Posts filed under ‘Financial Markets’
Markets Race Out of 2012 Gate
Article includes excerpts from Sidoxia Capital Management’s 2/1/2012 newsletter. Subscribe on right side of page.
Equity markets largely remained caged in during 2011, but U.S. stocks came racing out of the gate at the beginning of 2012. The S&P 500 index rose +4.4% in January; the Dow Jones Industrials climbed +3.4%; and the NASDAQ index sprinted out to a +8.0% return. Broader concerns have not disappeared over a European financial meltdown, high U.S. unemployment, and large unsustainable debts and deficits, but several key factors are providing firmer footing for financial race horses in 2012:
• Record Corporate Profits: 2012 S&P operating profits were recently forecasted to reach a record level of $106, or +9% versus a year ago. Accelerating GDP (Gross Domestic Product Growth) to +2.8% in the fourth quarter also provided a tailwind to corporations.
• Mountains of Cash: Companies are sitting on record levels of cash. In late 2011, U.S. non-financial corporations were sitting on $1.73 trillion in cash, which was +50% higher as a percentage of assets relative to 2007 when the credit crunch began in earnest.
• Employment Trends Improving: It’s difficult to fall off the floor, but since the unemployment rate peaked at 10.2% in October 2009, the rate has slowly improved to 8.5% today. Data junkies need not fret – we have fresh new employment numbers to look at this Friday.
• Consumer Optimism on Rise: The University of Michigan’s consumer sentiment index showed optimism improved in January to the highest level in almost a year, increasing to 75.0 from 69.9 in December.
• Federal Reserve to the Rescue: Federal Reserve Chairman, Ben Bernanke, and the Fed recently announced the extension of their 0% interest rate policy, designed to assist economic expansion, through the end of 2014. In addition, Bernanke did not rule out further stimulative asset purchases (a.k.a., QE3 or quantitative easing) if necessary. If executed as planned, this dovish stance will extend for an unprecedented six year period (2008 -2014).
Europe on the Comeback Trail?
Source: Calafia Beach Pundit
Europe is by no means out of the woods and tracking the day to day volatility of the happenings overseas can be a difficult chore. One fairly easy way to track the European progress (or lack thereof) is by following the interest rate trends in the PIIGS countries (Portugal, Ireland, Italy, Greece, and Spain). Quite simply, higher interest rates generally mean more uncertainty and risk, while lower interest rates mean more confidence and certainty. The bad news is that Greece is still in the midst of a very complex restructuring of its debt, which means Greek interest rates have been exploding upwards and investors are bracing for significant losses on their sovereign debt investments. Portugal is not in as bad shape as Greece, but the trends have been moving in a negative direction. The good news, as you can see from the chart above (Calafia Beach Pundit), is that interest rates in Ireland, Italy and Spain have been constructively moving lower thanks to austerity measures, European Central Bank (ECB) actions, and coordination of eurozone policies to create more unity and fiscal accountability.
Political Horse Race
Source: Real Clear Politics via The Financial Times
The other horse race going on now is the battle for the Republican presidential nomination between former Massachusetts governor Mitt Romney and former House of Representatives Speaker Newt Gingrich. Some increased feistiness mixed with a little Super-Pac TV smear campaigns helped whip Romney’s horse to a decisive victory in Florida – Gingrich ended up losing by a whopping 14%. Unlike traditional horse races, we don’t know how long this Republican primary race will last, but chances are this thing should be wrapped up by “Super Tuesday” on March 6th when there will be 10 simultaneous primaries and caucuses. Romney may be the lead horse now, but we are likely to see a few more horses drop out before all is said and done.
Flies in the Ointment
As indicated previously, although 2012 has gotten off to a strong start, there are still some flies in the ointment:
• European Crisis Not Over: Many European countries are at or near recessionary levels. The U.S. may be insulated from some of the weakness, but is not completely immune from the European financial crisis. Weaker fourth quarter revenue growth was suffered by companies like Exxon Mobil Corp (XOM), Citigroup Inc. (C), JP Morgan Chase & Co (JPM), Microsoft Corp (MSFT), and IBM, in part because of European exposure.
• Slowing Profit Growth: Although at record levels, profit growth is slowing and peak profit margins are starting to feel the pressure. Only so much cost-cutting can be done before growth initiatives, such as hiring, must be implemented to boost profits.
• Election Uncertainty: As mentioned earlier, 2012 is a presidential election year, and policy uncertainty and political gridlock have the potential of further spooking investors. Much of these issues is not new news to the financial markets. Rather than reading stale, old headlines of the multi-year financial crisis, determining what happens next and ascertaining how much uncertainty is already factored into current asset prices is a much more constructive exercise.
Stocks on Sale for a Discount
Source: Calafia Beach Pundit
A lot of the previous concerns (flies) mentioned is not new news to investors and many of these worries are already factored into the cheap equity prices we are witnessing. If everything was all roses, stocks would not be selling for a significant discount to the long-term averages.
