Monthly Archives: August 2014

taking a “barbell” approach

August 8, 2014 By in barbell Tags: , , , Leave a comment

creating a barbell

This is a metaphor that investors and their advisers use to describe the following strategy:

–sort the things you’re going to invest in  from, say, left to right in order of riskiness

–put the least risky on the extreme left, the most risky on the extreme right and fill in the rest in risk order

–if you were indexing, you’d have some of everything and your holdings would look kind of like a solid line along your riskiness scale.  Don’t do that.  Take a bunch of money from the center and put, say, half of it in the least risky assets and the other half in the most risky.

Now your portfolio looks like a barbell.

a persuasive–though bad–metaphor

The idea sounds good.  The picture of being a weightlifter instead of a wimp is appealing.  It also has tones of stability, familiarity and prudence.

why it’s a bad image

In general, the biggest problem with creating a barbell isn’t the idea itself, but the way risk is defined.  The metric that’s commonly used is day-to-day price variability.  Why?  …because that’s what finance professors use.  As far as I can see, the only thing short-term volatility has going for it is that the data are readily available.  But investors like you and me will find it hard to swallow that stocks that have wide daily trading ranges but are up 25% at the end of the year are somehow worse than stocks that seldom fluctuate in price and end the year 15% (or less) higher.

In particular, for today’s circumstances the issue is that models alike this almost always end up with bonds on the far left and emerging market stocks on the far right.  I’m not sure I’d get much sleep at night if I were loaded up with a barbell of Treasury bonds and frontier market stocks right now.  Symmetrical, yes, as safe as an index, probably not.

an S&P barbell forming?

What makes me write about this today is that during the current stock market turbulence, I’m noticing distinct barbelling in my own stock portfolio.

I own ZEN and SCTY, for example, not stocks I would recommend to anyone else.  I also continue to watch TSLA, although I no longer own it.  All three are pretty far to the right on the risk spectrum.  But all three are doing fine.

On the other hand, I’ve recently been looking for low PE industrial stocks.  I don’t care so much about dividend yield; I just want low relative and absolute PEs–relative meaning vs. both the market and the stock’s own history.  The couple I own (I’m still doing my homework, so no names) doing fine, too.

So it appears to me the stock market is now doing its own form of barbelling.

My conclusion, however, is not that stock market participants are stretching for extra risk and offsetting it with ultra-conservative names.  I think investors just want to get away from the center, at least for the moment, because they think it’s overvalued.

 

internet pricing

August 7, 2014 By in Industry Analysis, internet, Retail Tags: , , , , , , Leave a comment

Just thinking out loud…

Years ago, I was looking at a chain of convenience stores that had free-standing urban outlets as well as suburban/rural ones linked to gasoline stations.  The chain was beginning to implement variable, or dynamic, pricing.  It had installed electronic price signs on its shelves and had a wireless system it could use to change prices from one time to another during the day–either item by item or store by store, or across the entire chain.  The idea was to sell a carton of milk for $2 at noon  $3 at 7 pm and $4 a midnight.

As it turned out, the system never got off the ground.  There were technical legal issues, like whether you could use an electronic sign or whether a price had to be marked on each item.  But the main thing was that customers were outraged by the whole scheme.  They thought it was an incredible ripoff and stopped patronizing the chain.  Chagrined management apologized and shut the whole variable pricing effort down.

My guess is the same thing would happen today.

On the other hand, we all kind of know and accept that airplane seats and hotel rooms have been variable priced for years.  Hotels in college towns may triple room rates on graduation weekend.  Airlines raise their prices around traditional travelling high points.  Both routinely raise prices as the day its space will be used, based on computer analysis of demand and space availability.

No one minds.  In fact, through membership in rewards programs and with affinity credit cards, we flood hotel and airline companies with information about ourselves and our buying habits!

Then there’s e-commerce, ex travel.

For most publicly traded consumer companies this is not a big profit issue yet.  But it will be soon.  And for companies like Staples it already is.

We (sort of) know that websites practice variable intraday pricing.  We know that people in different zip codes get offered different prices, and that the distance to the nearest brick-and-mortar store that likely carries the item counts, too.  We know that if I’m thought to be a potential good customer, I’ll get different prices than if I’m perceived as not worth having.  We know that after browsing and returning to a site, the price we get may depend on whether we’ve closed/reopened our browser or not.  We also know that retailers don’t want to call attention to how much information they have about customers for fear of frightening them away.  (That said, I’ve recently noticed that if I leave an item unbought in a shopping basket, it follows me around in a semi-creepy way in subsequent browsing.)

Two potentially important things we don’t know:

–how much extra profit dynamic pricing brings internet retailers.  I have no idea.  If there were some way to make a small bet with a large payoff, I’d say that for a Wal-Mart or a Staples, it amounts to 5% -10% of internet revenue and 10%  – 20% of internet operating profit.

–when people become more familiar with what’s happening, will they react like the customers of my convenience store chain above, or like frequent fliers/stayers?  My guess is that it will be more the firmer than the latter.

