stocks vs. cash

At present, cash yields zero.  Investors who hold cash receive safeguarding of their deposits but no financial return.

Stocks carry no guarantees against loss.  At present, the S&P 500 yields about 2%.  One might reasonably estimate that yearly capital gains will average, say, 6% over longer periods of time.

A guaranteed zero vs. a possible +8% per year.  To my mind, not exactly a compelling case for cash.

In theory, and in practice during the 1970s- 1980s, investors have shifted large amounts of money from stocks to cash when the returns on cash have been high enough.

Hence, the thought-experiment question:  how high would short-term interest rates have to be to trigger serious reallocation away from stocks in favor of cash?

My answer:  I don’t know for sure.

In my experience, during periods of much higher interest rates than are the norm today, when short rates would get above half of the expected return (of about +10% per year) on stocks, then money would begin to shift away from equities.  That flow would accelerate–causing stocks to begin to stall–if short rates got to 60% of the expected return on stocks.


My conclusion is that short rates would have to get well above 3% in today’s world before reallocation becomes a worry.

If so, a rising Fed Funds rate is something to keep an eye on but not a serious current threat to stocks, in my view.

demographics and interest rates

In an op-ed column in Financial Times yesterday, Gavyn Davies wrote about the effect of demographics on interest rates.  His conclusion seems to be that demographics–not cyclical factors–may be the entire story behind why interest rates can remain so low without sparking an increase in business investment.

The demographic argument has three aspects:

–the slowdown in growth of the working population means that companies need to spend less on productivity-enhancing machinery.  This means lower issuance (supply) of corporate debt finance, therefore less upward pressure on rates.  I’m not sure I buy this, but one might equally argue that the price of tech machinery always falls and arrive in a way I find more plausible at the same conclusion

–life expectancy is increasing.  Therefore workers have to save more to support themselves after they retire, thus increasing demand for bonds

–a large proportion of the population is working, meaning the number of savers is high  …and workers save more than non-workers.  This percentage will gradually decrease as the Baby Boom retires.  But for now the population is in prime saving mode.  This, again, means high demand for bonds.

According to a Federal Reserve research paper Davies cites, demographics explains basically all the downward pressure on rates since 1980.

My reaction?

I think that we’re now truly at a point of inflection with interest rates.  I’m torn between two lines of reasoning in support of that conclusion, however.

The demographic argument is effectively that the current regime of extraordinary efforts to keep interest rates low is doing more harm than good.  It hurts savers, compelling them to accept lower returns for their savings than they would get otherwise, while having no positive effect on corporate borrowers.  If anything, the current stance of world monetary authorities mere fuels speculative financial markets activity.  Therefore, extraordinary money stimulus should be removed.

On the other hand, as they say, the market doesn’t bottom until the last bull capitulates.  In the current situation, this translates into:  the economy doesn’t begin to grow more vigorously until the last growth advocate begins to despair that the turn will never come.   That demographic explanation, i.e. abandoning the conventional business-cycle view, can be seen as evidence of that despair.


I don’t expect that rates will rise quickly or that they’ll rise very much–another aspect of the demographic argument that the conventional view of the “normal” level of rates has them pegged much too high.

Initiating the process in a systematic way will, however, gradually dispel the anticipatory anxiety about rate rises currently in financial markets.  That should, if nothing else, make for smoother sailing.




1Qfiscal17 earnings for Microsoft(MSFT)

MSFT reported a strong 1Q17 after the close last night.

Revenue was up +3% (non-GAAP) year on year.  Operating income was flat, on the same basis, and net up +6%.  EPS was up by +9%, at $.76, exceeding the high end of the expectations of the thirty-odd professional sell side analysts who follow the company.

Growth businesses, like the cloud or the Surface line of laptop/tablet hybrids, were up strongly.  Legacy businesses held their own.  Guidance is for a flattish 2Q17.


In many ways, the MSFT report is similar to the Intel (INTC) results from the night before.  Guidance for both companies appeared roughly the same, as well–more or less flat quarter on quarter performance, during a period that’s typically seasonally strong.

The reaction in the press and in the stock price for MSFT, however, was strongly positive.  The stock was up by 4%+ when the results were made public   …and by more than that after the conference call.  As I’m writing this on Friday afternoon, MSFT is holding onto almost all of its after-hours gain during a down day on Wall Street.

