scrolling at the bottom of our television sets reminds us. As far as concerns go, it’s tough to rank which ones are paramount. One day it’s the elections or Iran, and then the other day it’s the stock market crashing or the Ebola virus. Eventually the emotional pendulum will swing from fear and pessimism to optimism and euphoria, it always does. Like a lot of different professions, one of best strengths to have as an investment manager is the experience in knowing what noise to filter out and the ability to identify the relevant factors that drive outperformance.”

KS: Could you share the short-form responses that you might give to your clients when addressing the aforementioned issues.

Wade Slome: “The best advice I can give investors is to ignore the headlines. This principle is just as true today as it was a century or two ago. Mark Twain famously said, “If you don’t read the newspaper, you are uninformed.  If you do read the newspaper, you are misinformed.” This is obviously presented a little tongue-in-cheek, but the main point being is headlines should not drive your investment decisions. It’s perfectly fine to be informed about the economy and politics, but people must realize the stock market often moves independently and in contrarian directions to prevailing media stories. Rather than emotionally react to news flow, it is much more important to create an objective, long-term investment plan that takes advantage of market noise, hype, and volatility.”

KS: Finally, this is a little bit of a leading question that I hope you might run with. Do you find any useful purpose being served by the financial, general or political media that might aid an individual’s investment process?

Wade Slome: “In my view of the financial markets, there are a few underlying principles that drive stock prices over the long-term, and they include such basic factors as earnings, valuations, interest rates, and market psychology. What I would objectively try to argue is that the financial, general, or political media have little to no impact on the first three factors and only modest influence on the last one (market psychology). Part of the reason I have been so constructive on the markets on my Investing Caffeine blog over the last five years is because all these factors have generally pointed in the right direction. I will become nervous when earnings decline, valuations get stretched, interest rates spike, and/or psychology turns euphoric. Right now, I don’t think we are seeing any of that occurring.

With that said, I do believe there are exceptions to the rule that the “media is evil.” If you have the time, interest, and patience to stagger through the endless desert of financial media, you can find a few rare flowers. Although I do consume mass amounts of media, 99% of it ends up in the trash or ignored. I do my best to reserve my media consumption to those successful investors who have lived through multiple market cycles and have a winning track record to back it up. It is possible to find sage investment bloggers; Warren Buffett interviews on CNBC; or newspaper interviews of thriving venture capitalists, if you properly dine on a healthy media diet. Unfortunately there is a lot of junk food financial content out in media land. What should generally be avoided at all costs are rants from economists, journalists, analysts, commentators, and talking heads. No matter how eloquent or articulate they may sound, the vast majority of the people you see on television have not invested a professional dime in their careers, so all you are getting from them are worthless, vacillating opinions. I choose to stick to commentary from the tried and true investment veterans.”

Bill, thanks again for the thoughtful interview questions, and continued success with your Kort Sessions blog!

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own GOOG/GOOGL, and a range of positions in certain exchange traded fund positions, but at the time of publishing SCM had no direct position in TWTR, FB, WFC, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

August 23, 2014 at 6:57 pm Leave a comment

Got Growth?

Slide1

Investing in the stock market can be quite stressful, especially during periods of volatility…but investing doesn’t have to be nerve-racking. Investing legend T. Rowe price captured the beneficial sentiments of growth investing beautifully when he stated the following:

“The growth stock theory of investing requires patience, but is less stressful than trading, generally has less risk, and reduces brokerage commissions and income taxes.”

 

What I’ve learned over my investing career is that fretting over such things as downgrades, management changes, macroeconomic data, earnings misses, geopolitical headlines, and other irrelevant transitory factors leads to more heartache than gains. If you listen to a dozen so-called pundits, talking heads, journalists, or bloggers, what you quickly realize is that all you are often left with are a dozen different opinions. Opinions don’t matter…the facts do.

