Growth Stocks – Cheaper by the Day
Are you a value investor? If you said “yes,” how would you feel about buying an $18 stock with a P/E (Price/Earnings) ratio of greater than 100x and a Price/Sales ratio of 14x for a company that three years earlier was started in a garage? This may not sound like a value stock, but had you bought this stock at the initial public offering (IPO), it would have been a screaming bargain – priced at less than 1x P/E ratio, based on this year’s earnings estimates.
You may be surprised to know, this company with a meager $18 IPO share price is now worth $9,192 per share today (if you adjust for three stock splits)! Yes, that’s correct, a +50,900% return. If you are wondering to which stock I’m referring, I am talking about Amazon.com Inc. (AMZN). Incredibly, ever since Amazon went public in 1997, the CEO Jeff Bezos has managed to command the start-up e-commerce company from $31 million in revenues to $121 billion (with a “b”) on an annual basis in 2016 (a +389,000% increase).
Discovering the next IPO that turns into a $363 billion behemoth is easier said than done, and unfortunately these types of companies are a rare breed. Even if you are lucky enough to identify these diamonds-in-the-rough, early in their growth cycle, very few investors have the fortitude and discipline to continually own the stocks through the perpetual volatility (i.e., peaks and valleys).
The good news is, although you may be unable to find every unicorn out there, you can still apply the same principles and characteristics to any growth stock you invest in. In order to prudently achieve outsized returns, one must identify innovative market leaders that have gained some type of sustainable competitive advantage, which will serve as the profit and cash flow growth engine for the stock over the long-term.
If a company does not have a unique advantage over industry competitors, they will likely be unable to compound earnings growth – the key to becoming a big winner. Albert Einstein, Nobel Prize winner is credited with identifying compounding as the “eighth wonder of the world,” and without compounding there will be no gigantic results.
Amazon may be a rare breed, but there are plenty of other examples of so-called “expensive” stocks that get dismissed or fall through the cracks as they explode in value to the stratosphere. Consider Starbucks Corp. (SBUX), which at the time of its IPO in 1992 was priced at a very rich P/E of 52x. Sound expensive? Actually, this was a greatest offer in a generation. Adjusted for stock splits, the IPO shares were valued at $0.27 – in the most recent trading session Starbucks shares closed at $55.90, a +20,600% increase. Similar to Amazon, had you purchased Starbucks shares at the IPO price, you would have been paying less than a measly, eye-popping 1x P/E ratio based on 2016 earnings.
Alphabet Inc. (GOOGL), formerly Google Inc., is another case of growth stock appearing pricey on the outside, but really a value of a lifetime on the inside. The hype surrounding the Google IPO was so palpable in 2004, the stock priced at a relatively nose-bleed level of 60x P/E level, approximately. The unconventional auction bidding method to buy the initial shares made investors even more skeptical. Suffice it to say, the greater than +1,600% gain has once again shown that investors can reap handsome rewards, if they do thorough enough due diligence and ignore the illusory big ticket IPO prices.
What most investors fail to realize is that P/E ratios are temporary. By purchasing a growth stock, the numerator of the P/E ratio (price) becomes static or fixed. As earnings of a growth company expand, the stock becomes cheaper by the day. More specifically, the numerator of the P/E (price) is flat, while the denominator (earnings) grows, thereby making the P/E ratio smaller (cheaper). And as you can see from the few previous examples I have provided, if you are able to identify winners, and hold them long enough, you will eventually realize the initial hefty price tag at purchase will be considered almost free after all the earnings compounding.
Legendary growth investor Peter Lynch summed it up concisely when he noted, “People concentrate too much on the P, but the E really makes the difference.” Lynch goes on to highlight the importance of patience in growth investing because stocks often go down or move sideways for long periods of time before dramatic increases occur:
“My best stocks performed in the 3rd year, 4th year, 5th year, not in the 3rd week or 4th week.”
I’ve illustrated a few successful examples of meteoric growth stocks, but more importantly the misconception many investors place on the current P/E ratio. There still is no substitute for hard-nosed, detailed fundamental research for finding big growth winners, because true growth stocks bought and held for a long enough period, will become cheaper by the day. If you don’t have the time, discipline, or patience to execute this winning strategy, find and hire an experienced investment manager who understands these concepts.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), AMZN, and GOOGL, but at the time of publishing had no direct position in SBUX, 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.
Stocks Winning Olympic Gold
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (August 1, 2016). Subscribe on the right side of the page for the complete text.
The XXXI Olympics in Rio, Brazil begin this week, but stocks in 2016 have already won a gold medal for their stellar performance. The S&P 500 index has already triumphantly sprinted to new, all-time record highs this month. A significant portion of the gains came in July (+3.6%), but if you also account for the positive results achieved in the first six months of 2016, stocks have advanced +6.3% for the year. If you judge the 2%+ annualized dividend yield, the total investment return earns an even higher score, coming closer to +8% for the year-to-date period.
