Sharp Corp (6753) and Abenomics

Abenomics in brief

Prime Minister Shinzo Abe’s well-known plan for reinvigorating the Japanese economy has three “arrows.”  The first two are large government deficit spending and ultra-loose money policy, which were designed to buy time for structural reform of Japanese industry.   The two have had toxic side effects:  they have mortgaged Japan’s future with lots of new government debt and, through the currency depreciation they engendered, have reduced national wealth by a third.

Regular readers will know that from the outset I’ve believed that Japanese corporations won’t restructure voluntarily and that the Tokyo government had no interest in forcing corporate leaders to do so.  In other words, Abenomics a very expensive farce, that had no chance to succeed.

the Sharp case

The latest case in point is Sharp, a heavily indebted chronic money-loser which is in the process of being nationalized by state-owned Innovation Corporate Network of Japan (ICNJ).  ICNJ is offering shareholders a total of $2.5 billion for their shares and the company a continuing supply of the opium of state support.

Hon Hai Precision, a Taiwanese company best known in the US as Apple supplier Foxconn, has bid twice that figure.  It has pledged to keep all Japanese employees and to transfer its management and manufacturing technology into Sharp.  As I’m writing this, news is breaking that Hon Hai is about to sweeten its offer by pledging to invest a minimum of $850 million in Sharp operations after acquiring it.

the board decision…

So, which will the board of Sharp choose:

–twice the money for shareholders plus an infusion of new technology and world-class manufacturing management?, or

–what’s behind the curtain marked ICNJ?

Although no final decision has been made, all the press leaks indicate that Sharp is going to choose ICNJ–and that the Tokyo government is encouraging the company to do so.

a wake-up call?

The Financial Times seems to believe that the Sharp case will prove to be the ah-ha moment that will cause foreign investors to understand that Mr. Abe never intended to fire the crucial third arrow of Abenomics.  It thinks an outflow of foreign capital will follow this realization.  For the sake of Japanese citizens who are bearing the burden of the first two arrows, I hope the FT is wrong.  My private reaction is to ask why it’s taking foreigners so long to smell the coffee.


Millennials as socially aware investors

I’ve been at least peripherally conscious of the Socially Responsible Investing (SRI) segment of the investment management business for a very long time.  The criteria for a company or security being “socially responsible” have primarily been negative–typically no “sin” stocks, namely, tobacco, alcohol, gambling or weapons.  Maybe no heavily polluting industries, as well.

It’s also been a niche business, with high costs and poor performance results.  I don’t get the results part.  I don’t understand why any portfolio manager would hold tobacco stocks, thereby lowering the cost of capital for a terrible business and enabling in the harm it causes.  Polluters, who will inevitably be caught, fined and disgraced, are a poor bet, too.  In my experience few PMs in the US hold these sorts of stocks (how the ones who do justify this remains a mystery to me), although lots in Europe do.  I have less trouble with the other three industry groups, but all are relatively small parts of the index.  Holding Faceboook, Google or Netflix would more than offset any loss of performance avoiding the sin stocks would cause.  So I’ve never understood why SRI investing results haven’t been better.  Could  SRI investors want underpeformance to validate their virtue?

According to the Institutional Investor, however, the SRI backwater is undergoing a transformation.  That’s because Millennials are showing themselves to be genuinely socially aware investors.  Yes, there are industries where they don’t want to put their money.  But they also appear to be much more knowledgeable about publicly traded companies than older investors (the Internet?  PSI?).   And they have a much greater desire to own companies that aim to solve social or environmental problems, rather than simply avoiding doing harm.

As I mentioned above, most thinking PMs are socially aware in their stock selection anyway.  It’s the right thing to do  …and it makes good business sense.  Just don’t tell a potential client, or he’ll conjure up the image of a performance-indifferent hippie, despite your conservative suit and tie.