A key ratio measuring the priceyness of the stock market is the Price/Earnings (P/E) ratio. History has taught us the best long-term returns have been earned when purchases were made at lower P/E ratio levels. As you can see from the 60-year chart above (Calafia Beach Pundit), stocks can become cheaper (resulting in lower P/Es) for many years, similar to the challenging period experienced through the early 1980s and somewhat analogous to the lower P/E ratios we are presently witnessing (estimated 2012 P/E of approximately 12.4). However, the major difference between then and now is that the Federal Funds interest rate was about 20% back in the early-’80s, while the same rate is closer to 0% currently. Simple math and logic tell us that stocks and other asset-based earnings streams deserve higher prices in periods of low interest rates like today.
We are only one month through the 2012 financial market race, so it much too early to declare a Triple Crown victory, but we are off to a nice start. As I’ve said before, investing has arguably never been as difficult as it is today, but investing has also never been as important. Inflation, whether you are talking about food, energy, healthcare, leisure, or educational costs continue to grind higher. Burying your head in the sand or stuffing your money in low yielding assets may work for a wealthy few and feel good in the short-run, but for much of the masses the destructive inflation-eroding characteristics of purported “safe investments” will likely do more damage than good in the long-run. A low-cost diversified global portfolio of thoroughbred investments that balances income and growth with your risk tolerance and time horizon is a better way to maneuver yourself to the investment winner’s circle.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in XOM, MSFT, JPM, IBM, 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.
Darwin Meets Capitalism & Private Equity
Source: Photobucket
A rising discontent is spreading like wildfire in the wake of a massive financial crisis that erupted in the U.S. during 2008, and is now working its way through Europe. Irresponsible governments across the globe succumbed to the deceptive allure of leverage, and as a result racked up colossal debts and gargantuan deficits. Now governments everywhere are toggling between political gridlock and painful austerity. Citizens are feeling the pain through high unemployment, exploding education costs, crumbling social safety nets, and a general decline in the standard of living.
As a result of these dramatic changes, the contributions of capitalism are being questioned by many, whether it’s the Occupy Wall Street movement attack on the top 1%, or more recently the assault on private equity’s relevancy for a presidential candidate.
Although the media may prefer to sensationalize economic stories and tell observers, “This time is different” to boost viewership, usually the truth relies more on the nuanced evolution of issues over time. If Charles Darwin were alive today, he would understand that capitalism and democracies are evolving to massive changes in globalization, technology, and emerging markets. Darwin would appreciate the fact that capitalism can’t and won’t change overnight. Whether capitalism ultimately survives or goes extinct depends on how it adapts. Or as Darwin characterizes evolution:
It is not the strongest of the species that survives, nor the most intelligent, but the most responsive to change.
Will Capitalism Survive?
Capitalism and democracy fit like a hand in a glove, which explains why both have thrived for generations. Never mind that democracies have been around for centuries and their expansion continues unabated (see Spreading the Seeds of Democracy), nevertheless pundits feel compelled to question the sustainability of these institutions.
I guess the real response to all those experts who question the merits of capitalism is what alternative would serve us better? Would it be Socialism like we see grinding Europe to a halt? Or perhaps Communism working its wonders in North Korea and Cuba? If not that, then surely the Autocracies in Egypt and Libya are the winning formulas? The Occupy Wall Streeters may not be happy with their personal plight or the top 1%, but I don’t see them packing their bags for Greece, the Middle East or China.
There is arguably a growing disparity between rich and poor and the game of globalization is only making it more difficult for rising tides of growth to lift up our middle class. The beauty of capitalism is that money goes where it is treated best. Capitalism sucks money to the areas of the world that are the freest, most open, transparent, and practice the rule of law. Some of these components of American capitalism unquestionably eroded over the last decade or so, but the good thing is that in a democracy, citizens have the right to vote and elect growth-promoting leaders to fix problems. Growth comes from competitiveness, and competitiveness is derived from education, innovation, and pro-growth policies. Let’s hope the 2012 elections get agents of change in office.
Darwin & Private Equity
Republican Presidential primary candidate Mitt Romney has been raked over the coals for his prior professional career at private equity firm, Bain Capital. I’m convinced Charles Darwin would see private equity’s involvement as a critical factor in the process of global commerce. Businesses are like species, and only the fittest will survive.
Private equity firms prey upon weak businesses, looking to restructure and reorganize them to become more competitive. If private equity companies are bullies, then their business targets can be considered weaklings. Beating wimps into shape may not be fun to watch, but is a crucial evolutionary aspect of business. The fact of the matter is that deteriorating, uncompetitive companies cannot hire employees…only profitable, viable entities can createsustainable jobs. So our public policy officials have two choices:
• Prop up uncompetitive businesses inefficiently with tax dollars that save jobs in the short-run, but lead to bankruptcy and massive job losses in the future. Other unproductive tariffs and bailouts may garner short-term political votes, but only lead to long-term stagnancy.
OR
• Trim fat, restructure and reorganize now – similar to the swift pain experienced from extracting a rotted tooth. Jobs may be cut in the short-run, but a long-term competitively positioned company will be able to grow and create sustainable long-term jobs.
I can’t say I agree with all of private equity practices, such as leveraged recapitalizations – the practice in which private equity companies load up the target with debt so big fat dividends can be sucked out by the principals. But guess what? By doing so the principals are only reducing their own future exit value through a potential IPO (Initial Public Offering) or company sale. Moreover, if this is such an evil practice, lenders can curb the practice by simply not giving the private equity companies the needed borrowing capacity.