No wonder the U.S. is standing on the top of the economic podium compared to some of the other international financial markets, which have sucked wind during 2016:
- China Shanghai Index: -15.8%
- Japan Nikkei Index: -12.9%
- French Paris CAC Index: -4.3%
- German Dax Index: -3.8%
- Europe MSCI Index: -3.5%
- Hong Kong Heng Sang Index: -0.1%
While there are some other down-and-out financial markets that have rebounded significantly this year (e.g., Brazil +61% & Russia +23%), the performance of the U.S. stock market has been impressive in light of all the fear, uncertainty, and doubt blanketing the media airwaves. Consider the fact that the record-breaking performance of the U.S. stock market in July occurred in the face of these scary headlines:
- Brexit referendum (British exit from the European Union)
- Declining oil prices
- Declining global interest rates
- More than -$11,000,000,000,000.00 (yes trillions) in negative interest rate bonds
- Global terrorist attacks
- Coup attempt in Turkey
- And oh yeah, a contentious domestic presidential election
With so many competitors struggling, and the investment conditions so challenging, then how has the U.S. prospered with a gold medal performance in this cutthroat environment? For many individuals, the answer can be confusing. However, for Sidoxia’s followers and clients, the strong pillars for a continued bull market have been evident for some time (described again below).
Bull Market Pillars
Surprising to some observers, stocks do not read pessimistic newspaper headlines or listen to gloomy news stories. In the short-run, stock prices can get injured by emotional news-driven traders and speculators, but over the long-run, stocks and financial markets are drawn like a magnet to several all-important metrics. What crucial metrics am I referring to? As I’ve reiterated in the past, the key drivers for future stock price appreciation are corporate profits, interest rates, valuations (i.e., price levels), and sentiment indicators (see also Don’t Be a Fool).
Stated more simply, money goes where it is treated best, and with many bonds and savings accounts earning negative or near 0% interest rates, investors are going elsewhere – for example, stocks. You can see from the chart below, economy/stocks are treated best by rising corporate profits, which are at/near record high levels. With the majority of stocks beating 2nd quarter earnings expectations, this shot of adrenaline has given the stock market an added near-term boost. A stabilizing U.S. dollar, better-than-expected banking results, and firming commodity prices have all contributed to the winning results.
Price Follows Earnings…and Recessions
What history shows us is stock prices follow the direction of earnings, which helps explain why stock prices generally go down during economic recessions. Weaker demand leads to weaker profits, and weaker profits lead to weaker stock prices. Fortunately for U.S. investors, there currently are no definitive signs of imminent recession clouds. Scott Grannis, the editor of Calafia Beach Pundit, sums up the relationship between recessions and the stock market here:
“Recessions typically follow periods of excesses—soaring home prices, rising inflation, widespread optimism—rather than periods dominated by risk aversion such as we have today. Risk aversion can still be found in abundance: just look at the extremely low level of Treasury yields, and the lack of business investment despite strong corporate profits.”
Similar to the Olympics, achieving success in investing can be very challenging, but if you want to win a medal, you must first compete. If you’re not investing, you’re not competing. And if you’re not investing, you have no chance of winning a financial gold medal. Just as in the Olympics, not everyone can win, and there are many ups and downs along the way to victory. Rather than focusing on the cheers and boos of the crowd, implementing a disciplined and diversified investment strategy that accounts for your time horizon, objectives, and risk tolerance is the championship approach that will increase your probability of landing on the Olympic medal podium.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing 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.
Politics & Your Money
Will you be able to retire, and what impact will the elections have on your financial future? Answering these questions can be a scary endeavor. And unless you have been living in a cave, you may have noticed we are in the middle of a heated U.S. presidential election campaign between Donald Trump and Hillary Clinton. Regardless of which side of the political fence you stand on, the prospects of your retirement are much more likely to be impacted by your personal actions than by the actions of Washington politicians.
Even if you despise politics and were living in a cave (with WiFi access), there’s a high probability you would be overloaded with detailed and dogmatic online editorials from overconfident Facebook friends. Besides offering self-assured predictions, these impassioned political pleas generally itemize the top 10 reasons your favorite candidate is a moron, and another 10 reasons why their candidate is the greatest.
Your friends’ opinions may have pure intentions, but unfortunately, rarely, if ever, do their thoughts alter your views. A reference from a recent Legal Watercooler article summed it up best:
“Political Facebook rants changed my mind…said nobody, ever.”
Nearly as ineffectual as political Facebook opinions on your politics is the ineffectual influence of presidential elections on your finances. For example, over the last four decades, stock prices have gone up and down during both Republican and Democrat presidential terms. The picture looks much the same, if you analyze the fiscal performance of conservatives and liberals since 1970 – debt burdens as a percentage of economic output have risen and fallen under both political parties. No matter who wins the presidency, many investors forget the ability of that individual to affect change is highly dependent upon the political balance of power in Congress. If Congress holds a split majority in the House and Senate, or the opposition party commands the entire Congress, then the winning presidential candidate will be largely neutered.