My guess is the the first evidence of SRI-aware Millennials will not be in a flowering of SRI funds and ETFs.  Rather, we’ll see it in incrementally better performance of companies with highly ethical managements and in industries that target social good.  If SRI funds could post competitive investment performance, they may participate, too.


the Fed in 1994

Maybe there’s nothing in past Fed rate raising actions that’s strictly comparable to the situation today.  However, the period that’s most often cited as a possible model is the one from May 1994 through February 1995.  During that time the Fed raised rates by a total of +2.25% in four moves–May, August and November 1994 and February 1995.

the Fed in 1994-95

The Fed moves themselves, and the stock market responses, played out as follows:

–the Fed Funds rate remains constant at 3.75% throughout 1993, a period when the S&P 500 rises by 9%

——–from the market high on January 28, 1994 through May 13th     S&P falls by -10%

May 17, 1994, Fed raises the Fed Funds rate by 0.50% to 4.25%

——–S&P 500 rises by 4% from May 17 through August 16

August 16, 1994, Fed raises the Fed Funds rate, again by 0.50%, to 4.75%

——–S&P 500 is flat from August 16 through November 15

November 15, 1994, Fed raises Fed Funds rate by 0.75% to 5.50%

——–S&P 500 rises by 4% from November 15 through February 1, 1995

–February 1, 1995Fed raises the Fed Funds rate by 0.50% to 6.0%–and stops

——–S&P 500 rises by 29% through yearend 1995.

the pattern

aggressive rate increases every three months, totaling 225 basis points

the S&P 500 falls in ahead of the onset of rate moves, wobbles briefly as rates are raised, goes sideways/up until the next rate increase–and advances strongly once the Fed stops

relevance for today?

Entering 1994, real GDP in the US was growing at about a 5% annual rate (or about two percentage points above the maximum sustainable growth rate)–and accelerating.  So the Fed acted very quickly to slow the economy down.

We’ve got a very different problem today.  Growth is barely at trend.  Expansionary monetary policy has been exhausted, and has overstayed its welcome simply getting us to this point.  Washington has consistently failed to use fiscal policy to support GDP growth, and shows no signs of wanting to live up to its responsibilities.

The purpose of Fed Funds rate increases this time is to minimize economic distortions that happen when too much money is sloshing around in the system (think:  oil and gas junk bonds with no restrictive covenants), rather than to slow down runaway growth.

In 1994, the S&P sagged significantly in advance of the Fed’s initial move.  The index also stumbled slightly around the time of later rate increases.  But, apart from day-to-day wiggles, the index went sideways to up during the rate rising period.

Did the Fed design its rate behavior with an eye to keeping the stock market stable back then?  That’s not clear.  However, that certainly was what resulted from Fed action.  And avoiding stock market declines was clearly Allen Greenspan’s modus operandi in the Fed’s subsequent rate policy.

Today’s Fed has been quite explicit in its intention to avoid market turbulence that might occur were rates to rise too fast.  1994 shows us, I think, that it can accomplish that objective.  The Fed already seems to be signalling that its original plan to raise rates by 100 basis points this year is being revised downward.

That period also suggests that the major stock market adjustment comes very early in the process.  Arguably, that’s what the declines of August-September and November-January are all about.








Jim Paulsen: lower lows, but not by much

Jim Paulsen, equity strategist for Wells Capital Management, an arm of Wells Fargo, gave an interview on CNBC yesterday.  It’s well worth listening to.

His main points:

–the stock market decline we’ve seen since November is all about adjustment to lower future earnings growth prospects.  This is being caused by the resumption of “normal” growth as the bounceback from deep recession is completed.  Another aspect of the return to normal is the economic drag from gradual end to extraordinary monetary stimulus, at least in the US.

In Mr. Paulsen’s view, the S&P 500 can trade at 16x trailing earnings in this new environment, not the 19x it was at two months ago.

–we may have seen the lows for the year last Wednesday at midday (1812 on the S&P 500).  More likely, the market will revisit those lows in the near future.  It will break below 1800 on the S&P, creating a fear-filled selling climax.

–assuming, as he does, that the S&P will end the year flat, i.e. around the 2044 where it closed 2015, a buyer at yesterday’s close would have a 9% return (11% dividends) from holding the index by yearend.  A buyer at 1800 would have a compelling 14% (16%) return.  11% might be enough to attract buyers; 16% surely will be.

–2017 will be a stronger year for earnings growth than 2015, implying that the market will rise further as/when it begins to discount next year’s earnings growth.

–the current selloff will trigger a market leadership change.  The new stars will likely be industrials, small-caps and foreign stocks.

US wage growth and lower oil prices

For the past year or so, income for low-paid workers has been growing steadily at about a 4% annual rate, double the speed at which income has been expanding for workers in general.  In addition, it seems to me that low-income workers benefit the most, in percentage terms, from the fall in energy prices.

This is not to say that low-income workers are exactly feeling flush.  But in incremental terms, they’re becoming better off at greater speed than their high-income counterparts.