Finding Multi-Baggers: The Power of Compounding

Rather than succumbing to knee-jerk reactions from the worries of the day, great long-term investors realize the benefits of compounding. We know T. Rowe Price appreciated this principle because he agreed with Nobel Prize winning physicist Albert Einstein’s view that “compounding interest” should be considered the “8th wonder of the world” – see also how Christopher Columbus can turn a penny into $121 billion (Compounding: A Penny Saved is Billions Earned).

People generally refer to Warren Buffett as a “Value” investor, but in fact, despite the Ben Graham moniker, Buffett has owned some of the greatest growth stocks of all-time. For example, Coca Cola Co (KO) achieved roughly a 20x return from 1988 – 1998, as shown below:

Source: Yahoo! Finance

Source: Yahoo! Finance

If you look at other charts of Buffett’s long-term holdings, such as Wells Fargo & Company (WFC), American Express Co (AXP), and Procter & Gamble – Gillette (PG), the incredible compounded gains are just as astounding.

In recent decades, there is no question that stocks have benefited from P/E expansion. P/E ratios, or the average price paid for stocks, has increased from the early 1980s as long-term interest rates have declined from the high-teens to the low single-digits, but the real lifeblood for any stock is earnings growth (see also It’s the Earnings, Stupid). As growth investor extraordinaire Peter Lynch once said:

“People may bet on hourly wiggles of the market but it’s the earnings that waggle the wiggle long term.”

 

As Lynch also pointed out, it only takes the identification of a few great multi-bagger stocks every decade to compile a tremendous track record, while simultaneously hiding many sins:

“Fortunately the long-range profits earned from really good common stocks should more than balance the losses from a normal percentage of such mistakes.”

 

The Scarcity of Growth

Ever since the technology bubble burst in 2000, Growth stocks have felt the pain. Since that period, the Russell 1000 Value index – R1KV (Ticker: IWD) has almost doubled in value and outperformed the Russell 1000 Growth index – R1KG (Ticker: IWF) by more than +60% (see chart below):

Source: Yahoo! Finance

Source: Yahoo! Finance

Although the R1KG index has yet to breach its previous year 2000 highs, ever since the onset of the Great Financial Crisis (end of 2007), the R1KG index has been on the comeback trail. Now, the Russell 1000 Growth index has outperformed its Value sister index by an impressive +25% (see chart below):

Source: Yahoo! Finance

Source: Yahoo! Finance

Why such a disparity? Well, in a PIMCO “New Normal & New Neutral” world where global growth forecasts are being cut by the IMF  and a paltry advance of 1.7% in U.S. GDP is expected, investors are on a feverish hunt for growth. U.S. investors are myopically focused on our 2.34% 10-Year Treasury yield, but if you look around the rest of the globe, many yields are at multi-hundred year lows. Consider 10-year yields in Germany sit at 0.96%; Japan at 0.50%; Ireland at 1.98%; and Hong Kong at 1.94% as a few examples. This scarcity of growth has led to outperformance in Growth stocks and this trend should continue until we see a clear sustainable acceleration in global growth.

If we dig a little deeper, you can see the 25% premium in the R1KG P/E ratio of 20.8x vs. 16.7x for the R1KV is well deserved. Historical 5-year earnings growth for the R1KG has been +52% higher than R1KV (17.8% vs. 11.7%, respectively). Going forward, the superior earnings performance is expected to continue. Long-term growth for the R1KG index is expected to be around 55% higher than the R1KV index (14% vs 9%).

In this 24/7, Facebook, Twitter society we live in, investing has never been more challenging with the avalanche of daily news. The ultra-low interest rates and lethargic global recovery hasn’t made my life at Sidoxia any easier. But one thing that is clear is that the investment tide is not lifting all Growth and Value stocks at the same pace. The benefits of long-term Growth investing are clear, and in an environment plagued by a scarcity of growth, it is becoming more important than ever when reviewing your investment portfolios to ask yourself, “Got Growth?”