Rather than panic over a political loss or celebrate a candidate’s victory, here are some tangible actions to improve your finances:
- Organize. Typically individuals have investment and saving accounts scattered with no cohesive accounting or strategy. Get your financial house in order by gathering and organizing all your accounts.
- Budget. Spend less than you take in. Or in other words…save. You can achieve this goal in one of two ways – cut your spending, or increase your income.
- Create a Plan. When do you plan to retire? How much money do you need for retirement? What asset allocation and risk profile should you adopt to meet your financial goals?
If you have difficulty with any of these actions, then meet with an experienced financial professional to assist you.
Politics can trigger very emotional responses. However, realizing your actions have a much more direct impact on your finances than political Facebook rants and temporary elections will benefit you in achieving your long-term financial goals.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds and FB, but at the time of publishing 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.
Brexit-Schmexit
Do you remember the panic-inducing headlines related to PIIGS, Crimea, Ebola, Cyprus, and the Flash Crash? Probably not. But if you do remember, these false alarms have likely been relegated to the financial memory graveyard, along with the many other sensationalist news events that have been killed off in the post-financial crisis era. Time will tell whether Brexit dies off or becomes a resurrected concern, like the repeating fears of a China slowdown or Greek collapse. Regardless, as the S&P 500 stock index reaches new all-time record highs, investors are currently shrug off the noise while muttering, “Brexit-Schmexit.”
Individuals have tried to use scary headlines as a timing tool to consistently time market corrections for all of recorded history. Unfortunately, emotional, knee-jerk reactions to alarming news stories rarely is the best strategy. Famed fund manager Peter Lynch said it best when he noted,
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
Having invested for some 25 years, experience has taught me not only is conventional wisdom often wrong, but it also is frequently an accurate contrarian indicator. In other words, frightening news often should be an indicator to buy…not sell. Case in point is the U.K. European Union referendum. The Brexit referendum “Leave” vote caught virtually everyone by surprise, but the rebound in stock prices to new record highs may be even more surprising to most observers. However, for investors following the key factors of interest rates, profits, valuation, and sentiment (see also Don’t Be a Fool, Follow the Stool), may not be shocked by the positive price action.
- Interest Rates: For starters, you don’t have to be a genius to realize that stocks become more attractive when there is a scarcity of investment alternatives. When there are an estimated $13 trillion of negative interest rate bonds, a layman can quickly understand a 2%, 3%, or 4% dividend yield offered on certain stocks (and funds) can represent a much more attractive opportunity. With interest rates at record lows (see chart below), the overall dividend yield of stocks has provided a floor for stock prices and has limited the depth and duration of sell-offs and corrections.
Source: Calafia Beach Pundit
- Profits: Corporate profits are near record highs but have been sluggish due to several factors, including the negative impact of the strong dollar on multinational exports; the depressing effect of declining interest rates on the banking sector’s net interest profit margins; the general decline in oil and commodity prices; and general lethargic economic growth overall in international markets (emerging and developed economies). Encouragingly, a stabilization in the value of the U.S. dollar, along with a rebound in energy prices augurs well for a potential shift back to earnings growth in the coming quarters.
- Valuation: On a valuation basis, the Price/Earnings ratio of the stock market is about 10-15% above historical averages (see chart below). The average S&P 500 stock price trades around 19x’s the value of trailing twelve-month earnings. However, in the context of all-time record low-interest rates, a premium valuation is well deserved, especially for those companies paying a dividend and growing their bottom line.
Source: Calafia Beach Pundit
- Sentiment: Since the Great Financial Crisis / Recession, there has been about $1.5 trillion in equity investments that have been pulled out of U.S. equity mutual funds. This statistic is a clear sign of the extreme risk aversion and pervasive pessimism. Despite money flowing out of equity funds, corporations have bolstered the upward trajectory in stock prices with hundreds of billions in corporate stock buybacks and trillions in mergers & acquisition transactions. With all the universal jitteriness, I like to remind investors of Warren Buffett’s credo, “Buy fear, and sell greed.”
Brexit-Schmexit NOT Brexit-Panic
Despite the risk aversion in the marketplace, stock prices in the U.S. continue to grind higher to record levels. The stock market is currently communicating interest rates, profits, valuation, and sentiment are more important factors to price direction than are Brexit and other geopolitical concerns.
The silver lining behind severe investor skepticism is the creation of additional investment opportunities. As famous investor Sir John Templeton stated regarding stock market cycles, “Bull markets are born on pessimism and they grow on skepticism, mature on optimism, and die on euphoria.” Even the most objective observers have difficulty pointing to a broad set of indicators signaling euphoria, and the recent Turkish military coup attempt and domestic gun violence incidents will not squash out the negativity. Until optimism and elation rule the day, there’s no need to worry-schworry.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds , but at the time of publishing 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.
