Monthly Archives: December 2012

thinking beyond the fiscal cliff

December 10, 2012 By in Current Market Thoughts, economics, Portfolio management, Stock ideas, Strategy Tags: , , , , , , , , Leave a comment

the fiscal cliff

The current political debate over the impending fiscal cliff has a certain, almost hypnotic, attraction.

It’s great theater.

Ben Bernanke has added to the drama by making it clear that, in the Federal Reserve’s view, the stakes are high:  without taking action to mitigate the sharp fiscal contraction pencilled in by Washington to begin on January 1st, a six-to nine-month recession will ensue, one million+ more workers will lose their jobs, and the return to economic normal for the US will be pushed back by two years to 2018.

(Personally, I think the economic positions of both parties are rooted in a bygone era and don’t address the realities of the world of even a quarter-century ago, let alone today.  And we US citizens have so far followed the lead of Japan of reelecting the same intellectually threadbare patronage politicians who happily got us into this mess.   But the scary Japan parallels are a story for another day.)

Let’s get practical instead.

Looking at today’s stock market situation, either we’ll go over the fiscal cliff or we won’t.  Assuming we don’t–which is my base case–what conclusions can we draw about how 2013 will likely play out?

implications for the US economy in 2013

I think there are two main ones:

1.  Businesses, which have been preparing for the worst for some time now, will breathe a sigh of relief and loosen the purse strings a bit.  This will mean somewhat higher capital spending and a return to hiring at a somewhat higher rate.  I think the former is unambiguous good news for tech and telecom companies.  The latter is less clear-cut.

Let’s say that industry in the US begins to hire 25,000 more workers per month, starting in January.  That means 300,000 more people with jobs next year.  And because we’re already hiring at a rate that absorbs new entrants into the workforce, additional hiring should cut into the large number of long-term unemployed.  That’s a good thing.   On the other hand, an extra 300,000 workers won’t make a noticeable difference in aggregate spending in a workforce of 150 million+.  It amounts to a 0.2% gain.

2.  On the surface, consumer spending seems to have been almost completely unaffected by worries about the fiscal cliff.  Black Friday and Cyber Monday set spending records, after all.

Two other plusses:  the price of houses–the single largest source of wealth for most US families–is trending upward for the first time in half a decade.  And the price of oil is headed down.  Both developments should add to holiday cheer.

One might interpret robust holiday spending as a last hurrah before the start of adjustment to lower after-tax incomes.  I tend to think, with no hard evidence–only anecdotes, that the adjustment to lower incomes has already begun.  Tiffany, for example, has recently seen an unexpected dropoff in sales to US customers–concentrated in less affluent “aspirational” buyers.  Fast food restaurants like McDonald’s and casual dining like Darden have seen US customer slowdowns, too.  This season’s ratings for traditional TV shows are also off–a lot.

If I’m right in assuming that at least part of the payroll tax is re-instituted for next year and that  overall pretax consumer income will be at best flat because of this, then substitution of lower-priced alternatives for more expensive goods–like the ones cited in the past paragraph–will come into full flower.  This will be doubly true as/when consumers figure out that the fiscal cliff discussions are all about the glide path to lower household incomes, not about a remedy for the fact of lower incomes.

Substitution can take many forms.  There may be crosscurrents as well.  All of this is hard to predict.  In general the consumer mindset I’m envisioning–and which I think is already emerging now–will accelerate the pace of technological change.  Maybe the decline in readership of traditional newspapers goes into a higher gear.  Maybe an increasing number of people unplug from cable.  The key thing, in my mind, is to be alert for such changes and to react to them quickly.

stock market implications

1.  Half the earnings of US-listed companies come from outside the US.  With emerging economies, especially China, beginning to perk up, it seems to me investors should tilt their actively managed holdings toward firms with large Pacific and/or Latin American exposure.