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in KO/PG (non-discretionary accounts) and certain exchange traded fund positions, but at the time of publishing SCM had no direct position in TWTR, FB, WFC, AXP, IWF, IWD or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

August 16, 2014 at 6:18 pm 1 comment

Is the Stock Market Rigged? Yes…In Your Favor

ace of hearts

Is the Market Rigged? The short answer is “yes”, but unlike gambling in Las Vegas, investing in the stock market rigs the odds in your favor. How can this be? The market is trading at record highs; the Federal Reserve is artificially inflating stocks with Quantitative easing (QE); there is global turmoil flaring up everywhere; and author Michael Lewis says the stock market is rigged with HFT – High Frequency Traders (see Lewis Sells Flash Boys Snake Oil). I freely admit the headlines have been scary, but scary headlines will always exist. More importantly for investors, they should be more focused on factors like record corporate profits (see Halftime Adjustments); near generationally-low interest rates; and reasonable valuation metrics like the price-earnings (P/E) ratios.

Even if you were to ignore these previously mentioned factors, one can use history as a guide for evidence that stocks are rigged in your favor. In fact, if you look at S&P 500 stock returns from 1928 (before the Great Depression) until today, you will see that stock prices are up +72.1% of the time on average.

If the public won at such a high rate in Las Vegas, the town would be broke and closed, with no sign of pyramids, Eiffel Towers, or 46-story water fountains. There’s a reason Las Vegas casinos collected $23 billion in 2013 – the odds are rigged against the public. Even Shaquille O’Neal would be better served by straying away from Vegas and concentrating on stocks. If Shaq could have improved his 52.7% career free-throw percentage to the  72.1% win rate for stocks, perhaps he would have earned a few more championship rings?

Considering a 72% winning percentage, conceptually a “Buy-and-Hold” strategy sounds pretty compelling. In the current market, I definitely feel this type of strategy could beat most market timing and day trading strategies over time. Even better than this strategy, a “Buy Winners-and-Hold Winners” strategy makes more sense. In other words, when investing, the question shouldn’t revolve around “when” to buy, but rather “what” to buy. At Sidoxia Capital Management we are primarily bottom up investors, so the appreciation potential of any security in our view is largely driven by factors such as valuation, earnings growth, and cash flows. With interest rates near record lows and a scarcity of attractive alternatives, the limited options actually make investing decisions much easier.

Scarcity of Alternatives Makes Investing Easier

U.S. investors moan and complain about our paltry 2.42% yield on the 10-Year Treasury Note, but how appetizing, on a risk-reward basis, does a 2.24% Irish 10-year government bond sound? Yes, this is the same country that needed a $100 billion+ bailout during the financial crisis. Better yet, how does a 1.05% yield or 0.51% yield sound on 10-year government treasury bonds from Germany and Japan, respectively? Moreover, what these minuscule yields don’t factor in is the potentially crippling interest rate risk investors will suffer when (not if) interest rates rise.

Fortunately, Sidoxia’s client portfolios are diversified across a broad range of asset classes. The quantitative results from our proprietary 5,000 SHGR (“Sugar”) security database continue to highlight the significant opportunities in the equities markets, relative to the previously discussed “bubblicious” parts of the fixed income markets. Worth noting, investors need to also remove their myopic blinders centered on U.S. large cap stocks. These companies dominate media channel discussions, however there are no shortage of other great opportunities in the broader investment universe, including such areas as small cap stocks, floating-rate bonds, real estate, commodities, emerging markets, alternative investments, etc.

I don’t mind listening to the bearish equity market calls for stock market collapses due to an inevitable Fed stimulus unwind, mean reverting corporate profit margins, or bubble bursting event in China. Nevertheless, when it comes to investing, there is always something to worry about. While there is always some uncertainty, the best investors love uncertainty because those environments create the most opportunities. Stocks can and eventually will go down, but rather than irresponsibly flailing around in and out of risk-on and risk-off trades to time the market (see Market Timing Treadmill), we will continue to steward our clients’ money into areas where we see the best risk-reward prospects.

