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Category Archives: Current Market Thoughts
cascades of economic energy and finding a stock-picking focus
finding the focus
One of the most creative (and successful) investors I’ve ever encountered–and, luckily for me, one of my earliest mentors–gave me this example of his investment style:
Suppose, he said, Washington has decided to stimulate the economy and we’re in the early days of a nationwide road building boom. What stocks do you buy?
–Your first inclination is to look at construction companies. That’s what most people buy. But they’re usually conglomerates, with significant non-public works subsidiaries. There are also lots of them. It’s difficult to predict who will get contracts and how profitable they will be.
–Your next thought is probably construction materials, like cement or asphalt. Certainly, roadbuilding will require lots of that stuff. But the same problem arises here, on a smaller scale–determining who, among many possible suppliers, gets the contracts and how important they are for the overall profits. One extra quirk: the low value-added nature of construction materials and their high weight (meaning big transportation costs) make individual plant locations crucial. Figuring that out is especially hard.
My friend’s answer? …cement trucks. Buy stock in the one or two companies whose main business is making cement trucks. No matter who gets the government construction contracts, no matter which suppliers they choose, they’ll need to transport cement to the construction sites. As orders build, they’ll have to upgrade their truck fleets. Large-scale contracts also mean large-scale upgrades. That’s where the economic energy from the government road building program is going to be focused.
cascades of energy…
This is absolutely right, in my opinion. It’s Levy Strauss selling blue jeans to Gold Rush miners all over again.
To recap, the surest and safest way to play any economic phenomenon is to find, if you can:
–the sole supplier
–of an essential component
–whose price makes up a very small cost in the creation of the ultimate end product made or sold.
This most likely means that buyers of the component will be much more concerned with the quality of the component than the price. So the component maker should be able to make unusually high profits.
In my experience, I’ve found there’s also another–time-related– aspect to investor behavior in playing any powerful source of economic energy.
Institutional investors typically proceed as follows:
–initially they tend to buy largest-cap and most obvious ways to play whatever the theme is. In the context of my friend’s road example above, they buy the general construction companies.
–after the prices of these stocks have gone up for a while, the big investors’ attention begins to move to the most obvious derivative plays–the cement companies–and buy them.
–ultimately they “discover” the cement truck companies and add them to their portfolios as well.
If you know the industries involved well enough, you can see a cascade of successive waves of investment that chronicles the travels of the consensus deeper and deeper into the derivative plays.
…forming a timeline
This changing, and ever narrowing, focus of big investors typically forms a timeline that we can use to judge how much energy remains in a given economic phenomenon in stock market terms. Once the big guys work their way to the metaphorical cement trucks, that signals most of the money from the theme has already been made.
At this point, the market either goes back to the start of all the excitement–the general construction companies–and begins the cascade process all over again. More commonly, the market moves on to other areas.
where are we now?
Although it’s relatively early in the 1Q12 earnings season, I’m struck by two characteristics of the market reaction to earnings announcements so far.
The first is that positive reaction is highly company-specific and relatively narrowly focused in the sense I’ve been writing about. To me, this means that before long the market will no longer be following ever more indirect ways to play the fact of economic recovery from the Great Recession. It will be looking for new areas of interest instead.
I’ve also noticed that my portfolio, which is more of the cement truck type–and which had been in the dumps for the past several months–is beginning to perk up again. Yes, my stocks have had an extraordinary two years or so before starting to fade away, but that’s the past and not relevant for today. I’m also reading my recent outperformance as evidence of an ongoing maturing–maybe even an upcoming sea change–in stock market focus. More about this in my next Current Market Tactics, on Monday.
chit funds, crowdfunding and p2p banking (II)
two lessons from history
Thailand
I was just getting acquainted with Thailand when the Ms. Chamoy Thipyaso chit fund scandal broke. “Mae” (=Mother) Chamoy, the wife of a Thai Air Force officer, appeared to be running a very large chit fund investment operation that was stringing together a sequence of startlingly high investment returns. She had agents throughout Thailand collecting new money for her. Money was pouring in.