Capitalism and its private equity subset have gotten quite a bad rap lately, but I believe these forces are essential aspects for the rising standards of living for billions of people across the planet. When first introduced, Charles Darwin’s theory of evolution by natural selection was critically examined by many non-believers. Although capitalism will be forced to adapt to an ever-changing world and its merits have been questioned too, the chances of capitalism going extinct are about as likely as the extinction of Darwin’s evolutionary theory.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
2011: Beating Batter into Flat Pancake
As it turns out, 2011 can be characterized as the year of the pancake…the flat pancake. While the Dow Jones Industrial Average (Dow) rose about 6% this year (its third consecutive annual gain), the S&P 500 ended the year flat at 1257.6 (-0.003%), the smallest yearly move in more than four decades. Along the way in 2011, there was plenty of violent beating and whipping of the lumpy pancake batter before the flat cake was cooked for the year. With respect to the financial markets, the 2011 lumps came in the form of various unsavory events:
* Never-Ending Eurozone Financial Saga: After Ireland and Portugal sought bailouts, Greece added its negligent financial storyline to the financial soap opera. Whether European government leaders can manage out-of-control deficits and debt loads will determine if Greece and other peripheral countries will topple larger countries like Italy and Spain.
* Credit Rating Downgrade: Standard & Poor’s, the highest profile credit rating agency, downgraded the U.S.’s long-term debt rating to AA+ from AAA due to high debt levels and Congressional legislators inability to hammer out a deficit-reduction plan during the debt ceiling negotiations.
* Japanese Earthquake and Tsunami: Japan and the global economy were rocked by a magnitude 9.0 earthquake and tsunami on March 11, 2011, which resulted in 15,844 people dead and 3,451 people missing. The ripple effects are still being felt through large industries like the automobile and electronics industries.
* Arab Spring Protests: Protesters throughout the Middle East and North Africa provided additional uncertainty to the global political map as demonstrators demanded regime change and more political freedoms. In the long-run, removing oppressive leaders like Hosni Mubarak (Egypt’s leader for 30 years), Muammar Gadaffi (Libya’s leader for 42 years), and Zine al-Abidine Ben Ali (Tunisia’s president for 23 years) should be beneficial for global stability, but in the short-run, how the new leadership vacuum will be filled remains ambiguous.
* Occupy Movement Voices Disapproval: The Occupy Wall Street movement began on September 17, 2011 in Liberty Square in Manhattan’s Financial District, and spread to over 100 cities in the U.S. There has not been a cohesive articulated agenda, but a common thread underlying all the Occupy movements is a sense that 99% of the population is being treated unfairly due to a flawed corrupt system controlled by Wall Street that is feeding the richest 1%.
All these lumps experienced in 2011 were not settling to investors’ stomachs. As a result individuals continued the trend of piling into bonds, in hopes of soothing their investment tummies. Long-term Treasury prices spiked upwards in 2011 (+29% as measured by TLT Treasury ETF) and soaring 10-year Treasury note prices pushed yields (1.87%) below yields on S&P 500 equities (2.1%). Despite a more than 3,400 point increase in the Dow (+39%) since the end of 2008, investors have still poured $774 billion into bonds versus $33 billion yanked from equities, according to EPFR Global. Over-weighting bonds makes sense for some, including retirees on fixed budgets, but many investors should brace for an inevitable reversal in bond prices. Eventually, the sweet taste of safety achieved from bond appreciation will turn to heartburn, once interest rates reverse their 30 year trend of declines.
Syrupy Factors Help Sweeten Pancakes
Although the aforementioned factors lead to historically high volatility and flat flavors in 2011, there are also some countering sweet reasons that make equities look more palatable for 2012. Here are some of the factors:
* Record Corporate Profits: Even with the constant barrage of fear, uncertainty, and doubt distributed via the media channels, corporations posted record profits in 2011, with an estimated increase of +16% over last year (and another forecasted +10% rise in 2012 – Source: S&P).
* Historic Levels of Cash: Record profits mean record cash, and all those riches have been piling up on non-financial corporate balance sheets at historic levels. At the beginning of Q4 the figure stood at $2.12 trillion. Companies have generally been stingy, but as the recovery progresses, they have increasingly been spending on technology, equipment, international expansion, and even the beginnings of hiring.
* Interest Rates at 60 Year Lows: Interest rates are at record lows and home affordability has never been better with 30-year fixed rate mortgages hovering below 4%. Housing may not come screaming back, but the foundation for a recovery is being laid.
* Improving Economic Variables: Whether you’re looking at broader economic activity (Gross Domestic Product up for nine consecutive quarters); employment growth (declining unemployment rate and 21 consecutive months of private job creation), or consumer spending (consumer confidence approaching multi-year highs), all major signs are currently pointing to an improving outlook.
* Near Record Exports: While the U.S. dollar has made some recent gains against foreign currencies because of the financial crisis in Europe, the relative value of the dollar remains historically low versus the major global currencies. The longer-term depreciation of the dollar has buoyed exports of U.S. goods to near record levels despite the global uncertainty.
* Unprecedented Central Bank Support Globally: Ben Bernanke and the U.S. Federal Reserve is committed to keeping exceptionally low levels of lending interest rates at least through mid-2013, while also implementing “Operation Twist” and potential further quantitative easing (QE3). Translation: Ben Bernanke is going to do everything in his power to keep interest rates low in order to stimulate economic growth. The European Central Bank (ECB) has pulled out its lending fire trucks too, with an unparalleled three-year lending program to extinguish liquidity fires in the European banking sector.
