Category Archives: securities markets

stocks vs. bonds when interest rates are rising

November 14, 2016 By in bond market, government economic policy, securities markets, stock market, Uncategorized Tags: , , , , Leave a comment

A regular reader asked what I think about REITs in a comment last Friday.  I thought I’d answer him here, starting in a more general way.

One of the safer conclusions we can draw from the US election results is that interest rates are going to be rising over the next couple of years.  Most likely this will happen at a more rapid rate than under the Washington gridlock scenario a Hillary victory would probably have perpetuated.

Two reasons:

–the US appears to be at or near full employment, as evidenced by recent wage gain acceleration, so rates would be rising to fend off future inflation in any event, and

–Republicans, who have been blocking Obama’s infrastructure spending proposals (for no good economic reason), are in favor of fiscal stimulus now that they will get the credit. This will remove some of the pressure the Fed is now under to compensate for congressional failure to do its part to restore economic stability.

 

What happens to stocks and bonds as rates go up?

cash

— a point of merely academic interest right now, but something to tuck away in the back of our minds, there could come a time when the returns on cash are high enough to draw money to it that would otherwise have gone to stocks and bonds.  I don’t know what that point might be, just that it’s a long time away.  The question to answer is:  if the expected return for stocks is 8% a year and I can get, say, 4% in a savings account, am I willing to take the greater risk of owning stocks?

government bonds

–if we take the simplest case, a government bond is a high-quality promise (i) to pay a specified amount of interest for a set period of time, and (ii) to return the principal at the end of the bond’s term.

The annual return on a bond should be the return on cash + a premium to compensate for tying one’s money up for a long period of time.  At the moment, the rate for a 10-year Treasury bond is about 2.16%.  That compares with, say, 0.5% for overnight money.

Suppose the rate on overnight money rises to 2.0%.  A newly-issued 10-year would likely have to yield at a minimum, say, 3.25% to draw buyers (yes, the time premium normally fades as rates rise).  This implies that an already-existing 10-year yielding 2.16% must be worth less than par (since the going rate for a bond at par is 3.25%).

In other words, as interest rates go up, the value of an existing bond goes down.  There’s nothing the issuer can do to change that dynamic.  Since the issuer has the use of what is now cheap money, he will presumably have no desire to change it, either.

 

More tomorrow.

Veterans Day …and my birthday!

November 11, 2016 By in Analyzing performance, stock market, Uncategorized Tags: , , , 4 Comments

Given that way back when I served in the 101st Airborne, it’s a double holiday for me.

…a post nevertheless.

 

Yesterday was Day 2 of the President-to-be Trump era.

S&P 500 gains were more modest than on Day 1, but the general pattern of trading was similar.  Action continued to be “conceptual” in nature, that is, industries that Wall Street thinks will benefit from an end to Congressional gridlock generally did well—Industrials and Basic Materials, for example.  Both parties have long favored amped-up infrastructure spending, but Republicans had previously blocked any initiatives.  We won’t know what Democrats would do were positions reversed, but with Republicans in control of both houses any attempt to ape their past anti-Obama behavior will prove ineffective.

Financials continued to outperform strongly, both on the idea that finally getting fiscal stimulus will free the Fed to alter its super-low interest rate stance.  The market also seems to believe that some restrictive provisions of Dodd-Frank will be removed come 2017.  Whether this is good or bad remains to be seen (for what it’s worth, seeing that no one has gone to jail and the same clowns who caused the financial crisis are still in charge, my vote is “bad”).  If some shackles come off, however, bank profits for a while will be higher than previously thought.  (Note:  despite my just-expressed distain, I own JPMorgan Chase.  I guess I’m a Wall Streeter at heart.)

Healthcare was up as well, on the idea that the industry will have greater pricing power under Republicans.  Healthcare firms also generally pay corporate tax at the highest rates–the reason inversions have been so prominent in this sector.  Tax reform would presumably benefit these companies more than others.

Yesterday also saw sharp losers.  Telecom, Utilities and Staples were all down by over -2%.  IT came close to that mark, at -1.8%.  IT seemed to me to suffer from serious derivative-led selling.  Don’t ask me why.  The only sense I can see in the rest is that the US$ has begun to rise, potentially lowering the profits from Staples.  The idea that rates will be rising for sure, and faster than under a Hillary administration, is behind the weakness in bonds, Utilities and possibly Telecom as well.

Energy took the day off.

 

A closing thought:  if we were to roll back the clock by a week, liberals could have imagined that when Hillary won, disgruntled Trump supporters might organize anti-Clinton demonstrations in right-wing hotbeds.  These protests would have been labelled as typically Trumpish, and disgraceful.

As regular readers will know, I’m not a fan of Trump.  It seems to me, however, that the most effective way to influence Mr. Trump is to boycott the products bear his family name, not to cast doubt on peaceful transition of power to the election winner.

 

the changing nature of competition

October 31, 2016 By in Industry Analysis, internet, Portfolio management, securities markets, Uncategorized Tags: , , Leave a comment

Happy Halloween!!

This is the continuation of my post from last Friday.

A generation ago, establishing a competitive edge in a business was about having plant and equipment, operating that physical capital efficiently and, for consumer-facing firms, advertising to create and maintain a brand image.