For those other investors sitting on the sidelines due to market fears, I commend you for coming to the proper conclusion that stock markets are rigged. Now you just need to understand stocks are rigged for you (not against you)…at least 72% of the time.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold a range of exchange traded fund positions, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

August 9, 2014 at 5:18 pm 3 comments

Psst…Do You Want to Join the Club?

psst
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (August 1, 2014). Subscribe on the right side of the page for the complete text. 
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Investing is a tough game, and if you want to join the SIC (Successful Investors Club) there are a few top secret concepts you must learn and follow. Here are the all-important, confidential words of wisdom that will gain you entrance into the SIC:

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#1. Create a plan and stick to it.

#2. Don’t waste your time listening to the media.

Like dieting, the framework is simple to understand, but difficult to execute. Theoretically, if you follow Rule #1, you don’t have worry about Rule #2. Unfortunately, many people have no rules or discipline in place, and instead let their emotions drive all investing decisions. When it comes to following the media, Mark Twain stated it best:

“If you don’t read the newspaper, you are uninformed. If you do read the newspaper, you are misinformed.”

 

It’s fine to be informed, as long as the deluge of data doesn’t enslave you into bad, knee-jerk decision-making. You’ve seen those friends, family members and co-workers who are glued to their cell phones or TVs while insatiably devouring real-time data from CNBC, CNN, or their favorite internet blog. The grinding teeth and sweaty palms should be a dead giveaway that these habits are not healthy for investment account balances or blood pressure.

Thanks to the endless scary headlines and stream of geopolitical turmoil (fear sells), millions of investors have missed out on one of the most staggering bull market rallies in history. More specifically, the S&P 500 index (large capitalization companies) has almost tripled in value from early 2009 (666 to 1,931) and the S&P 600 index (small capitalization companies) almost quadrupled from 181 to 645.

The Challenge  

Source: FreeImage.com

Becoming a member of the Successful Investors Club (SIC) is no easy feat. As I’ve written in the past, the human brain has evolved dramatically over tens of thousands of years, but the troubling, emotionally-driven amygdala tissue mass at the end of the brain stem (a.k.a., “Lizard Brain“) still remains. The “Lizard Brain” automatically produces a genetic flight response to perceived worrisome stimuli surrounding us. In other words, our “Lizard Brain” often interprets excessively sensationalized current events as a threat to our financial security and well-being.

It’s no wonder amateur investors have trouble dealing with the incessantly changing headlines. Yesterday, investors were panicked over the P.I.I.G.S (Portugal, Italy, Ireland, Greece, Spain), the Arab Spring (Tunisia, Egypt, Iran, etc.), and Cyprus. Today, it’s Ukraine, Argentina, Israel, Gaza, Syria, and Iraq. Tomorrow…who knows? It’s bound to be another fiscally irresponsible country, terrorist group, or autocratic leader wreaking havoc upon their people or enemies.

During the pre-internet or pre-smartphone era, the average person couldn’t even find Ukraine, Syria, or the Gaza Strip on a map. Today, we are bombarded 24/7 with frightening stories over these remote regions that have dubious economic impact on the global economy.

Take the Ukraine for example, which if you think about it is a fiscal pimple on the global economy. Ukraine’s troubled $177 billion economy, represents a mere 0.29% of the $76 trillion global GDP. Could an extended or heightened conflict in the region hinder the energy supply to a much larger and significant European region? Certainly, however, Russian President Vladimir Putin doesn’t want the Ukrainian skirmish to blow up out of control. Russia has its own economic problems, and recent U.S. and European sanctions haven’t made Putin’s life any easier. The Russian leader has a vested economic interest to keep its power hungry European customers happy. If not, the U.S.’s new found resurgence in petroleum supplies from fracking will allow our country to happily create jobs and export excess reserves to a newly alienated EU energy buyer.

The Solution

Source: The Geek

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Rather than be hostage to the roller coaster ride of rising and falling economic data points, it’s better to follow the sage advice of investing greats like Peter Lynch, who averaged a +29% return per year from 1977 – 1990.