* Improving Mergers & Acquisitions Environment: We may not be back to the 2006 buyout “hay-days,” but U.S. mergers and acquisitions activity increased +24% in 2011. What’s more, high profile potential IPOs like an estimated $100 billion Facebook offering may help kick-start the new equity issuance market in 2012.
* Tasty Fat Dividends: Rarely have S&P 500 dividend yields (currently 2.1%) outpaced the interest rates earned on 10-year Treasury note yields, but now happens to be one of those times. Typically S&P 500 stock dividends have averaged about 40% of the yield on 10-year Treasury notes, and now it is 112%. In Q3 of 2011, dividend increases rose +17% and expectations are for nearly a +11% increase in 2012, said Howard Silverblatt, senior index analyst at S&P.
Any way you cut it (or beat the batter), 2011 was a volatile year. And despite all the fear, uncertainty, and doubt, profits continue to grow and sovereign nations are being forced to deal with their fiscal problems. Unforeseen risks always exist, but if Europe can contain its financial crisis and the U.S. recovery can continue into this new election year, then opportunities in the 2012 attractively priced equity markets should sweeten the flat equity pancake we ate in 2011.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, including a short position in TLT, 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.
U.S. – Best House in Bad Global Neighborhood
Article below represents a portion of free December 1, 2011 Sidoxia monthly newsletter (Subscribe on right-side of page)
There is no shortage of issues to worry about in our troubled global neighborhood, but then again, anybody older than 25 years old knows the world is always an uncertain place. Whether we are talking about wars (Vietnam, Cold War, Iraq); presidential calamities (Kennedy assassination, Nixon resignation/impeachment proceedings); international turmoil (dissolution of Soviet Union, 9/11 attacks, Arab Spring); investment bubbles (technology, real estate); or financial crises (S&L crisis, Long Term Capital, Lehman Brothers bankruptcy), investors always have a large menu of concerns from which they can order.
Despite the doom and gloom dominating the media airwaves, and the lackluster performance of equities experienced over the last decade, the Dow Jones Industrial Average and the S&P 500 index are both up more than 20-fold since the 1970s (those gains also exclude the positive impact of dividends).
Times Have Changed
Just a few decades ago, nobody would have talked or cared about small economies like Iceland, Dubai, and Greece. Today, technology has accelerated the forces of globalization, resulting in information travelling thousands of miles at the click of a mouse, often creating scary financial mountains out of meaningless molehills. As a result of these trends, news of Italian bond auctions, which normally would be glossed over on the evening news, instantaneously clogs our smart phones, computers, radios, and televisions. The implications of all these developments mean investing has become much more difficult, just as its importance has never been more crucial.
How has investing become more critical? For starters, interest rates are near 60-year lows and Treasury bond prices are at record highs, while inflation (food, energy, healthcare, leisure, etc.) is shrinking the value of people’s savings. Next, entitlement and pension reliability are decreasing by the minute – fiscal imbalances and unrealistic promises have contributed to a less certain retirement outlook. Layer on hyper-manic volatility of daily, multi-hundred point swings in the Dow Jones Industrial index and a less experienced investor quickly realizes investing can become an overwhelming game. Case in point is the VIX volatility index (a.k.a., the “Fear Gauge”), which has registered a whopping +57% increase in 2011.
December to Remember?
After an explosive +23% return in the S&P 500 index for 2009 (excluding dividends) and another +13% return in 2010, equity investors have taken a breather thus far in 2011 – the Dow Jones Industrial Average is up modestly (+4%) and the S&P 500 index is down fractionally (-1%). We still have the month of December to log, but in the short-run the European tail has definitely been wagging the rest of the global dog.
Although the United States knows a thing or two about lack of political leadership and coordination, herding the 17 eurozone countries to resolve the European debt financial crisis has proved even more challenging. As you can see below in the performance figures of the major global equity markets, the U.S. remains the best house in a bad neighborhood:
Our fiscal house undeniably needs some work (i.e., unsustainable deficits and bloated debt), but record corporate profits, record levels of cash, voracious consumer spending, improving employment data, and attractive valuations are all contributing to a domestic house that makes opportunities in our backyard look a lot more appealing to investors than prospects elsewhere in the global neighborhood.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and VGK, 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.
Wall Street Meets Greed Street
For investors, the emotional pendulum swings back and forth between fear and greed. Wall Street and large financial institutions, however, are driven by one single mode…and that is greed. This is nothing new and has been going on for generations. Over the last few decades, cheap money, loose regulation, and a relatively healthy economy have given Wall Street and financial institutions free rein to take advantage of the system.
Not only did the financial industry explode, but the large got much larger. The FCIC (Financial Crisis Inquiry Commission), a government appointed commission, highlighted the following:
“By 2005, the 10 largest U.S. commercial banks held 55% of the industry’s assets, more than double the level held in 1990. On the eve of the crisis in 2006, financial sector profits constituted 27% of all corporate profits in the United States, up from 15% in 1980.”
What’s more, the obscene profits were achieved with obscene amounts of debt:
“From 1978 to 2007, the amount of debt held by the financial sector soared from $3 trillion to $36 trillion, more than doubling as a share of gross domestic product.”