Technical Analysis – Astrology or Lob Wedge?
Investing comes in many shapes and sizes. And like religion (see Investing Religion article), most investment strategies are built on the essential belief that following certain rules and conventions will eventually lead to profit enlightenment. When it comes to technical analysis (TA), a discipline used with the principal aim of predicting future prices from past patterns, some consider it a necessity for making money in the market. Others, regard the practice of TA as a pseudoscience, much like astrology.
I feel there is a proper place for TA on selective basis, which I will describe later, but for the most part I agree with some of the legendary investors who have chimed in on the subject:
Warren Buffett: “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.”
Peter Lynch: “Charts are great for predicting the past.”
Technical Analysis Linguistics
Fundamental analysis, the antithesis of technical analysis, strives to predict future price direction by analyzing facts and data surrounding a company, industry, and/or economy. It too comes with its own syntax and versions, for example: value, growth, top-down, bottom-up, quantitative, etc.
I do not claim to be a TA expert, however in my many years of investing I have come across a smorgasbord of terms and flavors surrounding the discipline. Describing and explaining the density of material surrounding TA would encompass too large of a scope for this article, but here are some prevalent terms one should come to grips with if you want to become a technical analysis guru:
Technical Analysis Approaches
- Elliot Wave
- Relative strength / Momentum (see Momentum Investing article)
- MACD (Moving Average Convergence / Divergence)
- Fibonacci retracement
- Dow Theory
- Stochastics
- Bollinger bands
Price Patterns
- Head and shoulders
- Double bottom
- Cup and handle
- Channels
- Breakouts
- Pivot points
- Candlesticks
- Resistance/Support
- Dead cat bounce (my personal favorite)
Each of these patterns are supposes to provide insight into the future direction of price. At best, I would say the academic research surrounding the subject is “inconclusive,” and at worst I’d say it’s considered a complete “sham.”
The Lob Wedge
As I’ve stated earlier, I fall in the skeptical camp when it comes to TA, since fundamental analysis is the main engine I use for generating and tracking my investment ideas. For illustrative purposes, you may consider fundamental analysis as my group of drivers and irons. I do, however, utilize selective facets of TA much like I use a lob wedge in golf for a limited number of specific situations (e.g., shots over high trees, downhill lies, and fast greens). When it comes to trading, I do believe there is some value in tracking the relationship of extreme trading volume (high or low), especially when it is coupled with extreme price movement (high or low). The economic laws of supply and demand hold true for stock trades just as they do for guns and butter, and sharp moves in these components can provide insights into the psychological mindset of investors with respect to a security (or broader market). Beyond trading volume, there are a few other indicators that I utilize as part of my trading strategies, but these tactics play a relatively minor role, since most of my core positions are held on a multi-year time horizon.
Overall, there is a stream of wasteful noise, volatility, and misinformation that permeates the financial markets on a daily basis. A major problem with technical analysis is the many false triggered signals, which in many cases lead to excessive trading, transaction costs, and ultimately subpar investment returns. Although I remain a skeptic on the subject of technical analysis and I may not read my horoscope today, I will continue to keep a lob wedge in my golf bag with the hopes of finding new, creative ways of using it to my advantage.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own exchange traded funds and various securities, including BRK.B, but at time of publishing had no direct position in BRK.A or any company mentioned 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.
EU Marriage Ends in Messy Brexit Divorce
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (July 1, 2016). Subscribe on the right side of the page for the complete text.
What Just Happened?
Breakups are never easy, especially when they come as a surprise. That’s exactly what happened with last week’s “Brexit” (British exit) referendum results. History was made when 51.9% of the United Kingdom (U.K.) voters from England, Scotland, Wales and Northern Ireland cast their vote to divorce (“Leave”) their country from the European Union (EU). In the end, the 48.1% of U.K. voters could not generate enough support to “Remain” in the EU (see chart below). Despite torrential downpours in southern Britain, voter turnout was extraordinarily high, as 72% of the 46.5 million registered voters came out in full force to have their voices heard.
Divorce is never cheap, and UK Prime Minister David Cameron paid the ultimate price with his defeat in the Brexit referendum…the loss of his job. Immediately following the release of the referendum results, Cameron, the British Prime Minister since 2010 and leader of the Conservative Party, immediately announced his resignation, effective no later than October 2016 after the selection of his successor.
Source: Bloomberg
One of the reasons behind the shock of the Brexit Leave decision is the longstanding relationship the U.K. has had with the EU. European Union membership first began in 1957 with Belgium, France, Germany, Italy, Luxembourg, and Netherlands being the founding countries of this new political-economic union.
A few decades later, the U.K. officially joined the EU in 1973 with Ireland and the Denmark, shortly before Margaret Thatcher came into power. If you fast forward to today, some 43 years after U.K. originally joined the EU, the Brexit decision represents the largest turning point in European political history. Not since the 1989 falling of the Berlin Wall and the subsequent demise of the Cold War in the Soviet Union has such a large, earth-moving political shift occurred.