First mover advantage was often key, since it might allow the initial entrant to achieve economies of scale (lower unit costs) in manufacturing or marketing that would discourage potential rivals  by making their path to profits prohibitively long and expensive.

The Internet, and the rise of China as a low-cost contract manufacturing hub, changed all that.  Supply chain management software did allow vertically integrated companies to coordinate actions much more efficiently.  But it also gave smaller, more focused firms the power to create virtual integration using third-party supply chain partners.

 

Today’s competition, particularly in the consumer arena, is as much about services as physical products.  The development of internet-based social media has made it much easier for a fledgling niche product to find a voice without spending heavily on traditional advertising.

Knowledge and relationships have replaced plant and cumulative advertising expense as “moats” that protect a firm from competition.

 

These developments present two problems for stock market investors:

–the first one is straightforward.  Comparing a stock price with the per share value of tangible balance sheet assets (Benjamin Graham) may no longer provide relevant buy/sell signals.  Nor will supplementing this analysis by including intangibles (Warren Buffett), using, say, the sum of the past ten years’ advertising expense.

A very successful value investor friend of mine used to say that there are no bad businesses, there are only bad managements   …and bad managements will invariably be replaced.  In an overly simple form, he thought that so long as he could see large and growing revenue, everything else would take care of itself.  Broken companies were actually better investments, since their stock prices would leap as new managements created turnarounds.

As I see it, in today’s world this traditional approach to valuation is less and less effective–because assets no longer have the enduring worth they formerly did.

–first mover advantage is probably more important today than in the past.  But while network effects are readily apparent, a company’s development stage, where the network is growing but the source of eventual profits is unclear, can be very long.  And it may be difficult in the early days to separate a Fecebook from a Twitter.

 

So while we can all dream of finding a profit-spinning machine that has high turnover and negative working capital, today’s versions are inherently more vulnerable than those of a generation ago.  They may also come to market in their infancy, when what kind of adults they’ll tun into is harder to imagine or predict.

 

Warren Buffett and Dow Chemical (DOW)

August 25, 2016 By in Convertibles, Preferred Stock, Stock ideas, stock market, Stock options, Uncategorized Tags: , , , , , 1 Comment

Today’s Wall Street Journal contains a front page article that will be widely viewed on Wall Street, I think, as a bit of comic relief.

In times of financial stress, cash-short companies have tended to go to Berkshire Hathaway for financial assistance.  If successful, they receive both money and the implicit endorsement of Warren Buffet.

In 2009, it was DOW’s turn.  It wanted to acquire Rohm and Haas, another chemical company.   The best deal it could find for a needed $3 billion was in Omaha, where Berkshire took a private placement of $3 billion in DOW preferred stock, with an annual dividend yield of 8.5%.  The preferred has been convertible for some time now into DOW common (yielding 3.4%), at DOW’s option, provided DOW has traded above $53.72 for a period of at least 20 trading days out of 30.

DOW shares were trading below $20 each when the deal was struck seven years ago.

On July 26th, the shares breached the $53.72 barrier and traded above it for five consecutive days–the final two on extremely heavy volume–before falling back.  At the same time, according to the WSJ, short interest in the stock has risen sharply.  In other words, someone has been a heavy seller, using stock borrowed from others.

Who could that be?

Although nothing is stated outright, the strong implication of the article is that the shortseller is Berkshire, which stands to lose $150 million+ a year in dividend income on conversion.

Part of the Wall Street humor in the situation is that the playing field isn’t level.  It’s perfectly legal for Berkshire to sell DOW short, although it does seem to cut against the homespun image Mr. Buffett has been at pains to cultivate for years.  On the other hand, however, DOW would run the risk of being accused of trying to pump up its stock price (and the value of management stock options) if it went out of its way to absorb any unusual selling.

 

the Tesla (TSLA)/SolarCity (SCTY) merger

August 2, 2016 By in mergers and acquisitions, Uncategorized Tags: , , , , 1 Comment

Yesterday, TSLA and SCTY announced the two firms had reached agreement for TSLA to acquire SCTY in an all stock deal.  TSLA will exchange .11 shares of its stock for each share of SCTY, with closing sometime before yearend.  SCTY has 45 days to shop for a better offer.

Most commentaries I’ve read seem to miss two things:

–the original TSLA proposal said it anticipated an exchange ratio of between .122 and .131 to one, subject to closer examination of SCTY’s books.  The purpose of the range, as I see it, was to put a ceiling on what TSLA would pay for SCTY, no matter what good things it found on closer inspection.

Well, the opposite has happened.  The actual offer falls 10% below the lower bound, suggesting that SCTY looks considerably less great on the inside than its public financials would suggest.

–the combined entity, despite anticipated administrative/marketing savings of $150 million a year, assumes it will need to make an equity financing next year.

 

Overall, however, I think this is a good deal for SCTY.  Although I have traded the stock from time to time, the one thing that has always bothered me about SCTY is its stepchild status in the Elon Musk empire.  I say stepchild because TSLA, not SCTY, owns the Gigafactory, which will supply state-of-the-art batteries to SCTY.  To me, this signaled that TSLA was in the heart of the Elon Musk empire and that SCTY was on the periphery.  The merger changes that.