Here’s what he had to say about news consumption:

“If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.”

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“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Rather than fret about the direction of the market, at Sidoxia Capital Management we are focused on identifying the best available opportunities, given any prevailing economic environment (positive or negative). We assume the market will go nowhere and invest our client assets (and personal assets) accordingly by focusing on those areas we see providing the most attractive risk-adjusted returns. Investors who try to time the market, fail miserably over the long-run. If timing the market were easy, you would see countless people’s names at the tops of the Forbes billionaire list – regrettably that simply is not the case.

Since “fear” sells in the media world, it’s always important to sift through the deluge of data to gain a balanced perspective. During panic periods, it’s important to find the silver linings. When everyone is euphoric, it’s vital to discover reasons for caution.

While a significant amount of geopolitical turmoil occurred last month, it’s essential to remember the underlying positive fundamentals propelling the stock market to record highs. The skeptics of the recovery and record stock market point to the Federal Reserve’s unprecedented, multi-trillion dollar money printing scheme (Quantitative Easing – QE) and the inferior quality of the jobs created. Regarding the former point, if QE has been so disastrous, I ask where is the run-away inflation (see chart below)? While the July jobs report may show some wage pressure, you can see we’re still a long ways away from the elevated pricing levels experienced during the 1970s-1980s.

 


Source: Calafia Beach Pundit

A final point worth contemplating as it relates to the unparalleled Fed Policy actions was highlighted by strategist Scott Grannis. If achieving real economic growth through money printing was so easy, how come Zimbabwe and Argentina haven’t become economic powerhouses? The naysayers also fail to acknowledge that the Fed has already reversed the majority of its stimulative $85 billion monthly bond buying program (currently at $25 billion per month). What’s more, the Federal Open Market Committee has already signaled a rate hike to 1.13% in 2015 and 2.50% in 2016 (see chart below).

 


Source: Financial Times

 

The rise in interest rates from generationally low levels, especially given the current status of our improving economy, as evidenced by the recent robust +4.0% Q2-GDP report, is inevitable. It’s not a matter of “if”, but rather a matter of “when”.

On the latter topic of job quality, previously mentioned, I can’t defend the part-time, underemployed nature of the employment picture, nor can I defend the weak job participation rate. In fact, this economic recovery has been the slowest since World War II. With that said, about 10 million private sector jobs have been added since the end of the Great Recession and the unemployment rate has dropped from 10% to 6.1%. However you choose to look at the situation, more paychecks mean more discretionary dollars in the wallets and purses of U.S. workers. This reality is important because consumer spending accounts for 70% of our country’s economic activity.

While there is a correlation between jobs, interest rates, and the stock market, less obvious to casual observers is the other major factor that drives stock prices…record corporate profits. That’s precisely what you see in the chart below. Not only are trailing earnings at record levels, but forecasted profits are also at record levels. Contrary to all the hyped QE Fed talk, the record profits have been bolstered by important factors such as record manufacturing, record exports, and soaring oil production …not QE.

 Source: Dr. Ed’s Blog
 

Join the Club

Those who have been around the investing block a few times realize how challenging investing is. The deafening information noise instantaneously accessed via the internet has only made the endeavor of investing that much more challenging. But the cause is not completely lost. If you want to join the bull market and the SIC (Successful Investors Club), all you need to do is follow the two top secret rules. Creating a plan and sticking to it, while ignoring the mass media should be easy enough, otherwise find an experienced, independent investment advisor like Sidoxia Capital Management to help you join the club.

 

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in certain exchange traded funds ans securities, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

August 2, 2014 at 9:00 am 4 comments

NVEC: A Cash Plump Activist Target…For Icahn?

Cash-Icahn

Some might call Carl Icahn a greedy capitalist, but at the core, the 78 year old activist has built his billions in fortunes by unlocking shareholder value in undervalued companies. His targets have come in many shapes and sizes, but one type of target is cash bloated companies without defined capital allocation strategies. A recent high profile example of a cash ballooned target of Icahn was none other than the $591+ billion behemoth Apple Inc. (AAPL).  