In addition, many of the firms patronized by the wealthy, especially luxury goods purveyors, are international concerns exposed to things like the ongoing shift in China’s spending away from Western goods to domestic, as well as the lower value in dollars of their foreign sales.

Both trends suggest a shift in Consumer Discretionary exposure away from large multinationals and toward smaller, US-focused firms that cater to the man in the street.  The trick, though, is to find companies where the benefit from higher sales is greater than the increase in the wage bill for lower-income employees.  TGT, anyone?

a change in market leadership?

Very often, when the stock market makes a significant low and begins to rebound, a change in market leadership also takes place.  A new group of individual stocks and sectors emerges as the strongest performers as the market rises, sometimes emerging from areas least expected by conventional wisdom.  At the same time, at least some of the prior market stars are left by the wayside.  In my experience, the left-behind phenomenon occurs much more frequently.

It isn’t 100% clear that the recent market decline has been significant enough to be one of these transformative moments, although the drop of around 15% in the S&P from its intraday high last November to (what we hope was) the intraday low on Wednesday is the largest fall we’ve seen in some years. Still, it doesn’t cost anything to observe and analyze stock price movements to try to uncover new trends.  And if there were one time we should be extra-sensitive to deviations from the prior norm, this would be it.

(Monthly performance records of the S&P 500 by sector going back for years can be found on my Keeping Score page.)

Has the market really bottomed?  The intraday plunge in New York trading on Wednesday, followed by sharp rises around the world on Thursday and more so far today is the typical bottoming/rebound pattern.  So my guess is Yes.  Typically, the market will repeat the pattern we saw in the S&P last August-September–that is, a rally for several weeks, followed by a return to the vicinity of the prior lows and then a stronger rebound.

Will Energy and Materials lead on the way up?  I find that hard to believe, but both sectors have been drubbed over the past year or more.

Will Healthcare and Consumer discretionary lag?  That wouldn’t be my first instinct, either.  But the important thing isn’t what I think, it’s what the performance numbers begin to say in the coming weeks.

Other possibilities?

My guess is that we’ll find more separation of companies on the Millennials vs. Baby Boomers theme.   We may also see a sharper distinction between companies born out of WWII and whose managements have resisted structural change vs. those firms, both old and new, who have embraced the internet, mobile and the cloud.  Small may begin to outperform large.



timing the stock market

In its simplest form, timing the stock market means trying to figure out when stocks are either very expensive or very cheap and acting on your conclusion by selling stocks at the high points, holding cash for a while and backing up the truck to buy them again when prices are at their lows.

Two problems with market timing:

–it’s risky.  Historically the bulk of the positive returns from owning stocks occur on about 10% of the days.  Missing them can be devastating.

–it’s difficult to do.  In fact, in almost thirty years in the business I’ve never met a successful market timer.  I’ve encounter lots of unsuccessful ones, though.

There are professionals who are good at calling market tops.  Some are good at calling bottoms.  But I don’t know anyone who can do both.  More typical is the portfolio manager who “helps” his clients by raising a ton of cash on his view that the market is toppy, is psychologically unable to admit his mistake as stocks continue to rise and whose successor gets the task of cleaning up the resulting performance mess.


I have no idea where the strong negative emotion driving stocks lower globally is coming from.  So I think it’s best to stay on the sidelines until the craziness burns itself out.

Still, I noticed a couple of things about yesterday’s trading that suggest a bottom may be approaching.

–the S&P 500 broke through support at 1865 or so at the open and in short order found itself at the next support level of around 1815 at lunchtime.  The market made an immediate reversal and closed right around (just below) the former support.

The next support below 1815 is at 1870 or so.  We’ll see in the next few days whether the S&P can either recover above 1865 or hold above 1815.

–some stocks that I don’t hold but which are on my screen went crazy yesterday.

SCTY fell by -12% in the morning but closed up by almost +9% for the day.  That’s a 20% intraday swing.

LC fell by -9% in the morning but closed up by +8% for the day.  That’s a +17% intraday swing.

Yes, these are speculative stocks.  And they’ve been pummeled during the market downdraft.  But wild intraday swings like this are most often found at market turning points.

What to do?

I’m starting to comb through my portfolio for stocks that have held up well during the downturn to date and thinking about switching them for more interesting stocks that have been slammed over the past couple of months.  I’m not doing anything yet.  And I’m in no way contemplating making basic changes in portfolio structure.  But there may be an opportunity developing to upgrade at reasonable prices.