2.  Look downmarket, away from luxury goods, for US consumer exposure.

3.  Look for beneficiaries of technological change. They’re typically more resistant to economic headwinds than other businesses.  They may also provide lower-cost alternatives to traditional goods/services, which may find much faster than normal acceptance in slow-growth times.

 

More about this in my 2013 strategy.

the November 2012 Employment Situation Report

December 7, 2012 By in economics, employment, Employment Situation report, Strategy Tags: , , , , , , Leave a comment

the report

As usual, at 8:30am Eastern time, the Bureau of Labor Statistics of the Labor Department issued its monthly Employment Situation report.  Economists had been expecting a gain of around +80,000 new jobs, arguing that the negative effects of Hurricane Sandy would depress job creation in the Northeast.  The actual figure came in at +146,000, consisting of +147,000 additions in the private sector and a loss of -1,000 jobs by state and local governments.

As I’m writing this, S&P futures have swung from a loss of about 2 points to a gain of 4.

the revisions

If you recall, last month’s ES was somewhat controversial.  Total job gains for October were reported as a whopping +171,000 (+184,000 private, -13,000 government).  September figures were revised up by +28,000, as well.  Some Republicans claimed that the Labor Department was succumbing to administration pressure to inflate the figures in order to influence the election.  I can imagine politicians from either party contemplating trying to influence the figures, but I can’t imagine that any attempt could be kept secret for more than a nanosecond.

In any event, the initially reported October figures were revised down, to +138,000.  The private sector hires were revised up, however, to +189,000 new jobs.  The entire revision came from reported government layoffs of -51,000.  Hmm.

September figures were also revised down from +148,000 (+128,000, +20,000) to +132,000 (+122,000, +10,000).

For September + October revisions totalled -49,000 (-1,000, -48,000).

State and regional jobs numbers come out on December 21st.  They might be worth taking a look at.

my take

The November job additions are good news.

I’m not sure where the +80,000 consensus estimate came from.  In each of the past several months the economy has been adding about +150,000 new jobs.  The areas worst affected by Sandy, the Northeast, represent a little more than 10% of the population of the US.  If you argue the effect of the hurricane was to completely eliminate job creation in the Northeast, and gross up the estimate by 10%, the result is +88,000 jobs.  That would be not much more than half the recent job growth trend.  Adding another, say, +8,000 to account for storm-related job disruption elsewhere doesn’t change the picture much at all.  So it seems to me there’s something wrong with the estimates–not that I’ve taken the time to peruse any of the particulars.

The Labor Department says that “Hurricane Sandy did not substantively impact” the November figures.  If my back of the envelope calculation in the paragraph above is even remotely near the mark, the storm shouldn’t have.  Maybe ex Sandy the job additions would have been +10,000-+15,000 higher.

The biggest gains for the month came in retail, with +52,600.  The ES figures are seasonally adjusted, so this means holiday hiring is pretty robust this year.  Construction (-20,000) and Manufacturing (-7,000) lost jobs.  These numbers fit pretty well with the sense I’m getting from company reporting that consumers are oblivious to the impending fiscal cliff, while businesses are much more cautious.

All in all, I think the current ES is as encouraging as bulls could hope for.

Intel (INTC)’s $6 billion bond offering

December 6, 2012 By in Dividends, double taxation, Stock ideas Tags: , , , , , , , , Leave a comment

INTC has just filed a prospectus with the SEC for a proposed $6 billion bond offering.  The securities it intends to sell are as follows:

Title of Each Class of
Securities To Be Registered		 Amount To Be
Registered		 Proposed Maximum
Offering Price
Per Unit		 Proposed Maximum
Aggregate
Offering Price
1.350% Notes due 2017 $3,000,000,000 99.894% $2,996,820,000
2.700% Notes due 2022 $1,500,000,000 99.573% $1,493,595,000
4.000% Notes due 2032 $750,000,000 99.115% $743,362,500
4.250% Notes due 2042 $750,000,000 99.747% $748,102,500

Several aspects of this offering are interesting:

1.  INTC says it will use the proceeds for general corporate purposes (this is the boilerplate answer to the use question) and to buy back stock.