His initial tweet on August 13, 2013 announced his “large position” in the “extremely undervalued shares” of Apple ($67 split adjusted). We have been long-term shareholders of Apple ourselves and actually beat Carl to the punch three years earlier when the shares were trading at $35 – see Jobs: The Gluttonous Cash Hog. Icahn doesn’t just nonchalantly make outrageous claims…he puts his money where his mouth is. After Icahn’s initial proclamation, he went onto build a substantial $3.6 billion Apple position by January 2014.

Icahn Tweet

Icahn initially demanded Apple’s CEO Tim Cook to execute a $150 billion share repurchase program before downgrading his proposal to a $50 billion buyback. After receiving continued resistance, Icahn eventually relented in February 2014. But Icahn’s blood, sweat, and tears did not go to waste. His total return in Apple from his initial announcement approximates +50%, in less than one year. And although Icahn wanted more action taken by the company’s management team, Apple has repurchased about $50 billion in stock and paid out $14 billion in dividends to investors over the last five quarters. Despite the significant amount of capital returned to shareholders over the last year, Apple still holds a gargantuan net cash position of $133.5 billion, up approximately $3 billion from the 2013 fiscal third quarter.

Icahn’s Next Cash Plump Target?

Mr. Icahn is continually on the prowl for new targets, and if he played in the small cap stock arena, NVE Corp. (NVEC) certainly holds the characteristics of a cash bloated company without a defined capital allocation strategy. Although I rarely write about my hedge fund stock holdings, followers of my Investing Caffeine blog may recognize the name NVE Corp. More specifically, in 2010 I picked NVEC as my top stock pick of the year (see NVEC: Profiting from Electronic Eyes, Nerves & Brains). The good news is that NVEC outperformed the market by approximately +25% that year (+36% vs 11% for the S&P 500). Over the ensuing years, the performance has been more modest – the +42% return from early 2010 has underperformed the overall stock market.

Rather than rehash my whole prior investment thesis, I would point you to the original article for a summary of NVE’s fundamentals. Suffice it to say, however, that NVE’s prospects are just as positive (if not more so) today as they were five years ago.

Here are some NVE data points that Mr. Icahn may find interesting:

  • 60% operating margins (achieved by < 1% of all non-financial companies FINVIZ)
  • 0% debt
  • 15% EPS growth over the last seven years ($1.00 to $2.29)
  • Cutting edge, patent protected, market leading spintronic technology
  • +7% Free Cash Flow yield ($13m FCF / $194 adjusted market value) $294m market cap minus $100m cash.
  • $100 million in cash on the balance sheet, equal to 34% of the company’s market value ($294m). For comparison purposes to NVE, Apple’s $133 billion in cash currently equates to about 23% of its market cap.

Miserly Management

As I noted in my previous NVE article, my beef with the management team has not been their execution. Despite volatile product sales in recent years, it’s difficult to argue with NVE CEO Dan Baker’s steering of outstanding bottom-line success while at the helm. Over Baker’s tenure, NVE has spearheaded meteoric earnings growth from EPS of $.05 in 2009 to $2.29 in fiscal 2013. Nevertheless, management not only has a fiduciary duty to prudently manage the company’s operations, but it also has a duty to prudently manage the company’s capital allocation strategy, and that is where NVE is falling short. By holding $100 million in cash, NVE is being recklessly conservative.

Is there a reason management is being so stingy with their cash hoard? Even with cash tripling over the last five years ($32m to $100m) and operating margins surpassing an incomprehensibly high threshold (60%), NVE still has managed to open their wallets to pursue these costly actions:

  • Double Capacity: NVE doubled their manufacturing capacity in fiscal 2013 with minimal investment ($2.8 million);
  • Defend Patents: NVE fought and settled an expensive patent dispute against Motorola spinoff (Everspin) as it related to the company’s promising MRAM technology;
  • R&D Expansion: The company shored up its research and development efforts, as evidenced by the +39% increase in fiscal 2014 R&D expenditures, to $3.6 million. 