The fund turned out to be a gigantic Ponzi scheme, however.
The scheme sustained itself for an unusually long time. It continued to operate even after it had become so large (US$100 million+) it was implausible to think Mae could find enough lucrative “secret” microfinancing opportunities in Thailand. Several reasons for this:
–people wanted to believe.
–the fund appeared to have the backing of the military, the ultimate source of political and business leadership in Thailand. This gave an implied assurance that the investment results were real. Prominent high-ranking Air Force officers invested with Mae, and forcefully urged their subordinates to do so as well.
–investors who thought about withdrawing some of their “profits” were pressured not to do so, with the threat that if they took money out they would be blacklisted and not allowed to invest in the fund thereafter.
Interestingly, large investors in the Chamoy fund continued to urge their friends and work subordinates to plow money into the fund even after they realized it was a Ponzi scheme. Their rationale? …it bought them more time. That extra time allowed them to continue to enjoy a lifestyle they knew was going to end when the fraud was discovered. And it allowed them to arrange their financial affairs in a way that would minimize the negative impact on them personally. To followers of the Bernie Madoff case in the US, this must certainly sound familiar.
my thoughts
In my reading about microfinance, it seems that Ponzi schemes have been a constant problem wherever third-party chit funds–not the ones where friends and neighbors lend to one another–operate. That means virtually everyplace in South Asia and Africa. There seems to be an especially large amount of study done of the industry in India, which I have no practical experience with (because the stock market isn’t easily open to foreigners–and I think the political environment is particularly unfriendly toward equity investors.)
Personally, I’d worry more about Ponzi schemes in the US springing up among the firms that the JOBS Act will allow to raise equity. These are the entities that won’t have adequate financial controls or accounting statements for shareholders.
My chief p2p banking concern is a more prosaic one–that the present very low loan loss rates will prove to be more a function of the industry’s newness rather than of the creditworthiness of borrowers. Time will tell. And, unlike fraud, this is a risk we can take precautions for.
Taiwan
There was a unique twist to the Taiwanese chit fund industry that I encountered in the mid-1980s. Chit fund loans were secured by post-dated checks issued to the borrowers by the lenders. In Taiwan at that time, “bouncing” a check–having insufficient funds in the account to cover payment–was a felony, punishable by the check writer serving time in prison.
The threat of jail time was thought to be sufficient incentive to ensure repayment. So no one worried too much about the creditworthiness of the borrowers, which–as it turned out–included large publicly-traded companies. American accountants I met, who’d been sent to Taiwan to break into the auditing business there, told me that they could see the fact of unaccounted-for money sloshing around in potential client companies. They just couldn’t see how much. Because of this, they were reluctant to take any engagements. And they were continually undercut by local accounting firms who charged virtually nothing for “audits.” American bank lending officers told me the same thing.
The chit fund business received a major shock, during a mild economic downturn, some large companies had made hundreds of millions of dollars in chit fund loans–all unrecorded in the financial accounts–that they couldn’t repay. Bankruptcies resulted.
my thoughts
This is another potential problem for equity holders in firms crowdfunded under the JOBS Act. Without audited financials, it’s impossible for an outside investor to determine what the capital structure of a company is.
I also think, à la Taiwan, a legitimate auditor will simply walk away from a suspect company rather than make a public outcry. Non-disclosure agreements may force it to do no more. A less fastidious auditor, one nobody ever heard of, might take the business and issue a clean opinion. After all, Bernie Madoff got one for years, didn’t he?
chit funds, crowdfunding and p2p banking (I)
chit funds in emerging markets
I began to look at smaller Asian markets as an investor in 1985. It was there that I encountered the informal self-help savings and lending associations that are typical in developing economies. My introduction came through chit funds in Thailand and Taiwan, but these structures exist throughout the developing world.