Today, there are 28 member countries in the EU with Croatia being the newest member in 2013. Despite the Brexit outcome, there still is a backlog of countries wanting to join the EU club, including Turkey, Serbia, Albania, and Montenegro (and this excludes Scotland, which has voiced an interest in leaving the U.K. for the EU).
What Were Investors’ Reactions?
Financial markets around the world were caught off guard, given many pre-referendum polls were showing the Remain camp with a slight edge, along with British betting parlors that were handicapping an overwhelming victory for the Remain camp. Here’s a summary of stock market reactions around the globe from June 23rd to June 30th:
U.S. (S&P 500): -0.7%
U.K. (FTSE 100): +2.6%
Japan (Nikkei): -4.1%
Germany (DAX): -5.6%
Hong Kong (Hang Seng): +0.4%
China (Shanghai): +1.3%
India (BSE): -0.0%
Surprisingly, modest monthly gains achieved in the S&P 500 prior to the Brexit vote (up +0.8%) were quickly pared after the results came in but remained positive for the entire month (up +0.1%). For the year, U.S. stocks are up a limited +2.7%, which isn’t too bad considering investors’ current mood.
Stocks were not the only financial market disrupted after the Brexit announcement, foreign exchange currency rates were unstable as well. The British pound dived to a 30-year low shortly after the vote to a level of approximately $1.33/£, and was down more than -10% on the day of the announcement (see chart below). UK banks like Barclays PLC (BCS) and Lloyds Banking Group PLC (LYG) also saw their share prices significantly pressured as EU regulatory risks of losing access to European customers and negative global interest rates further squeeze the banks’ profit margins.
To put the currency picture into perspective, the value of the British pound ($2.64/£) peaked in March 1972 at a rate about double the U.S. dollar today. On the positive side of the ledger, a weaker British pound could help boost exports and vacation time to Stonehenge or London, but there is also a risk for a spike of inflation (or stagflation) on the country’s roughly $740 billion in imports (e.g., food, energy, and raw materials).
Source: Calafia Beach Pundit
Why Did it Happen?
While economically prosperous regions like London and Scotland voted heavily for Remain, the message for change of the Leave camp resonated well with working class towns and rural areas of England (seen here). Besides a geographic split, there was also a demographic divide between voters. As you can see from the YouGov poll below, the majority of younger citizens overwhelmingly voted for Remain, and vice versa for older citizens as it relates to the Leave vote.
18-24: 75% Remain
25-49: 56% Remain
50-64: 44% Remain
65+: 39% Remain
While geography and demographics certainly played a key role in the outcome of the EU Leave referendum result, at the core of the movement also was a populist discontent with immigration and the negative economic consequences created by globalization. There are many reasons behind the sluggish economic global recovery, even if the U.S. is doing best out of the developed countries, but rightly or wrongly, immigration policies and protectionism played a prominent part in the Brexit.
At the heart of the populist sentiment of lost control to Brussels (EU) and immigration is the question of whether the benefits of globalization have outweighed the costs. The spread of globalization and expanded EU immigration has disenfranchised many lower skill level workers displaced by eastern European immigrants, Syrian refugees and innovative solutions like automated machinery, software, and electronic equipment. Economic history clearly shows the answer to the effectiveness of globalization is a resounding “yes”, but the post-financial crisis recovery has been disappointingly sluggish, so a component of the populist movement has felt an urgency to find a scapegoat. The benefits of globalization can be seen in the chart below, as evidenced by the increases in per capita GDP of the UK relative to Germany and France, after joining the EU in 1973. Many observers are quick to identify the visible consequences of globalization (i.e., lower-paying job losses), but fail to identify the invisible benefits (i.e., productivity, lower prices, investment in higher-paying job gains).
Source: The Wall Street Journal
What happens next?
While some EU leaders want to accelerate the Brexit transition, in actuality, this will require a long, drawn-out negotiation process between the still-unnamed new UK Prime Minister and EU officials. The complete EU-Brexit deal will take upwards of two-years to complete, once Article 50 of the EU Lisbon Treaty has been triggered – likely in October.
In light of the unchartered nature of the Brexit Leave vote, nobody truly knows if this decision will ultimately compromise the existential reality of the EU. Time will tell whether Brexit will merely be a small bump on the long EU road, or the beginning of a scary European domino effect that causes the 28 EU country bloc to topple. If the U.K. is successful in negotiating EU trade agreements with separate European countries, the Brexit even has a longer-term potential of benefiting economic activity. Regardless of the EU outcome, the long-term proliferation of capitalism and democracy is likely to prevail because citizens vote with their wallets and capital goes where it is treated best.
What does Brexit Mean for Global Markets?