The massive surge in cash after these significant expenditures highlights the indefensible logic behind holding such a large cash mound. How can we put NVE’s pile of cash into perspective? Well for starters, $100 million is enough cash to pay for 110 years of CAPEX (capital expenditures), if you simply took the company’s five year spending average. Currently, the company is adding to the money mountain at a clip of $13,000,000 annually, so the amount of cash will only become more ridiculous over time, if the management team continues to sit on their hands.

To their credit, NVE dipped half of a pinky toe in the capital allocation pool in 2009 with a share repurchase program announcement. Since the share repurchase was approved, the cash on the balance sheet has more than tripled from the then $32 million level. To make matters worse, the authorization was for a meaningless amount of $2.5 million. Over a five year period since the initial announcement, the company has bought an irrelevant 0.5% of shares outstanding (or a mere 25,393 shares).

A Prudent Proposal

The math does not require a Ph.D. in rocket science. With interest rates near a generational low, management is destroying value as inflation eats away at the growing $100 million cash hoard. I believe any CFO, including NVE’s Curt Reynders, can be convinced that earning +7% on NVE shares (or +15% if earnings compound at historical rates for the next five years) is better than earning +2% in the bank. Or in other words, buying back stock by NVE would be massively accretive to EPS growth. Conceptually, if NVE used all $100 million of its cash to buy back stock at current prices, NVE’s current EPS of $2.59 would skyrocket to $3.63 (+40%). 

A more reasonable proposal would be for NVE management to buy back 10% of NVE’s stock and simultaneously implement a 2% dividend. At current prices, these actions would still leave a healthy balance of about $75 million in cash on the balance sheet by the end of the fiscal year, which would arguably still leave cash at levels larger than necessary. 

Despite the capital allocation miscues, NVE has incredibly bright prospects ahead, and the recently reported quarterly results showing +37% revenue growth and +57% EPS growth is proof positive. As a fellow long-term shareholder, I share management’s vision of a bright future, in which NVE continues to proliferate its unique and patented spintronic technology. With market leadership in nanotechnology sensors, couplers, and MRAM memory, NVE is uniquely positioned to take advantage of game changing growth in markets such as nanotechnology biosensors, electric drive vehicles (EDVs), consumer electronic compassing, and next generation MRAM technology. If NVE can continue to efficiently execute its business plan and couple this with a consistent capital allocation discipline, there’s no reason NVE shares can’t reach $100 per share over the next three to five years.

While NVE continues to execute on their growth vision, they can do themselves and their shareholders a huge favor by implementing a shareholder enhancing capital return plan. Carl Icahn is all smiles now after his successful investments in Apple and Herbalife (HLF), but impatient investors and other like-minded activists may be lurking and frowning, if NVE continues to irresponsibly ignore its swelling $100 million cash hoard.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in Apple Inc. (AAPL), NVE Corp. (NVEC), and certain exchange traded funds, but at the time of publishing SCM had no direct position in TWTR, MOT, Everspin, HLF, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

July 27, 2014 at 6:23 pm Leave a comment

Day Trading Your House

House Day Trade

By several measures, this economic recovery has been the slowest, most-challenging  expansion since World War II. Offsetting the painfully slow recovery has been a massive bull market in stocks, now hovering near all-time record highs, after about tripling in value since early 2009. Unfortunately, many investors have missed the boat (see Markets Soar – Investors Snore and Gallup Survey) with stock ownership near a 15-year low.