what they are
the simplest
In their simplest form, the associations are groups of friends of neighbors who contribute a specified amount of money to a pool on a regular basis. The funds pooled each time the group meet are lent to a single participant, determined either by the implied interest rate bid or on a rotating basis.
more complex
At a higher level of organization, groups come to a designated place at a specific time–like by having a meal at a certain restaurant on Saturday–and offer to third parties the money they’re willing to lend. They may signal their intent simply by piling their money in the center of their table. Prospective borrowers move from table to table to negotiate loan terms.
the pinnacle
For the largest such chit funds, agents for the fund do the collection and forward the money to the fund’s central headquarters. Lenders don’t have any direct contact with the borrowers.
why chit funds?
There are a number of motivations, normally all based on the idea that the formal banking system doesn’t function well. For instance:
1. There may not be any local banks.
2. Banks may offer very low interest rates to depositors.
3. Banks may decide to lend only to large companies.
4. Potential depositors may worry about bank solvency–the possibility that they’ll lose their money in a bankruptcy or nationalization.
5. People may not want to reveal the extent of their wealth, or the extent of their taxable income.
the US equivalent
Interestingly enough, this emerging world form of microfinancing is beginning to make a strong showing in the US. It’s taking two forms:
–Congress recently passed the JOBS (Jumpstart Our Business) Act. JOBS greatly simplifies the procedures for a small company to make an offering of equity. For companies with less that $1 billion in annual sales, JOBS does away with the requirement that they present audited financials to potential investors (not a stellar idea, in my opinion). JOBS also defines the maximum amount that low-income investors can put into a given offering. By so doing, it legitimizes the efforts at equity crowdfunding (see my post) now underway in the US.
–John Mack, former head of Morgan Stanley, recently joined the Lending Club, a P2P (peer to peer) lender. P2P lending is chit funds come back to life, but on the internet instead of in your local restaurant. You can go to the websites of P2P firms like Prosper and Lending Club and select the borrowers you wish to lend to by yourself. Or you can hire a financial advisor to do this for you.
why now?
To start with the obvious, the technology needed to run P2P or equity crowdfunding is readily available.
Interest rates have been low for a long enough period of time–with little relief in sight–that more conventional means for savers to obtain high returns have been exhausted. Not only that, but getting a return above 2% in Treasury bonds requires committing money for a very long time, exposing the lender to the risk of loss as/when rates eventually begin to rise.
I see the JOBS ACT as an attack (maybe as the first step in a prolonged attack) by Washington on the current IPO practices of Wall Street investment banks. Conventional IPO costs in the US are very high by world standards, and a private individual stands about the same chance of getting an IPO allocation as a snowball in northern hemisphere July.
The naming of the JOBS Act suggests that Washington wants to be seen as doing something to create jobs. What a commentary if this is the best they can do.
My first reaction to P2P is that it may be a true innovation, like money market funds and junk bonds were in their day. P2P could end up being a very big business–unlike JOBS, which I see, in its present form, as gimmicky and filled with opportunities for fraud.
That’s it for today. Tomorrow: historic problems with P2P lending, including a word on Bernie Madoff.
is anything “wrong” with Apple?
APPL’s extraordinary recent performance
I was talking about the stock with my brother-in-law, a big AAPL booster, a month or so ago. I’d been fooling around with one-year performance charts, an obvious indication that I somehow had too much time on my hands. But doing so made me realize that, as I pointed out to my brother-in-law (who probably already knew), APPL had had an extraordinary impact on the S&P 500′s near-term performance. Over the prior 12 months, AAPL was up around 80%. Over the same time span, the S&P was up a bit less than 4%. But AAPL alone was responsible for most of the 4%!!
Some rough arithmetic: AAPL probably represented 3% of the index at the beginning of the period. 3% up 80% is the same as 80% up 3%, which is also the same as 100% up 2.4%. In other words, AAPL’s gains represented 2.4 percentage points out of the 4 percentage point advance the index made during that year. The other 97% of the index chipped in only 1.6 percentage points. Those stocks were basically flat.