INTC, in contrast, fell at all three waypoints–announcement, conference call, next-day trading.


Part of the contrast in stock performance has to do with the differing nature of the two companies’ businesses, hardware vs. software.  Part is a function of the greater speed at which MSFT has been able to demonstrate that it is turning itself around.


On the other hand, I find it noteworthy that there should be a 10% relative performance difference in two days between the two behemoths who were once the constituents of the former Wintel alliance–and on bottom lines that, if we removed the company names, don’t look all that different.

The rest, of course, must represent two different sets of expectations.  I hold both stocks, which I’ve been studying for over a quarter century (and which I find a little scary).  My expectations aren’t that different.

I’m not simply grousing about being wrong aobut INTC.  I think of investing in the stock market as somewhat like playing a game whose rules each player has to figure out as play progresses.  I’ve often likened the difference between investing in, say, the UK or Japan vs. the US as like that between playing checkers or Sorry and playing chess.

I have a hunch that in reports like these we’re seeing evidence of a change in how the stock market game will be played in the US in the future.  If so, it will be important to catch on to the new state of things as soon as possible.


firming oil prices: seasonal strength or something more?

September through mid-January is the period of greatest seasonal strength in oil prices.  Early in this period, refineries shift from making gasoline to supply drivers to manufacturing heating oil in advance of winter in the northern hemisphere.  There’s normally some friction in the supply chain as this takes place.  But the key reason for current oil price strength, I think, is the typical behavior of wholesalers, retailers and end users accumulating supplies of heating oil for winter use as autumn commences.

This period of strength usually ends in late January–after which there’s be no time to get newly-refined heating fuel to users before the weather warms.

What follows from February through April is the period of greatest seasonal weakness for oil.


What to make of current firmness in crude.  Is there any evidence that the proposed OPEC production limiting agreement is exerting upward pressure on the price?

My private hunch is that, yes, there is.  At the same time, I also think there will be little lasting (meaning over six months or a year) collective discipline to keep to promised quotas once they’re seen to be having an effect.  Budget deficits are too large and the third world us-against-them cohesiveness that enabled OPEC’s remarkable past cartel success is no longer present.


Still, I think that prices will be strong seasonally for a while in any event, so there’s no need to have a view on whether a production agreement will stick.  That time will come early in the new year.

At that point, for 2017 investment success, having a (correct) opinion about oil will be crucial, I think.  I’m hoping–and anticipating–that I’ll be able to make that decision on other grounds, i.e., the innate cheapness (or not) of shale-related exploration stocks, even without price increases.  In the meantime, I’m content to be on the sidelines.


3Q16 earnings for Intel (INTC): implications

Last night after the close, INTC reported 3Q16 earnings results.

The number were good.  INTC’s growth businesses grew; its legacy arms showed unusual pep.  The latter development had been flagged by INTC during the quarter when the company announced wholesale customers were increasing their chip inventories. Nevertheless, earnings per share of $.80 exceeded the average of 29 Wall Street analysts by $.07–and surpassed even the highest street estimate by a penny.

Despite this, the stock fell by about 3% as soon as the earnings release was made public.  Traders clipped another 2% off the share price on the earnings conference call.  During trading today, the stock initially fell almost another 2%, before rallying a bit to close just below its worst aftermarket level.

There was some bad news in the report.  It will cost INTC more than anticipated to rid itself of McAfee.  It also looks like chip customers are no longer so eager to build inventory.  Instead, thus far in the fourth quarter they seem to be subtracting some of the extra they added during 3Q.   The result of this is that INTC thinks 4Q–usually the strongest period of the year seasonally–will only be flat with the robust performance of 3Q16.


I find the selling to be unusually harsh (be aware:  I own INTC shares).  After all, if INTC had earned the $.73/share the market had expected, a forecast of $.76 wouldn’t look all that bad.  That outcome, which appears to be the company’s current guidance, would also be better than the analyst consensus had been predicting for 4Q last week.

I’m not trying to argue that the stock should have gone up on this report.  I just don’t see enough bad–or, better said, enough unforeseeably bad–news to warrant a selloff of this magnitude in a gently rising market.