But it’s not too late for the “sideliners” to get in…is it? (see Get out of Stocks!*). Milfred and Buford are asking themselves that same question (see Investor Wake-Up Call). Milfred and Buford are like many other individuals searching for the American Dream and are looking for ways to pad their retirement nest egg. The seasoned couple has been around the block a few times and are somewhat familiar with one get-rich-quick strategy…day trading stocks. Thankfully, they learned that day trading stocks didn’t work out too well once the technology boom music ended in the late 1990s. Here’s what the SEC has to say about day trading on their government site:

Be prepared to suffer severe financial losses. Day traders typically suffer severe financial losses in their first months of trading, and many never graduate to profit-making status. Given these outcomes, it’s clear: day traders should only risk money they can afford to lose. They should never use money they will need for daily living expenses, retirement, take out a second mortgage, or use their student loan money for day trading.

 

Milfred & Buford Day Trade House

Milfred: “Now, Buford, I know we lost of our IRA retirement money day trading tech stocks, but if technical analysis works and all the financial news shows and talking babies on TV say it will make us a lot of cabbage, maybe we should try day trading our house?”

Buford: “Now I know why I married you 60 years ago – it’s that brilliant mind of yours that complements that sexy figure!”

Veteran readers of Investing Caffeine know I’ve been a skeptic of technical analysis (see Technical Analysis: Astrology or Lob Wedge), but a successful investor has to be open to new ideas, correct? So, if technical analysis works for stocks, then why not for houses? The recovery in housing prices hasn’t been nearly as robust as we’ve seen in stocks, so perhaps there’s more upside in housing. If I can get free stock charting technicals from my brokerage firm or online, there’s no reason I couldn’t access free charting technicals from Zillow (or Trulia) to make my fortunes. Case in point, I think I see a double-bottom and reverse head-and-shoulders pattern on the home price chart of Kim Kardashian’s house:

Source: Zillow

Source: Zillow

Of course, day trading isn’t solely dependent on random chart part patterns. Pundits, bloggers, and brokerage firms would also have you believe instant profits are attainable by trading based on the flow of news headlines. This is how Milfred and Buford would make their millions:

Milfred: “Snookums, it’s time for you to pack up all our stuff.”

Buford: “Huh? What are you talking about honey buns?”

Milfred: “Didn’t you see?! The University of Michigan consumer confidence index fell to a level of 81.3 vs. Wall street estimates of 83.0, bringing this measure to a new 4-month low.”

Buford: “I can’t believe I missed that. Nice catch ‘hun’. I’ll start packing, but where will we stay after we sell the house?”

Milfred: “We can hang out at the Motel 6, but it shouldn’t be long. I’m expecting the Philly Fed Manufacturing index to come in above 23 and I also expect a cease fire in Ukraine and Gaza. We can buy a new house then.”

I obviously frame this example very tongue-in-cheek, but buying and selling a house based on squiggly lines and ever-changing news headlines is as ridiculous as it sounds for trading stocks. The basis for any asset purchase or sale should be primarily based on the cash flow dynamics (e.g., rent, dividends, interest, etc., if there are any) of the asset, coupled with the appreciation/depreciation expectations based on a rigorous long-term analysis.

When Day Trading Works

Obviously there are some differences between real estate and stocks (see Stocks & Real Estate), including the practical utility of real estate and other subjective factors (i.e., proximity to family, schools, restaurants, beach, crime rates, etc.). Real estate is also a relatively illiquid and expensive asset to buy or sell compared to stocks. – However, that dynamic is rapidly changing. Like we witness in stocks, technology and the internet is making real estate cheaper and easier to match buyers and sellers.

Does day trading a stock ever work? Sure, even after excluding the factor of luck, having a fundamental information advantage can lead to immediate profits, but one must be careful how they capture the information. Raj Rajaratnam used this strategy but suffered the consequences of his insider trading conviction. Furthermore, the information advantage game can be expensive, as proven by Steven Cohen’s agreement to pay $1.2 billion to settle criminal charges. While I remain a day trading and technical analysis skeptic, I have noted a few instances when I use it.

Whatever your views are on the topics of day trading and technical analysis, do Milfred and Buford a favor by leading by example…invest for the long-term.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in certain exchange traded funds, but at the time of publishing SCM had no direct position in Z, TRLA, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

July 19, 2014 at 6:13 pm Leave a comment

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