Times have changed, and financial institutions have gone from victors to villains. Sluggish economic growth in developed countries and choking levels of debt have transitioned political policies from stimulus to austerity. This in turn has created social unrest. Who’s to blame for all of this? Well if you watch the evening news and Occupy Wall Street movement, it becomes very easy to blame Wall Street. Certainly, fat cat bankers deserve a portion of the blame. As one can see from the following list, over the last few years, the financial industry has paid for its sins with the help of a checkbook:
CLICK TO ENLARGE
The disgusting amount of inequitable excess is smeared across the whole industry in this tiny, partial list. Billions of dollars in penalties and disgorged assets isn’t insignificant, but besides Bernie Madoff and Raj Rajaratnam, very little time has been scheduled behind bars for the perpetrators.
Whom Else to Blame?
Are the greedy bankers and financial institution operators the only ones to blame? Without doubt, lack of government enforcement and adequate regulation, coupled with a complacent, debt-loving public, contributed to the creation of this financial crisis monster. When the economy was rolling along, there was no problem in turning a blind-eye to subversive activity. Now, the greed cannot be ignored.
At the end of the day, voters have to correct this ugly situation. The general public and Occupy Wall Street-ers need to boycott corrupt institutions and vote in politicians who will institute fair and productive regulations (NOT more regulations). Sure corporate financial lobbyists will try to tip the scales to their advantage, but a vote from a lobbyist attending a $10,000 black-tie dinner carries the same weight as a vote coming from a Occupy Wall Street-er paying $5 for a foot-long sandwich at Subway. As Thomas Jefferson stated, “A democracy is nothing more than mob rule, where fifty-one percent of the people may take away the rights of the other forty-nine.”
Investor Protocol
Besides boycotting greedy institutions and using the voting booth, what else should individuals do with their investments in this structurally flawed system? First of all, find independent firms with a fiduciary duty to act in your best interest, like an RIA firm (Registered Investment Advisor). Brokers, financial consultants, financial advisors, or whatever euphemism-of-the-day is being used for an investment product pusher, may not be evil, but their incentives typically are not aligned to protect and grow your financial future (see Fees, Exploitation, and Confusion and Letter Shell Game).
There is a lot of blame to be spread around for the financial crisis, and the intersection of Wall Street and Greed Street is a major contributing factor. However, investors and voters need to wake up to the brutal realities of our structurally flawed system and take matters into their own hands. Only then can Main Street and Wall Street peacefully coexist.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in MS, UBS, C, JPM, WFC, SCHW, AMTD, BAC, GS, STT, Galleon, RBC, Subway, Amer Home, Brookside Captl, Morgan Keegan, 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.
The Rule of 20 Can Make You Plenty
There is an endless debate over whether the equity markets are overvalued or undervalued, and at some point the discussion eventually transitions to what the market’s appropriate P/E (Price-Earnings) level should be. There are several standard definitions used for P/Es, but typically a 12-month trailing earnings, 12-month forward earnings (using earnings forecasts), and multi-year average earnings (e.g., Shiller 10-year inflation adjusted P/E – see Foggy P/E Rearview Mirror) are used in the calculations. Don Hays at Hays Advisory (www.haysadvisory.com) provides an excellent 30+ year view of the historical P/E ratio on a forward basis (see chart below).
Blue Line: Forward PE - Red Line: Implied Equilibrium PE (Hays Advisory)
If you listen to Peter Lynch, investor extraordinaire, his “Rule of 20” states a market equilibrium P/E ratio should equal 20 minus the inflation rate. This rule would imply an equilibrium P/E ratio of approximately 18x times earnings when the current 2011 P/E multiple implies a value slightly above 11x times earnings. The bears may claim victory if the earnings denominator collapses, but if earnings, on the contrary, continue coming in better than expected, then the sun might break through the clouds in the form of significant price appreciation.
Just because prices have been chopped in half, doesn’t mean they can’t go lower. From 1966 – 1982 the Dow Jones Industrial index traded at around 800 and P/E multiples contracted to single digits. That rubber band eventually snapped and the index catapulted 17-fold from about 800 to almost 14,000 in 25 years. Even though equities have struggled at the start of this century, a few things have changed from the market lows of 30 years ago. For starters, we have not hit an inflation rate of 13% or a Federal Funds rate of 20% (~3.5% and 0% today, respectively), so we have some headroom before the single digit P/E apocalypse descends upon us.
Fed Model Implies Equity Throttle
Hays Advisory exhibits another key valuation measurement of the equity market (the so-called “Fed Model”), which compares the Treasury yield of the 10-year Note with the earnings yield of stocks (see chart below).
Blue Line: 10-Yr Treasury - Red Line: Forward PE (Hays Advisory)
Regardless of your perspective, the divergence will eventually take care of it in one of three ways:
1.) Bond prices collapse, and Treasury yields spike up to catch up with equity yields.
2.) Forward earnings collapse (e.g., global recession/depression), and equity yields plummet down to the low Treasury yield levels.
AND/OR
3.) Stock prices catapult higher (lower earnings yield) to converge.
At the end of the day, money goes where it is treated best, and at least today, bonds are expected to treat investors substantially worse than the unfaithful treatment of Demi Moore by Ashton Kutcher. The Super Committee may not have its act together, and Europe is a mess, but the significant earnings yield of the equity markets are factoring in a great deal of pessimism.