The short answer is not much economically, however there have been plenty of less substantial events that have roiled financial markets for relatively short periods of time. There are two basic questions to ask when looking at the economic impact of Brexit:
1) What is the Brexit impact on the U.S. economy?
If you objectively analyze the statistics, U.S. companies sold approximately $56 billion of goods to the U.K. last year (our #7 trading partner). Even if you believe in the unlikely scenario of a severe U.K. economic meltdown, the U.K. trade figure is a rounding error in the whole global economic scheme of things. More specifically, $56 billion in trade with the U.K. equates to about .003 of the United States’ $18+ trillion GDP (Gross Domestic Product).
2) What is the Brexit impact on the global economy?
The U.K.’s GDP amounts to about $3 trillion dollars. Of that total, U.K. exports to the EU account for a reasonably insignificant $300 billion. As you can see from the chart below, $300 billion in UK exports to the EU are virtually meaningless and coincidentally equate to about .003 of the world’s $78 trillion estimated GDP.
Source: The National Archives
What to Do Next?
Like many divorces, the U.K. Brexit may be messy and drawn out, until all the details are finalized over the next couple years. It’s important that you establish a strong foundation with your investments and do not divorce the sound, fundamental principles needed to grow and preserve your portfolio. As is usually the case, panicking or making an emotional decision relating to your investments during the heat of some geopolitical crisis rarely translates into an optimal decision over the long-run. As I repeatedly have advised over the years, these periods of volatility are nothing new (see also Series of Unfortunate Events).
If you catch your anxiety or blood pressure rising, do yourself a favor and turn off your TV, radio, or electronic device. A more productive use of time is to calmly review your asset allocation and follow a financial plan, with or without the assistance of a financial professional, so that you are able to achieve your long-term financial goals. This strategy will help you establish a more durable, long-lasting, and successful marriage with your investments.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing 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.
Brexit Briefing
Pair of British Briefs
There is no shortage of Brexit articles, but as I compile information for my monthly newsletter later this week (subscribe at Investing Caffeine – right column), here are some of my favorite links:
1) How to Make Sense of the Brexit Turmoil (FiveThirtyEight)
2) Brexit Meltdown Charts (Ritholtz)
3) House of Commons UK-EU Economic Relations Report (Parliament Research Briefings)
4) What is article 50 and why is it so central to the Brexit debate? (The Guardian)
5) The Difference Between the EU and Euro Zone (Moody’s)
6) Brexit’s First 100 Days (Bloomberg)
7) Brexit Impact on Wimbledon Paychecks (Fox Sports)
8) Relationship Between the U.K., Britain, England, Great Britain, Ireland, Northern Island, Wales, and British Isles (Project Britain)
9) Brexit Voting Results by Age (Ben Riley-Smith – Twitter)
10) Brexit Impact on Global Economy (Wall Street Journal)
11) Brexit is Not the End of the World (Calafia Beach Pundit)
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds , but at the time of publishing 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.
The New Abnormal: Living with Negative Rates
Pimco, the $1.5 trillion fixed-income manager located a stone’s throw distance from my office in Newport Beach, famously (or infamously) coined the phrase, “New Normal”. As former Pimco CEO (Mohamed El-Erian) described years ago, around the time of the Great Recession, the New Normal “reflects a growing realization that some of the recent abrupt changes to markets, households, institutions, and government policies are unlikely to be reversed in the next few years. Global growth will be subdued for a while and unemployment high.”
As it turns out, El-Erian was completely wrong in some respects and shrewdly prescient in others. For instance, although the job recovery has been one of the slowest in a generation, 14.5 million private sector jobs have been added since 2010, and the unemployment rate has been more than halved from 10% in early 2009, to below 5% today. However, the pace of global growth has been relatively weak since the 2008-2009 financial crisis, which has forced central banks all over the world to lower interest rates in hope of stimulating growth. Monetary policies around the globe have been cut so much that almost 25% of global GDP is tied to countries with negative interest rates (see chart below).
Source: Financial Times
The European central banks started the sub-zero trend in 2014, and the Bank of Japan recently joined the central banks of Denmark, Sweden and Switzerland in negative territory. The negative short-term rate virus has spread further to long-term bonds as well, as evidenced by the 10-Year German Bund (sovereign bond) yield, which crossed into negative territory last week (see chart below).
Source: TradingEconomics.com
The New Abnormal
The unprecedented post-crisis move to a 0% Fed Funds rate target, along with the implementation of Quantitative Easing (QE) by former Federal Reserve Chairman Ben Bernanke, was already pushing the envelope of “normal” stimulative monetary policy. Nevertheless, central banks pushing rates to a negative threshold takes the whole stimulus discussion to another level because investors are guaranteed to lose money if they hold these bonds until maturity.
As we enter this new submerged rate phase, this activity can only be described as abnormal…not normal. Preserving money at a 0% level and losing value to inflation (i.e., essentially stuffing money under the proverbial mattress) is a bitter enough pill to swallow. Paying somebody to lend them money gives “insanity” a good name.
