Category Archives: Basic Concepts

where to from here?

June 10, 2020 By in currency effects, deprecating currency, economics, Strategy Tags: , , Leave a comment

signs of excess

The US is now awash in money being pumped into it by the federal government, both through Federal Reserve buying bonds and offering overnight money to banks basically for free and Congress sending out trillions of dollars in stimulus money. Why? …to combat the enormous and unnecessary damage done to the economy by the pandemic (not by the virus itself but by Trump’s bizarre implosion under pressure–calling the pandemic a hoax, urging citizens to ignore medical advice, fomenting race conflict to cover up his failure).

For the stock market, most of this is in the near-term rear view mirror. There are clear signs that there’s no shortage of cash in circulation. Barstool Sports’ shift from sports betting to day trading stocks is one. The increasing popularity of Robinhood–and the response of traditional discounters in offering trading in fractional shares is another. The weird resurrection of the stocks of bankrupt companies like Hertz (I can’t think of an instance where common shareholders have ever come out of a Chapter 11 proceeding with anything at all).

it’s all about the money (supply)

Yes, these are serious warning. But healing at least some of the damage Trump has done during his time in office takes priority for now, as I see it. And until there’s a change in government policy to “take away the punch bowl,” stocks will likely continue to hold up relatively well. This was certainly the case during the gigantic bull market in Japan during the 1980s as well as in the runup in the US stock market during the Y2K/Internet bubble of 1999.

my biggest question marks today

–is the market rotation toward domestic economy-centric stocks that began in late March over? My guess is not yet.

The winning strategy for Wall Street since the positive effect of the 2017 corporate income tax cut began to wear off in early 2018 has been to hold the US-traded stocks that have the least to do with the domestic economy. From late March to late April, these laggards, as measured by the Russell 2000, began to keep pace with the broader market. For the past 6 weeks or so, thanks (I think) to Washington stimulus, they have been outperforming. A counter-trend rally, which is what I think this is, typically lasts about two months. I regard the start as the end of April, not the end of March. So even though price movement can be read as the R2000 rally being over, my guess is that it still has some weeks to run.

–will Trump be reelected? Former Wall Street economist, Stephen Roach, now teaching at Yale, is the first public figure to be talking about my Mexico-1980s analogy as a possible future for the US. He does so in a Bloomberg article that reads in part:

“Look no further than the Trump administration. Protectionist trade policies, withdrawal from the architectural pillars of globalization such as the Paris Agreement on Climate, Trans-Pacific Partnership, World Health Organization and traditional Atlantic alliances, gross mismanagement of Covid-19 response, together with wrenching social turmoil not seen since the late 1960s, are all painfully visible manifestations of America’s sharply diminished global leadership.”

He thinks a fall in the dollar of about a third is possible.

Although Roach doesn’t put it this way, a very big question to be answered in November is whether the US doubles down on the Trump anti-growth, anti-science, white supremacist agenda or tries to start to repair the damage done to date.

A final point: Mexico in the 1980s was a horrible place economically, where the currency lost 90+% of its value. But because the government did not permit citizens to move assets abroad the stock market there was the best-performing in the world over that period.

more tomorrow

it’s mostly about interest rates

June 8, 2020 By in administration economic strategy, economics, stocks vs. bonds, Strategy Tags: , Leave a comment

There are three big categories of liquid investments: stocks, bonds and cash. Typically, the progression for individuals as they begin to save is: cash first, then bonds, then stocks.

There’s also an age-related progression, generally from riskier stocks to the steadier returns of government bonds. The old-fashioned formulation is that your age in years is the percentage of savings that should be in bonds, the remainder in stocks. A 30-year old, for example, would have 70% of savings in stocks, the rest in fixed income.

A strong tailwind has been aiding bond returns in the US since the early 1980s, since after the Fed raised short-term interest rates to 20%+ to choke off an inflation spiral spawned by too-loose money policy during the Seventies. The financial collapse of 2008 required another huge dose of money policy stimulus. Recently, Trump has been badgering the Federal Reserve to push short rates below zero to cover up the damage he has done to the domestic economy since being elected, in addition to the big hole he punched in the bottom of the boat this year by his pandemic denial.

No matter how we got here, however, and no matter how bad the negative long-term consequences of Trump’s bungling, the main thing to deal with, here and now, is that one-month T-bills yield 0.13%. 10-year notes yield 0.91%. That’s because during times of stress investors almost always shrink their horizons very substantially. They’re no longer interested in what may happen next year. They just want to get through today.