The dividend yield on INTC shares at a price of $20 each is 4.5%.  Total interest expense for the offering, ignoring accretion of discount, will likely be $142.875 million, meaning INTC is paying a blended interest rate of 2.38% for the money it will receive.

Unlike dividends, interest payments are a deductible expense for income tax.  After tax, the interest rate is 1.55%.  So for every share of stock INTC buys it will pay out $.31 in annual interest but save $.90 in dividend payments.  So the issue makes INTC’s cash flow go up. A $1 billion buyback at current stock prices would add about $30 million to annual cash flow.

2.  Why an offering now?

A short while ago, INTC boosted its quarterly per share payout to $.225, even though the company knew its new product spending would remain very high through this year.  Companies typically don’t raise the dividend based on future earnings potential;  they do so based on the idea that they have plenty of extra cash, come what may.  In other words, INTC thought it had lots of money to spare.

What’s changed?

–for one thing, the stock price is a lot lower than I would have expected, and the dividend yield is very high.  The chance to buy INTC assets for less than management thinks they’re worth + being paid through dividend savings to do so, the opportunity may have been too good to pass up.  I think this is the main reason for the fundraising.

–INTC’s operations generated over $5 billion in cash during a (relatively weak) 3Q12 alone.  The company also has about $11 billion in cash and short-term investments on the balance sheet.  So why borrow?   …presumably because the bulk of that money is located outside the US.

3.  My initial reaction on seeing the announcement was that problems had developed with planned cash flow in the US.  I don’t think that’s correct, though.  The US has been weak for a while.  It’s emerging markets that have been surprisingly bad for INTC recently.  And those profits presumably remain overseas.

In other words, I don’t think the offering comes as a result of adverse internal cash flow developments.

4.  INTC may be figuring that current low rates won’t last very long.  To me it’s striking that the company is raising 20-year and 30-year money.  Why else do that today?

my conclusion:  I’ve written about confirmation bias recently, partly with INTC in mind.  If I’m suffering from it, INTC’s board is, too.  In any event, the company’s indicated intention to buy back a significant amount of its shares appears to be what’s behind the stock’s current strength.  My guess is that this strength will continue for a while more.

 

Macau gambling crackdown?

December 5, 2012 By in Asian economic development, capital flight/brain drain, Casinos, China, economics, Entertainment, Hong Kong, Industry Analysis, Recent Market Action, Stock ideas Tags: , , , , , , , , , , Leave a comment

The Financial Times, among others, ran stories yesterday attributing the sharp, across the board fall in Macau casino shares in Hong Kong Tuesday to the detention by Chinese authorities of several junket operators who organize groups of high roller gamblers travelling from the mainland to the SAR to gamble.  Government inquiries have apparently also been made to the casinos themselves for information about the structure and betting behavior of some junkets.

To my mind, it’s not yet clear what’s going on.  The possible government concerns, as I see them, might be:

–displays of affluence in a socialist economy.  This has never bothered Beijing before, so I doubt this is the issue now, other than as a formalistic expression of official disapproval.

–possibly illegal flow of foreign exchange out of China.  This is a perennial problem for any country with foreign exchange controls.  The time-honored method of moving funds abroad, however, is through corporate transfer pricing.  But there’s no evidence of a wider crackdown, so I don’t think this is the issue, either.

–money laundering.  This was a notorious problem while Macau was a Portuguese colony, and while the former casino incombent had a monopoly on legal gambling.  Money of dubious origin enters the casino and leaves as legal, taxable gambling winnings–with the casino serving much the same function that urban parking lots sometimes serve on a smaller scale.

This is a serious issue.  In my view, eliminating criminal influence in the Macau casino industry is the prime reason the Macau SAR granted gambling concessions to Wynn Resorts and Galaxy Entertainment.  I’d be surprised and disappointed if Galaxy, Sands or Wynn were involved in money laundering.  Authorities have apparently contacted all three for information, however.