The stimulative objectives of negative interest policies established by central bankers may be purely intentioned, however there can be plenty of unintentional consequences. For starters, negative rates can produce too much of a good thing, in the form of excess borrowing or leverage. In addition, retirees and savers across a broad spectrum of ages are getting crushed by the paltry rates, and bank profit margins (net interest margins) are getting squeezed to boot.
Another unintended consequence of negative rate policies could be a polar opposite outcome to the envisioned stimulative design. Scott Mather, a co-portfolio manager of the $86 billion PIMCO Total Return Fund (PTTRX) is making the case that these policies could be creating more economic contractionary effects than invigorating expansion. More specifically, Mather notes, “It seems that financial markets increasingly view these experimental moves as desperate and consequently damaging to financial and economic stability.”
Eventually, the cheap money deliberately created by central banks will result in a glut of risk-taking and defaults. However, despite all the cries from hawks protesting money printing policies, cautious bank lending behavior coupled with regulatory handcuffs have yet to create widespread debt bubbles. Certainly, oceans of cheap money can create pockets of problems, as I have identified and discussed in the private equity market (see also Dying Unicorns), but supply and demand rule the day at some point.
In the end, as I have repeatedly documented, money goes where it is treated best. Realizing guaranteed losses while trapped in negative rate bonds is no way to treat your investment portfolio over the long-run. In the short-run, the safety and stability of short duration bonds may sound appealing, but ultimately rational and efficient behavior prevails. Why settle for 0% or negative rates when yields of 2%, 4%, and 6% can be found in plenty of other responsible investment alternatives?
Arguably, in this post financial crisis world we live in, we have transitioned from the New Normal to a New Abnormal environment of negative rates. Pundits and prognosticators will continue spewing fear-filled cautionary advice, but experienced, long-term investors will continue taking advantage of these risk averse markets by investing in a quality, diversified portfolio of superior yielding investments. For now, there are plenty of opportunities to choose from, until the next phase of this economic cycle… when the New Abnormal transitions to the New Normalized.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds , but at the time of publishing had no direct position in PTTRX, 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.
Rise of the Robots
We’re losing our jobs to robots, and they will destroy our economy. It makes for a great news soundbite, but has no factual basis in reality, if you look at the actual trajectory of automation and technology innovations throughout history. The global economy did not collapse when the steam engine replaced the oar; the automobile supplanted the horse; the computer became a substitute for the abacus; and the combine killed off the farmer. The same notion holds true today as robots become more ubiquitous in our daily commercial and personal lives.
From the early, post-revolutionary birth of our country in the 18th century, the agrarian economy accounted for upwards of 90% of jobs and financial activity…until farming technology evolved (see chart below). As new agricultural advancements were introduced, like the cotton gin, plow, scythe, chemical fertilizers, tractors, combine harvesters, and genetically engineered seeds, human capital (jobs) were redeployed into other growth sectors of the economy (e.g., factories, aerospace, semiconductors, medicine, etc.).
Source: Carpe Diem
Given that human labor accounts for about 2/3 of an average company’s expense structure, it should come as no surprise that corporations are looking to reduce costs by introducing more robotics and automation into their processes. The advantages to robotics adoption are numerous and I describe many of the reasons in my article, Chainsaw Replaces Paul Bunyan:
A robot won’t ask for a raise; it always shows up on time; you don’t have to pay for its healthcare; it can work 24/7/365 days per year; it doesn’t belong to a union; dependable quality consistency is a given; it produces products near your customers; and it won’t sue for discrimination or sexual harassment.
At Sidoxia Capital Management we opportunistically identified this growing trend quite early as evidenced by our initial 2012 investment in KUKA AG (Ticker: KUKAF), a German manufacturer of industrial robots. KUKA has recently made headlines due to a bid received from Chinese home-appliance company (Midea Group: Ticker – 000333.SZ) that values the dominant German robotics leader at $5 billion. Despite KUKA’s +273% share price appreciation from the end of 2012, not many people have heard of the company. While KUKA may not have caught the attention of many U.S. investors, the company has captured a bevy of blue-chip global customers, including Daimler, Airbus Group, Volkswagen, Fiat, Boeing, and Tesla.
Rather than sitting on its hands, KUKA has done its part to develop a higher profile. In fact, President Barack Obama and German Chancellor Angela Merkel recently received a robotics demonstration from KUKA’s CEO Till Reuter at the world’s largest industrial technology trade fair in Hannover, Germany this April (picture below)
Source: Bloomberg
The recent multi-billion dollar bid by Midea Group has turned some onlookers’ heads, but what the potential deal really signals is the vast opportunity for robotics expansion in Asia. Rising labor costs in China, coupled with the enormous efficiency benefits of automation, have pushed China to become the largest purchasing country of robots in the world, ahead of the U.S., Japan, Korea and Germany (see chart below). However, according to the International Federation of Robotics (IFR), in 2015, Japan remained the country with the largest number of installed robots. IFR does not expect Japan to remain the “king” of the installed robotics hill forever. Actually, IFR estimates China will leapfrog Japan over the next few years to become both the largest purchaser of robots, along with maintaining the largest installed base of robots.