The holidays are rapidly approaching. If for some reason the auspice of gifts is looking scarce, then review the Fed Model and Rule of 20, these techniques may make you plenty.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
Fear & Greed Occupy Wall Street in October
Excerpt from Free November Sidoxia Monthly Newsletter (Subscribe on right-side of page)
Fear and frustration dominated investor psyches during August and September as backlash from political gridlock in the U.S. and worries of European contagion dominated action in volatile investment portfolios. Elevated 9.1% unemployment and a sluggish recovery in the U.S. also led populist Occupy Wall Street protesters to flood our nation’s streets, blaming the bankers and the wealthy as the cause for personal misfortunes and the widening gap between rich and poor. However, in the face of the palpable pessimism, economic Halloween treats and greedy corporate profits scared away bearish naysayers like invisible ghosts during the month of October.
While many investors stayed home for Halloween in the supposed comfort of their inflation-losing savings accounts and bonds, those investors choosing to brave the chilling elements in the frightening equity markets were handsomely rewarded. Stockholders tasted the sweet pleasure of a +11% October return in the S&P 500 index, the largest monthly advance in 20 years.
Of course, as I always advise, investors should not load themselves to the gills in stocks just to chase performance. Rather, investors should construct a diversified portfolio designed to meet one’s objectives, constraints, risk tolerance, and liquidity needs. Within that context, a portfolio should also periodically rebalance by selling pricey investments (i.e., Treasuries) and redeploy those proceeds into unloved investments (i.e., equities).
Glass Half Full
There is never a shortage of reasons to be fearful and a one-month rally in equities is not reason enough to blindly pile on risk, but there are plenty of reasons to counter the endless pessimism pornography peddled by media outlets on a continuous basis. Here are some of the “half-full” reasons:
- Euro Plan in Place: After months of conflicting headlines, European leaders reached an agreement to increase the European Union’s bailout fund to one trillion euros ($1.4 trillion) and negotiated a -50% debt reduction deal with Greek bondholders. In addition, European officials agreed on a plan to increase bank reserves by 106 billion euros to support potential bank losses due to European debt defaults. This plan is not a silver bullet, but it is a start.
- Bulging Corporate Profits: With the majority of S&P 500 companies now having reported their actual third quarter results, profit growth is estimated to exceed +16% for the three month period ending in September. Expectations for fourth quarter earnings are currently forecasted to top a respectable +11% growth rate (Data from Thomson Reuters).
- Tortoise-Like Growth Continues: Even though it’s Halloween, the double-dip recession boogeyman is still hiding. U.S. economic growth actually accelerated its growth to +2.5% in the third quarter on a year-over-year basis, up from +1.3% last quarter. The growth in Gross Domestic Product (GDP) was primarily driven by consumer and business spending.
- Jobs Still on the Rise: The unemployment rate remains stubbornly high, but offsetting the ongoing decline in government jobs has been a 19 consecutive month spurt in private job creation activity, resulting in +2.6 million jobs being added to the economy over the period. This doesn’t make up for the 8 million+ jobs lost during the 2008-2009 recession, but the economy is moving in the right direction.
- Consumers Opening Wallet: Consumers can be like cockroaches in that they are difficult to kill off when it comes to spending. Consumers whipped out their wallets in September as retail sales advanced at a brisk +7.9% pace (+7.8% excluding auto sales).
- Dividends on the Rise: While nervous Nellies park money in money losing cash and Treasuries (on an inflation-adjusted basis), corporations flush with cash are increasing dividends at a rapid clip. According to Standard & Poor’s rating agency, dividend increases rose over +17% during the third quarter of 2011. As of October 25th, the indicated dividend for the S&P stood at a decent +2.20% rate.
I am fully aware that equity investors are not out of the woods yet, as the European debt crisis has not been resolved, and the structural deficit/debt issues we face in the U.S. still have a long way to go before becoming disentangled. As a matter of fact, fear is building as we approach the looming deficit reduction Super Committee resolution (or lack thereof) later this month – I can hardly wait. If a $1.5 trillion bipartisan debt reduction agreement can’t be reached, some bored Occupy Wall Street protesters can shift priorities and take a tour bus to Washington D.C. to demonstrate. Regardless of the potential grand European or Washington debt plans that may or may not transpire, observers can rest assured fear and greed are two emotions that will remain alive and well when it comes to Wall Street and “Main Street” portfolios.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
Boo! Will History Offer a Bearish Trick or BullishTreat?
October is not only a scary month for trick-or-treaters during Halloween, but October is also a scary month for investors.
Boo! Scared yet? Well if not, need I remind you of the market crashes of 1929 and 1987 also occurred during this ghoulish month? With a wall of worry and concerns galore overwhelming myopic traders, it’s no surprise nervous memories become shortened in anxious times like these.
The financial crisis of 2008-2009 is seared into the minds of investors and every Greek debt negotiation creates fresh new Armageddon fears. But perhaps history will repeat itself in a shorter-term more positive way? Just last year, I wrote about the excessive pessimism (It’s All Greek to Me) in July 2010, when “de-risking” was the buzz word of the day and hedge funds were bailing in droves – right before the +30%+ QE2 (quantitative easing) melt-up. Despite a massive expansion in earnings growth over the last few years, the S&P 500 just touched 1074 a few weeks ago – putting the index at similar trading levels as in Fall 2009 (see chart below).