Investment implications?   Two, I think:  for mixed bricks-and-mortar plus internet retailers, the internet business will be surprisingly strong; if I’m correct that consumers will see dynamic pricing as an abuse of trust, the negative reaction could be severs as/when its use is make evident (other than a huge journalistic investigation, I don’t see how).

 

 

 

 

the July 2014 Employment Situation

August 6, 2014 By in employment, Employment Situation report Tags: , , , , , , Leave a comment

Last Friday, the Bureau of Labor Statistics of the Labor Department released its monthly Employment Situation report for July.   Total Employment gains for the month came in at +209,000 new positions, of which +198,000 were private sector job gains and +11,000 in government.

As media commentators immediately pointed out, the US has now had the longest string of +200,000 job gain months in almost two decades.  True, the figure came in below the economists’ consensus of +230,000 new positions, but no one seemed to care.  After all, the number was good,–nd it’s the result of subtracting the 3-4 million people who leave their jobs every month from the 3-4 million who take up new ones.  So a difference of 20,000 jobs is an error of 0.5% in either of the two numbers.  The BLS itself says that differences of less than 100,000 aren’t significant.

Revisions to prior months’ data were also positive.  The May figures were revised up by +5,000 to +229,000′ the June tally was boosted by +10,000 to +298,000.

The unemployment rate went up by 0.1% to 6.2%.  But that’s also a good thing.  The unemployment figures are highly politicized.  When unemployed workers become so discouraged that they figure looking for a job is futile and stop trying, they’re not classified as super-unemployed.  Instead, they’re erased from the figures.  All other things being equal, their reclassification makes the unemployment rate fall.  

When conditions improve, the reverse happens.  When people regain hope and start looking for work again, all other things being equal, the unemployment rate rises.  That’s what’s happening now.

What’s left to monitor in the ES?

…wage gains.

In developed economies, inflation is predominantly caused by rising wages.  Because of this, the timing of the Fed moving interest rates out up from intensive care levels and back to normal will be strongly influenced by signs of wage inflation.  So far, the ES shows overall wages rising at a 2.3% annual clip.  There continues to be upward pressure on IT compensation; the same is just beginning to emerge in the construction industry.

Again, this isn’t a bad thing.  In fact, the scarier idea would be that we’ve had the monetary taps wide open for six years without being able to get the economy to perk up to the point where there aren’t tons of unemployed.  What we’re seeing now is nothing more than the economy having a pulse again.

On the one hand, scattered wage gains give the Fed the go-ahead to start to raise short=term rates.  On the other, they’re telling the Fed not to rush.

evaluating stocks vs. bonds

August 5, 2014 By in bond market, securities markets, stock market, Strategy Tags: , , , , , 1 Comment

In theory, there’s no demand for stocks.  There’s also no demand for bonds.  There is, however, a demand for liquid forms of saving, a category that includes stocks, bonds and cash.

Each of us will choose a basket containing a somewhat different proportion of the three, depending on factors like age, wealth and risk tolerance.  But for all of us, a change in price of any of the three will probably persuade us to shift away from the more expensive investments and toward the now-cheaper one.

Given that the Fed has been signalling for some time that a rise in interest rates–meaning a change in the price of cash–is on tap for next year, the question of how this will affect the price of the other two, bonds and stocks, is probably the most important near-term investment issue for you and me.

One way of starting to look at this issue is to look at what the current price relationship between stocks and bonds is.  The typical way this is done is to compare the interest yield on Treasuries (either the 10-year or the 30-year) with the inverse of the PE on a market index like the S&P (academics call 1/PE the “earnings yield,” because it measures the portion of total profits that each share has a claim to, divided by the share price).

Over my investment career, Wall Street has taken stocks and bonds to be at roughly equivalent value when the interest yield = earnings yield.  (During the 1950s bonds traded at a considerable premium; during the Great Depression, dividend yields exceeded coupon payments on bonds.  But I don;t think either period is relevant today.)

As I’m writing this, the S&P 500 stands at about 1930.  EPS for the index in 2014 will probably come in at about $110.  Thus, the PE of the market on 2014 earnings is about 17.5x.  This means the earnings yield is 5.7%.

EPS for the S&P in 2015 will likely rise to $125+, implying a market PE of 15.4x and an earnings yield of 6.5%.

In other words, the S&P already seems to be discounting a 250 bp increase in the yield on the 30-year Treasury.  Arguably, this is more than the long bond yield is likely to rise in the coming normalization of interest rates by the Fed.

I don’t think this guarantees that stocks will have smooth sailing throughout the interest rise process.  But I do think it argues against the idea that stocks will either mirror the fall in bond prices–or simply collapse.  During the Great Recession and the subsequent recovery, equity investors badly underestimated the severity and the duration of the downturn.  As a result, Wall Street was always on guard against the possibility of imminent interest rate rises.  It never fully discounted the actual interest rate lows–something that will serve stocks well during the normalization process.

Two other points:

–this stock market behavior is not that unusual.  In past periods of Fed tightening, stocks have gone sideways to up.

–on my Current Market Tactics page, I wrote last month that I thought the market stall we’re in now is purely based on valuation and not on worries about rising interest rates.  If that were wrong, the first place to look for deterioration would be in income-oriented stocks, which are in effect quasi-bonds.