I attribute the aftermarket selloff to some combination of computer trading and thin volumes.  What surprises me is that there were no significant buyers once regular trading–overseen, presumably, by senior human investors–began.

Because of this, I think that trading in INTC over the next days is well worth watching to see if/when buyers reenter the market.  We may be able to draw conclusions that reach wider than INTC itself.

“The Dying Business of Picking Stocks”

That’s the title of an interesting article in today’s Wall Street Journal on the accelerating replacement of active investing with indexing in portfolios of all stripes in the US.

One important factor in the lagging performance of most active investment groups is being left out, however.  It’s the one no active investment organization wants to talk about.

Beginning in the 1980s and increasing in momentum in the 1990s, active investment groups began to dismantle their in-house investment research departments.

Why do this?

In my view it’s because,

–research departments are expensive.  They’re hard to run well.  Evaluating securities analysts over short periods of time, like a year, is as much an art as a science.  Because of its pain-in-the-neck character, a less tha nstellar research effort is very easy to regard as an unneeded expense rather than a valuable asset

–most money management organizations are run by the chief marketing person, with the head portfolio manager being the Chief Investment Officer.  So the ultimate decision maker on firm-wide administrative matters is typically not an expert on what it takes to have sustainably good investment performance

–in the 1980s and 1990s brokerage firms built and maintained strong research departments, whose output they offered to money management clients in return for charging a higher commission rate for trades.  So reliable–although not proprietary–third party research was available to money managers without their having to pay for it from management fees.  This added to the view that good in-house research was unnecessary

–eliminating in-house research would mean salaries “saved” that could be used to boost compensation for the professionals who remained (including the CEO and CIO, of course).


Not every firm used all the reasons on this list, but many found some combination of them persuasive enough that they decided to substantially reduce, or eliminate their independent research entirely.

This, of course, made these firms radically dependent on brokerage research…

…which has proved a disaster when, in their dark days immediately after the stock market collapse of 2008-09, most brokerage houses laid off virtually all their experienced researchers and pared back their for-commission research efforts to the bone.

This left money managers who had eliminate their own research high and dry.  It also meant the affected firms were faced with the prospect of rebuilding their own in-house research.  Because this would involve a substantial expansion of the professional staff, the resulting expense would pressure income for–I think–at least a couple of years.


I haven’t followed this issue carefully.  My experience, though, is that this is the kind of decision CEOs really don’t want to make–to admit they were wrong, and badly enough that fixing their mistake will retard or eliminate future profit growth.  As a result, a kind of paralysis sets in and the process of fixing the error never begins.



Calpers: one pension, two sets of books

For some time, the Los Angeles Times has been running articles aleerting readers to the troubles that California’s famous Calpers retirement system is having.  In a nutshell, the assets Calpers has on hand to meet future municipal employee pension benefits fall far short of what it will likely need.

The New York Times chimed in last week with a story about the troubles that individual cities, worried about their future and seeking to extract themselves from Calpers, are experiencing.

There are two parts to the latter:

–the “official” Calpers books give a relatively rosy picture of the current situation for each municipality.  They do this essentially by assuming the pension plan will eventually grow itself out of the problem.  The issue here is that their actuarial assumptions have lnot been adjusted down enough to account for today’s low-inflation, near-zero interest rate world.  In a sense, that pie-in-the-sky attitude would be ok with cities that want to leave Calpers   …except that Calpers presents potential leavers with a far different–and much higher–bill to bring their accounts up to full funding so they can depart.

–The Stanford Institute for Economic Policy Research has developed a Pension Tracker website where Californians in many areas can quickly look up how deeply in the hole their cities are.

Irwindale, a small town in the San Gabriel Valley of Los Angeles County, has the dubious honor of being #1 on the Stanford list of most exposed to pension shortfalls.  Irwindale’s Calpers account is short by $134, 907 per household of having its municipal pension funded.  Irwindale has other woes–Huy Fong Srirscha, for example.  But with the Stanford pension info a mouse click away, who is likely to move to Irwindale?    …or to other cities high on the unfunded list?

Worse than that, I’d certainly be thinking of moving elsewhere.


California may be the most high profile instance of municipal pension underfunding, but it’s certainly not the only one.