Source: Yahoo! Finance
Will Europe crater the U.S. into an abyss, or will Bernanke need to pull a QE3 rabbit out of his hat? I’m not sure what’s going to happen, but I do know it’s better to follow the wisdom of Warren Buffett who says to “buy fear and sell greed.” If a 2% 10-Year Treasury, elevated VIX, and trillions in swollen cash reserves do not represent fear, then I may just need to pack my backs and head out to the Greek island of Santorini – that way I can at least enjoy my fear on a sunny beach.
Regardless of the Q4 outcome, I thought my friend Mark Twain could provide some insight about history’s role in financial markets. Here is an Investing Caffeine flashback from the fall of 2009 (History Never Repeats Itself, but it Often Rhymes) which also questioned the extremely negative sentiment at the time (S&P 500: 1069):
As Mark Twain said, “History never repeats itself, but it often rhymes.” There are many bear markets with which to compare the current financial crisis we are working through. By studying the past we can understand the repeated mistakes of others (caused by fear and greed), and avoid making similar emotional errors.
Do you want an example? Here you go:
Today there are thoughtful, experienced, respected economists, bankers, investors and businessmen who can give you well-reasoned, logical, documented arguments why this bear market is different; why this time the economic problems are different; why this time things are going to get worse — and hence, why this is not a good time to invest in common stocks, even though they may appear low.”
Although the quote above seems appropriate for 2009, it actually is reflective of the bearish mood felt in most bear markets. We have been through wars, assassinations, banking crises, currency crises, terrorist attacks, mad-cow disease, swine flu, and yes, even recessions. And through it all, most have managed to survive in decent shape. Let’s take a deeper look.
1973-1974 Case Study:
For those of you familiar with this period, recall the prevailing circumstances:
- Exiting Vietnam War
- Undergoing a recession
- 9% unemployment
- Arab Oil Embargo
- Watergate: Presidential resignation
- Collapse of the Nifty Fifty stocks
- Rising inflation
Not too rosy a scenario, yet here’s what happened:
S&P 500 Price (12/1974): 69
S&P 500 Price (8/2009): 1,021
That is a whopping +1,380% increase, excluding dividends.
What Investors Should Do:
- Avoid Knee-Jerk Reactions to Media Reports: Whether it’s radio, television, newspapers, or now blogs, the headlines should not emotionally control your investment decisions. Historically, media venues are lousy at identifying changes in price direction. Reporters are excellent at telling you what is happening or what just happened – not what is going to happen.
- Save and Invest: Regardless of the market direction, entitlements like Medicare and social security are under stress, and life expectancies are increasing (despite the sad state of our healthcare system), therefore investing is even more important today than ever.
- Create a Systematic, Disciplined Investment Plan: I recommend a plan that takes advantage of passive, low-cost, tax-efficient investment strategies (e.g. exchange-traded and index funds) across a diversified portfolio. Rather than capitulating in response to market volatility, have a systematic process that can rebalance periodically to take advantage of these circumstances.
For DIY-ers (Do-It-Yourselfers), I suggest opening a low-cost discount brokerage account and research firms like Vanguard Group, iShares, or Select Sector SPDRs. If you choose to outsource to a professional advisor, I recommend interviewing several fee-only* advisers – focusing on experience, investment philosophy, and potential compensation conflicts of interest.
If you believe, like some economists, CEOs, and investors, we have suffered through the worst of the current “Great Recession” and you are sitting on the sidelines, then it might make sense to heed the following advice: “Some people say they want to wait for a clearer view of the future. But when the future is again clear, the present bargains will have vanished.” Dean Witter made those comments 77 years ago – a few weeks before the end of worst bear market in history. The market has bounced quite a bit since March of this year, but if history is on our side, there might be more room to go.
Portions of this article were originally published on September 16, 2009.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
*For disclosure purposes: Wade W. Slome, CFA, CFP is President & Founder of Sidoxia Capital Management, LLC, a fee-only investment adviser based in Newport Beach, California.
Playing Whack-A-Mole with the Pros
Source: Flickr
Deciphering the ups and the downs of the financial markets is a lot like playing a game of Whack-A-Mole. First the market is up 300 points, then down 300 points. Next Greece and Europe are going down the drain, and then Germany and the ECB (European Central Bank) are here to save the day. The daily data points are a rapid moving target, and if history continues to serve as a guide (see History Often Rhymes with the Future), the bobbing consensus views of pundits will continue to get hammered by investors’ mallets.
Let’s take a look at recent history to see who has been the “whack-er” and whom has been the “whack-ee.” Whether it was the gloom and doom consensus view in the early 1980s (reference BusinessWeek’s 1979 front page “The Death of Equities”) or the euphoric championing of tech stocks in the 1990s (see Money magazine’s March 2000 cover, “The Hottest Market Ever”), the consensus view was wrong then, and is likely wrong again today.