–defining political have-nots.  It seems that a lot, if not all, of the regulatory attention has been focused on associates of the disgraced former head of Chongqing, Bo Xilai, whom Beijing regarded as a threat to the stability of the Communist Party.

my take:  my guess is that what’s going on is some combination of #3 and #4 and that any investigation will end up having little negative impact, if any, on Wynn Macau, Sands China or Galaxy.  But I have no hard facts to base this view on.  So my reaction is to trim my positions–the Hong Kong stocks have been very strong performers recently–and wait for further clarification.

confirmation bias

December 4, 2012 By in confirmation bias, Constructing a Portfolio, Portfolio management, Trading Tags: , , , 2 Comments

what it is

Confirmation bias is the idea that you analyze something, form an opinion—and then spend the rest of your time searching for data that support your initial conclusion.  Anything that doesn’t confirm your opinion, you simply ignore or attribute little significance to.

To some extent, everyone does this. And in many situations in life, you can argue that everyone should. What if Michael Jordan had accepted the fact he wasn’t good enough to play high school basketball?

But it’s one of the worst faults an equity investor can have.

I can see three reasons it’s so bad:

–it takes a long time to become thoroughly acquainted with a company you invest in. My experience is that it takes at least a year of watching management at work—and maybe a lot longer–to figure out whether they’re any good at running a company and whether their strategy makes any sense.

In practical terms, almost no one is going to wait twelve months after getting an idea before taking a position. This is especially true if the stock price is already starting to move up as more people discover the company’s possible profit potential.  So professionals always make provisional “buy” decisions.

For a considerable portion of a stock’s life in a professional’s portfolio, then, it’s more or less on probation, subject to being kicked to the curb if a deeper inspection of the company proves the initial impression to be wrong.

That never happens if the investor spends no time looking for leaks in the boat, or refuses to acknowledge they’re there as the vessel beings to list.

–the world changes. Markets become saturated. New competitors emerge. Old competitors improve their game. The business cycle advances from recession to recovery to expansion—and then back to recession.

In addition, stock prices change, both in absolute terms and for one industry group vs. another. …one stock vs. another within the same industry, too.

–companies change. Managements become more—or less—responsive to alterations in the competitive environment. Great companies reinvent themselves as the environment changes; merely good ones often don’t.

APPL, for example, was a failing personal computer hardware company. Then it became the iPod company. Then it became the iPhone company…

NOK was once an obscure, failing Finnish conglomerate. Then it was the world’s leading cellphone firm. Now it’s a mess…

where the problem arises

It’s unusual to see a working professional suffering from terminal confirmation bias. Normally, anyone infected is quickly fired. In places where office politics counts for a lot they may be kicked upstairs—not a great move for the organization’s long-term health. But it solves the short-term problem.

For private individuals, I think this phenomenon surfaces mostly as lack of awareness of how smart the market is—a naïve belief that after a brief perusal they understand more about a company than the people they’re trading with.

Professionals face a different issue. Your analysis says the stock should be going up. It’s going down instead. When do you concede that the market knows more than you—either about the company, the environment or the stock valuation?  No one wants to be scared out of a stock by adverse price action.  On the other hand, no one wants to be caught looking only for information that supports his position, either.

what to do?

Many professionals use mechanical rules.  For example, if a stock underperforms the index by, say, 15% (or some other fixed number), at least part of the position is sold–maybe the whole thing.

Others. like me, don’t like fixed rules and depend on aggressively seeking out negative information about the positions they own, instead.

In well-run organizations, the Chief Investment Officer plays a role here, creating an atmosphere where portfolio managers feel able to sell losers, as well as limiting the size of iffy holdings where he/she sees the question of what to do with an underperformer is likely to arise.

individuals in this situation?

Thinking about a 15% rule before buying anything would be my advice.