My sense is that we’re bouncing along the bottom for both short and long rates–and that we’re going to stay this way for a long time. If so, not only is income from Treasures of all maturities substantially below the 1.9% yield on stocks, a rise in interest rates toward a more normal 3% will result in a loss for today’s holders of any fixed income other than cash.

So for now at least, for investors it’s all stocks, all day long.

Looked at this another traditional way, the inverse of the yield on the long Treasury should be the PE on the stock market. If we take the 10-year as the benchmark, the PE on the stock market should be 111; if we take the 30-year (at 1.68%), the PE should be 59.5.

We have to go back to the gigantic bubble of 1980s Japan to see anything similar. If the comparison is valid, then bonds are already in full bubble mode; stocks are halfway there.

the current market: apps vs. features

May 12, 2020 By in administration economic strategy, internet bubble, Strategy, Uncategorized Tags: , 2 Comments

sizing up the market

In some ways, current trading in tech stocks reminds me of the internet boom of 1999.  To be clear, I don’t think we are at anything near the crazy valuation levels we reached back twenty+ years ago.  On the other hand, I’m not willing to believe we’ll reach last-century crazy, mostly because nothing in the stock market is ever exactly the same.

On the (sort-of) plus side, three-month Treasury bills back then were just below to 5% vs. 1.5% today and 10-year Treasury notes were 4.7% vs 1.9% now.  If we were to assume that the note yield and the earnings yield on stocks should be roughly equivalent (old school would have been the 30-year bond), the current PE supported by Treasuries is 50+, the 1999 equivalent was 21 or so.   This is another way of saying that today’s market is being buoyed far more than in 1999 by accomodative government policy.

On the other, the economic policy goal of the Trump administration, wittingly or not, seems to be to follow ever further down the trail blazed by Japan during the lost decades starting in the 1990s.  So the post-pandemic future is not as cheery as the turn of the century was.

what to do

I think valuations are high–not nosebleed high, but high.  I also know I’m bad at figuring out what’s too high.  I started edging into cyclicals a few weeks ago but have slowed down my pace because I’m now thinking that cyclicals might get weaker before they get stronger (I bought more MAR yesterday, though).

With that shift on the back burner, what else can I do to make my portfolio better?

features vs. apps

Another thing that’s also very reminiscent of 1999 is today’s proliferation of early-stage loss-making companies, particularly in software.

The 1999 favorites were online retailers (e.g., Cyberian Outpost, Pets.com, eToys) and internet infrastructure (Global Crossing) whose eventual nemesis, dense wave division multiplexing, was also a darling.

The software losers were by and large undone, I think, not because the ideas were so bad but because they weren’t important enough to be stand-alone businesses.  They were perfectly fine as features of someone else’s app.  A number were eventually bought for half-nothing after the mania ended, to become a part of larger entities.

 

One 2020 stock that comes to mind here is Zoom (ZOOM), a name I held for a while but have sold.  The video conferencing product is inexpensive and it’s easy to use.  It’s also now on center stage.  But there are plenty of alternatives that can be polished up and then offered for free by, say, Google or Microsoft.

 

Another group is makers of meat substitutes (I bought a tiny amount of Beyond Meat on  impulse after reading about 19th-century working conditions in meatpacking plants).  Same issue here, though.  Where’s the distribution?  Will BYND end up as a supplier, say, to McDonalds?  …in which case the PE multiple will be very low.  Or will it be able to develop a brand presence that separates it from other meat substitutes and allows it to price at a premium?  Who knows?  My reading is that the market is voting for the latter, although I think chances are greater for the former outcome  …which is why I’m in the process of selling.

 

 

 

 

 

 

Disney (DIS), Berkshire Hathaway (BRK) and the discounting mechanism

May 6, 2020 By in Discounting, discounting in the AI age, Uncategorized Tags: , Leave a comment

discounting

This is Wall Street jargon for the investor process of factoring into today’s prices the effects of anticipated future events.

old school

Pre-2009, legions of experienced securities analysts and portfolio managers pored over company SEC filings and put that information together with their industry and business cycle knowledge to make reasoned projections of future company profits–and of possible stock performance if their guesses were right.

In bear markets, investors paid little attention to the future.  In bull markets, this is the time of year investors would begin to adjust their thinking not only for this year’s possible profit gains but next year’s as well.