Here are some of the fresher consensus views that have popped up and then gotten beaten down:
End of QE2 – The Consensus: If you rewind the clock back to June 2011 when the Federal Reserve’s $600 billion QE2 (Quantitative Easing Part II) monetary stimulus program was coming to an end, a majority of pundits expected bond prices to tank in the absence of the Fed’s Ben Bernanke’s checkbook support. Before the end of QE2, Reuters financial service surveyed 64 professionals, and a substantial majority predicted bond prices would tank and interest rates would catapult upwards. Actual Result: The pundits were wrong and rates did not go up, they in fact went down. As a result, bond prices screamed higher – bond values increased significantly as 10-year Treasury yields fell from 3.16% to a low of 1.72% last week.
Debt Ceiling Debate – The Consensus: Just one month later, Democrats and Republicans were playing a game of political “chicken” in the process of raising the debt ceiling to over $16 trillion. Bill Gross, bond guru and CEO of fixed income giant PIMCO, was one of the many pros who earlier this year sold Treasuries in droves because fears of bond vigilantes shredding prices of U.S. Treasury bonds .
Here was the prevalent thought process at the time: Profligate spending by irresponsible bureaucrats in Washington if not curtailed dramatically would cascade into a disaster, which would lead to higher default risk, cancerous inflation, and exploding interest rates ala Greece. Actual Result: Once again, the pundits were proved wrong in the deciphering of their cloudy crystal balls. Interest rates did not rise, they actually fell. As a result, bond prices screamed higher and 10-year Treasury yields dived from 2.74% to the recent low of 1.72%.
S&P Credit Downgrade – The Consensus: The S&P credit rating agency warned Washington that a failure to come to meaningful consensus on deficit and debt reduction would result in bitter consequences. Despite a $2 trillion error made by S&P, the agency kept its word and downgraded the U.S.’s long-term debt rating to AA+ from AAA. Research from JP Morgan (JPM) cautioned investors of the imminent punishment to be placed on $4 trillion in Treasury collateral, which could lead to a seizing in credit markets. Actual Result: Rather than becoming the ugly stepchild, U.S. Treasuries became a global safe-haven for investors around the world to pile into. Not only did bond prices steadily climb (and yields decline), but the value of our currency as measured by the Dollar Index (DXY) has risen significantly since then.
Dollar Index (DXY) Source: Bloomberg
What is next? Nobody knows for certain. In the meantime, grab some cotton candy, popcorn, and a rubber mallet. There is never a shortage of confident mole-like experts popping up on TV, newspapers, blogs, and radio. So when the deafening noise about the inevitable collapse of Europe and the global economy comes roaring in, make sure you are the one holding the mallet and not the mole getting whacked on the head.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in JPM, MHP, 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 Shakes, Rattles, and Swirls
Shake, Rattle, & Swirl: Category 3 hurricane Irene pounded the eastern seaboard with winds reaching 110 miles per hour, knocking out power in an estimated 8 million homes and businesses. Some analysts estimate the damage to be somewhere between $7 billion and $10 billion. If that wasn’t enough, earlier in the same week, a 5.8-magnitude earthquake rippled from its Virginia epicenter up to Maine rattling both buildings and people’s nerves.
Volatility Spikes in August: Volatility, as measured by the Volatility Index (VIX – a.k.a. “Fear Gauge”), reared its ugly head again in August, reaching a level exceeding 44 (Source: Hays Advisory). This reading has only been experienced nine times in the last 25 years. Historically, on average, these have been excellent buying points for long-term investors.
Steve Jobs Lets Go of Reins: After being Chief Executive Officer of Apple Inc. (AAPL – formerly Apple Computers) for more than 20 years, Steve Jobs passed the CEO reins over to Tim Cook, who has been with the company for 13 years (including interim CEO). Jobs will remain on board as Chairman of Apple and still provide assistance in a more limited capacity.
Buffett Puts Dry Powder to Work: Billionaire Warren Buffett is putting his money where his mouth is. Although he is one of a few wealthy individuals griping about too LOW income taxes (NYT OpEd), at least he is using some of his extra bucks to support the country’s financial system. More specifically, Buffet’s Berkshire Hathaway Inc. (BRKA) is investing $5 billion in troubled banking giant Bank of America Corp.’s (BAC) preferred stock (paying a 6% dividend), with warrants to buy additional stock in the future at a mutually prearranged price.
Google Buys Motorola Mobility: Google Inc. (GOOG) agreed to pay $12.5 billion to buy cellphone maker Motorola Mobility Holdings (MMI) in a move designed to protect the internet giant, and its partners, against patent litigation as it pertains to the Google Android mobile phone operating system. that could shake up the balance of power among among tech rivals. Time will tell whether Motorola’s assets will providing valuable resources for Google’s partners (i.e., HTC, LG Electronics and Samsung Electronics) or whether the acquisition will create competitive conflicts.
ECB Buys some Bonds:The European Central Bank (ECB), Europe’s equivalent of the U.S. Federal Reserve Bank, began buying up billions of dollars in Spanish and Italian bonds last month. The goal of the bond buying program is to stem any potential contagion effect arising from debt crises occurring in countries like Greece, Portugal, and Ireland.
Quote of the Month
On Volatility:
“Worry gives a small thing a big shadow.”
- Swedish Proverb
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: For those taking this article seriously, please look up “parody” in the dictionary. Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, GOOG, and AAPL, but at the time of publishing SCM had no direct position in BRKA, MMI, HTC,
LG Electronics and Samsung Electronics, 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