Source: Financial Times
In the coming months and years, there will be a steady stream of sensationalist headlines talking about the rise of the robots, and the destruction of jobs. We’ve repeatedly seen this movie before throughout history. Rather than a scary bloodbath ending, over the long-run we’ll likely see another happy ending. Any potential job losses will likely be outweighed by productivity gains, coupled with the benefits associated with more efficiently deployed labor to new growth sectors of the economy.
Even KUKA realizes the automation dynamics of the 21st century will serve as a net labor enhancer not detractor. If you don’t believe me, just ask Timo Boll, world champion table tennis player, who tested this theory vs. a KUKA robot (see video below). Ultimately, the rise of robots will lead to the rise of global growth and productivity.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), KUKAF, BA, and TSLA, but at the time of publishing had no direct position in Daimler, Airbus Group, Volkswagen, Fiat Chrysler, 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.
Cleaning Out Your Investment Fridge
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (June 1, 2016). Subscribe on the right side of the page for the complete text.
Summer is quickly approaching, but it’s not too late to do some spring cleaning. This principle not only applies to your cluttered refrigerator with stale foods but also your investment portfolio with moldy investments. In both cases, you want to get rid of the spoiled goods. It’s never fun discovering a science experiment growing in your fridge.
Over the last three months, the stock market has been replenished after a rotten first two months of the year (S&P 500 index was down -5.5% January through February). The +1.5% increase in May added to a +6.6% and +0.3% increase in March and April (respectively), resulting in a three month total advance in stock prices of +8.5%. Not surprisingly, the advance in the stock market is mirroring the recovery we have seen in recent economic data.
After digesting a foul 1st quarter economic Gross Domestic Product (GDP) reading of only +0.8%, activity has been smelling better in the 2nd quarter. A recent wholesome +3.4% increase in April durable goods orders, among other data points, has caused the Atlanta Federal Reserve Bank to raise its 2nd quarter GDP estimate to a healthier +2.9% growth rate (from its prior +2.5% forecast).
Consumer spending, which accounts for roughly 70% of our country’s economic activity, has been on the rise as well. The improving employment picture (5.0% unemployment rate last month) means consumers are increasingly opening their wallets and purses. In addition to spending more on cars, clothing, movies, and vacations, consumers are also doling out a growing portion of their income on housing. Housing developers have cautiously kept a lid on expansion, which has translated into limited supply and higher home prices, as evidenced by the Case-Shiller indices charted below.
Source: Bespoke
Spoiling the Fun?
While the fridge may look like it’s fully stocked with fresh produce, meat, and dairy, it doesn’t take long for the strawberries to get moldy and the milk to sour. Investor moods can sour quickly too, especially as they fret over the impending “Brexit” (British Exit) referendum on June 23rd when British voters will decide whether they want to leave the European Union. A “yes” exit vote has the potential of roiling the financial markets and causing lots of upset stomachs.
Another financial area to monitor relates to the Federal Reserve’s monetary policy and its decision when to further increase the Federal Funds interest rate target at its June 14th – 15th meeting. With the target currently set at an almost insignificantly small level of 0.25% – 0.50%, it really should not matter whether Chair Janet Yellen decides to increase rates in June, July, September and/or November. Considering interest rates are at/near generational lows (see chart below), a ¼ point or ½ point percentage increase in short-term interest rates should have no meaningfully negative impact on the economy. If your fridge was at record freezing levels, increasing the temperature by a ¼ or ½ degree wouldn’t have a major effect either. If and when short-term interest rates increase by 2.0%, 3.0%, or 4.0% in a relatively short period will be the time to be concerned.
Source: Scott Grannis
Keep a Fresh Financial Plan
As mentioned earlier, your investments can get stale too. Excess cash sitting idly earning next-to-nothing in checking, savings, CDs, or in traditional low-yielding bonds is only going to spoil rapidly to inflation as your savings get eaten away. In the short-run, stock prices will move up and down based on frightening but insignificant headlines. However, in the long-run, the more important issues are determining how you are going to reach your retirement goals and whether you are going to outlive your savings. This mindset requires you to properly assess your time horizon, risk tolerance, income needs, tax situation, estate plan, and other unique circumstances. Like a balanced diet of various food groups in your refrigerator, your key personal financial planning factors are dependent upon you maintaining a properly diversified asset allocation that is periodically rebalanced to meet your long-term financial goals.
Whether you are managing your life savings, or your life-sustaining food supply, it’s always best to act now and not be a couch potato. The consequences of sitting idle and letting your investments spoil away are a lot worse than letting the food in your refrigerator rot away.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing 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.
Investing Caffeine 