 

in the AI world

I don’t know yet.  But I think this is a crucial thing to try to figure out.

recent data points

BRK had its annual investor event last Sunday.  When I entered the stock market in 1978, CEO Warren Buffett, professional investor and disciple of Benjamin Graham, was already an investing legend.  This was based on his earlier-than-everyone-else understanding of the value of intangible assets like brand names and distribution networks.  The last fifteen years or so have not been especially kind to Mr. Buffett, but he remains a legend nonetheless.  Anyway, at the meeting Buffett announced that BRK had sold its entire $6 billion stake in major domestic airlines.

Those stocks fell by about 10% on Monday.  Why did he sell?  My simple answer is that airlines need to sell an average of 70% of their available seats to break even on a financial reporting basis.  That’s impossible to achieve while social distancing protocols are in effect–and unlikely, I think, even when those are lifted.

But who didn’t know that before Sunday?  Monday’s price action indicates there certainly was someone.

DIS

DIS reported March-quarter results after the close yesterday.  Y-ear-to-date, DIS has underperformed the S&P, although wildly outperforming other leisure and entertainment companies (softer fall, more muted rebound).  This is partly, I think, (justified, in my view) admiration of the company’s transformation under CEO Bob Iger, partly the possibility that the DIS streaming service will be a success.  While investors haven’t been particularly positive, press coverage has been uniformly upbeat.

In yesterday’s conference call, the financial press”learned” that the company’s theme parks are closed, movie theaters are shut and ESPN is showing reruns of old spelling bees and writing about Korean baseball because there’s no live domestic sports.  the company also decided to halt the dividend for now.  Financial press coverage has turned sharply negative.

in early trading today, DIS is flattish.  It will be interesting to see how it finishes out the day.

negative working capital

April 8, 2020 By in negative working capital, Uncategorized, working capital Tags: , Leave a comment

Working capital is all about the inventory cycle–meaning the journey from cash in the bank to production materials to finished goods to sales and back to cash.  For pharma distributors the cycle may take two weeks, for a scotch distillery six years.  Conventionally, however, working capital is defined as assets and liabilities being used over a 12-month period.

Manufacturers typically have lots of working capital, much of it tied up in inventory.  Retailers of consumer durables and jewelry do, too.

There’s another class of companies, however, like utilities, restaurants, hotels…that typically have negative working capital, meaning the company doesn’t need to feed cash into the production process to keep it going.  Instead, operations generate cash, at least for a time.   And the amount of cash grows as the business expands.

Why is this?

–A restaurant is an easy example.  In the US, sales happen either in cash or by credit card, where the funds are available for use almost immediately.  So it has no receivables on the asset side of the balance sheet and it has an inventory of maybe a couple of days’ food.  On the liabilities side, rent, utilities, salaries and food ingredients are paid for an average of, say, two weeks after their inputs are used.  So once it gets going, the restaurant has many more current liabilities than current assets and it has the use of the upfront payments for about 14 days.  If the restaurant prospers, the gap between liabilities and assets may expand in percentage terms, but even if not the cash “float” will grow in the absolute.

–An online service charging a monthly or yearly subscription fee–music, books, news, Adobe Cloud–works the same way.  People pay in advance for services provided bit by bit over the term of the subscription.

–hotels, cruise ships and public utilities, too.

There’s a temptation for negative working capital companies, seeing apparently idle cash of $100,000, then $125,000, then $175,000 (much bigger figures for publicly-traded companies) just lying on the balance sheet for years, to use this money to, say, open a second restaurant that would potentially double the size of the firm, create economies of scale…  In fact, the only company I can think of that steadfastly refused to touch any portion of its cash buildup was Dell in its heyday as a PC manufacturer.

The problem:  suppose a negative working capital company takes a risk with its “float” money and stumbles.   In our restaurant example, let’s say the company takes $50,000 out of its cash balance, uses it to set up a second location and the second restaurant flops.  All of a sudden, salaries, utilities, rent, food bills come due and there isn’t enough money.  Whoops.

Suppose the business begins to shrink.  If so, so too does the cash pile.  But at least initially the liabilities remain the same.  Potential trouble, unless the company adjusts very quickly.

More relevant today, suppose there’s a quarantine and incoming cash dries up completely.  In the restaurant case, in less than a month, the cash is all gone!   And the owner has to decide whether to inject more capital into the business, close its doors, or not pay the bills and see what happens.

CCL

A case in point is cruise line Carnival (CCL), which raised about $6 billion last week in a stock/bond sale, shortly after drawing down much, if not all, of its $3 billion bank credit lines.  Three entries on the balance sheet explain these moves to me.  As of last November CCL had $518 million in cash on the asset side:  liabilities:  $4.7 billion in customer deposits + $1.8 billion in accrued liabilities (= other stuff).