Index dominance by one stock never happens in the US. In emerging markets, where a single issue can be 10%-15% of the overall market, yes. ..in the US, no. Nevertheless, that’s what AAPL did over the past year.
Then it fell by 10%.
more numbers
Let’s take a quick look at how AAPL has performed, even after that fall. And let’s include some of the “AAPL eco-system” stocks as well, to see how they’ve made out.
one year (through yesterday)
AAPL +77.2%
INTC +43.8%
QCOM +24.7%
NASDAQ index +8.1%
S&P 500 +3.8%
ARMH -4.8%
six months
AAPL +37.5%
INTC +20.9%
QCOM +20.1%
S&P 500 +11.8%
NASDAQ +8.1%
ARMH -1.9%
year to date
AAPL +43.1%
QCOM +21.1%
INTC +17.1%
NASDAQ +14.7%
S&P +8.9%
ARMH +0.8%
what I make of this
1. Even after the drop of the past few days, the overall situation of AAPL outperformance hasn’t changed very much. What has happened over the past six months, though, is that the rest of the market has begun to revive. So AAPL’s gains aren’t as dominant as they had been when the rest of the market was drooping.
2. The performance of “eco-system” stocks has been spotty.
–Qualcomm, whose chips are in virtually every high-end mobile device, has done well. But its performance over each of the periods above is a pale imitation of AAPL’s.
–ARM Holdings, whose low power chip designs are in just about every mobile device, high-end and low-, has been left behind in the dust. Of course, it was trading at close to 100x earnings a year ago.
–Intel, the “anti-APPL,’ the “dinosaur” that ARMH was going to put out of its misery, has been second on the one-year list. Or course, it was trading at 9x earnings a year ago and yielding close to 4%.
3. A counter-trend movement, where AAPL goes down and the rest of the world catches up a bit, wouldn’t be the least bit unusual after a year+ like APPL has had.
the rumors
Over the past few days, perhaps only in response to the AAPL decline, I’ve seen three worries circulating about the company, namely:
–Phone companies in the US want to reduce iPhone subsidies. (Who wouldn’t. The carriers pay AAPL $600 or so for phones that they resell for $200.) There’s talk that ATT and Verizon want to charge $230 instead. It’s not clear that the carriers will be successful. But if they are, higher prices might clip a couple of percentage points off the growth of AAPL’s most important business (half the company’s profits). But if that means 22% growth instead of 25%, that’s not such a big deal.
–Mac sales may be slowing. One analyst is reportedly suggesting that AAPL computer sales may have been down year on year in the March quarter. That wouldn’t be good, either. But, realistically, Macs are too small to matter that much to AAPL’s business. And although tere are good industry data for slow-growth markets like the US and the EU, I don’t think there’s any good way to gauge Asian sales.
–iPad sales may be slowing. This would be a more serious issue, since tablets are 20% of AAPL’s sales–and thought of as the company’s next hot product after smartphones. I’m not sure what evidence there is, however.
my take
I’m reading the downward AAPL price move over the past week or so as a natural reaction by market participants with short time horizons–taking profits in a stock that has performed so well in both relative an absolute terms. The really noteworthy thing is that the reaction took this long.
It’s possible that the worries I’ve seen surface in the past couple of days are justified, but my initial reaction is that the declines prompted the rumors–not the other way around. We’ll know for sure when AAPL reports earnings in a couple of weeks.
What impresses me most about AAPL is its valuation. On consensus estimates, the stock is trading at under 14x fiscal 2012 earnings and yielding around 2.5%. If those are anywhere near correct, there’s nothing “wrong” with AAPL other than that no stock goes up each and every day.
Current weakness may well be the trigger for AAPL holders to give their position sizes a sanity check. That alone may prompt further selling as long-time holders give more thought to exactly how much AAPL they hold.
