Category Archives: Portfolio management

a market of stocks or an overall stock market?

October 26, 2015 By in Current Market Thoughts, Portfolio management, Recent Market Action, stock market, Strategy Tags: , , , , , , , Leave a comment

my worry

This is the question I was writing about a few days ago.

The outstanding characteristic of the US stock market vs. other national markets during my career has been that Wall Street has been, almost uniquely, dominated by stock pickers.  While political or macroeconomic concerns occasionally arise, the focus of the vast majority of stock market participants has been on the merits (or lack of them) of individual stocks.

Many veteran stock pickers on the sell side have either retired or been laid off over the past several years, however, and institutional pension money allocated to active investing has increasingly been funneled to trading-oriented hedge funds or other “alternative” investment vehicles in a so-far vain attempt to close the gap between the assets they have on hand and the minimum they need to meet their present and future obligations.

The result of this change has been an increasing influence on stock prices by computers that react to news of all sorts as it is published and by short-term human traders sensitive to macroeconomic trends but with (to me) surprisingly little knowledge of the ins and outs of individual companies or industries.

My worry has been that–as has happened in other countries–the macro woes of sectors like Energy and Materials, or perhaps the demise of the post-WWII industrial corporate structure, overwhelm the attractions of even large micro pockets of strength in, say, IT.

last Friday

My worries have no basis in fact, at least so far, if last Friday’s trade is any indication.

The S&P 500 was up by 1.1%, the IT-heavy NASDAQ by 2.3%.  However, consider the performance of the following companies that reported earnings before the open:

Microsoft         +10.0%

Alphabet (aka Google)          +7.7%

Amazon          +6.2%

athenahealth   (a weak performer before Friday)      +27.5%.

 

Compare that with:

VF          -12.9%

Skechers          -31.6&

Pandora Media          -35.6%%.

 

Two things stand out to me:

–most of these reactions are extreme, suggesting that the market is reacting to the news rather than anticipating it, and

–the market is very willing to differentiate sharply between individual winners and losers.

 

My conclusion:  we as individuals can still ply our stock-selecting trade.   The reward for finding superior companies, however, may come all at once, and later than we have been used to in the past.

 

thinking about 2016: commodities

October 20, 2015 By in Current Market Thoughts, Portfolio management, Recent Market Action, stock market, Strategy Tags: , , , , , , , , , , 4 Comments

commodities

In the broadest sense, commodities are undifferentiated products or services.  Producers are price takers–that is, they are forced to accept whatever price the market offers.

Commodity products are often marked by boom and bust cycles, that is, periods where supply exceeds demand, in which case prices can plummet, followed by ones where supplies fall short and prices soar.

 

For agricultural commodities, the cycle can be very short.  For crops, the move from boom to bust and back may be as little at one planting season, or three-six months.  For farm animals, like pigs, chickens or cows, it may be two years.

 

For minerals, which right now is probably the most important commodity category for stock market investors, cycles can be much longer.  Base and precious metals have recently entered a period of overcapacity.  The previous one lasted around 15 years.  One might argue that prices for many metals have already bottomed.  I’m not sure.  But I think it’s highly unlikely that they will rise significantly for an extended period of time.

 

Oil is a special case among mined commodities.  Lots of reasons

–the market is huge, dwarfing all the metals other than iron/steel.

–there’s a significant mismatch between countries where oil is produced and where it’s consumed.

–there’s one gigantic user, the US.

–for many years, there was an effective cartel, OPEC, that regulated prices.

To my mind, the most important characteristic of oil for investors at present is the wide disparity in out-of-pocket production costs between Saudi crude ($2 a barrel) on the one hand, and Canadian tar sands ($70? a barrel) on the other.  US fracked oil ($40? a barrel) is somewhere in the middle.  The lower-cost producers have gigantic capacity, and the potential to ramp output up if they choose.  This wide variation in costs makes it very difficult to figure out at what price enough capacity is forced off the market that the price will stabilize.  For example, Goldman, which has an extensive commodities expertise, has argued that under certain conditions crude might have to fall to $20 a barrel before it bottoms.

 

The oil and metals situation is important for any assessment of 2016, because:

–about 25% of the earnings of the S&P come from commerce with emerging markets, many of which depend heavily on exports of metals and/or oil for their GDP growth

–the earnings for about 10% of the S&P 500–the Energy, Materials and Industrials sectors–are positively correlated withe the price of metals and oil.

–a low oil price is a significant economic stimulus for most developed countries, meaning margins expand for companies that use oil as an input  and consumers spending less on oil will have more money left to spend elsewhere.

As a result, one of the biggest variables in figuring out earnings fo the S&P next year will be one’s assumptions about mining commodities prices, especially oil.

 

More tomorrow.

 

 

will the poor performance of Energy, Materials and Industrial sectors derail the S&P 500?

October 6, 2015 By in Current Market Thoughts, Energy, Japanese development, Portfolio management, securities markets, stock market, Strategy Tags: , , , , Leave a comment

In the course of doing a performance attribution for the S&P 500 year-to-date last week, I noted that the S&P 500 ex Energy, Materials and Industrials, is pretty close to flat so far this year on a total return basis.

But is it correct to conclude that the “healthy” sectors of the S&P will continue to be relatively immune to the economic illness caused by the price collapse of global mining commodities?   …or will they eventually be dragged down if, as I expect, commodity weakness continues for an extended period of time.

This isn’t as silly a question as it might seem at first.

In the early 1990s I was asked by the board of the company I worked for to present my views on the stock market in Japan at that time.  I created a presentation that divided the Topix index, which was trading at about 70x earnings, into three parts:

–highly speculative property-related companies that were trading at around 500x earnings and made up 10% of the market

–export-oriented industrials, such as the autos or tech companies like Canon, which were trading at 15-20x earnings and made up 30% of the market, and

–everything else, which made up 60% of the market and traded at around 25x.

I said what I believed:  that, while the index might do poorly as the speculatives came back to earth and the bulk of the market went sideways, the export-oriented stocks were cheap and would go up significantly in price–not only in yen but in dollars, too.  My model was the behavior of the US market throughout the second half of the 1970s, when former speculative favorites, the Nifty Fifty, were crushed while everything else went up.

An aside: a famous finance academic on the board, who made it clear he had not sought the opinion of a mere “practitioner” like me, objected that the low dividend yields of Japanese stock proved they remained wildly overvalued.  A little embarrassed (for him), I had to explain that Japanese tax laws did not provide the same preference for dividend income that the IRS did. In fact, dividend income was subject to income tax at an extremely high rate (up to 90%) in Japan.  Because of this, taxable investors (the majority at that time) had a very strong preference for (untaxed) capital gains.  Companies tended to make negligible cash payouts and to use stock dividends as a substitute.

Embarrassingly (for me), it turned out that my reasonable analysis was completely wrong.  Yes, the exporters were cheap, but for the next decade they significantly underperformed similar-quality companies elsewhere in the world.  In this case, the general economic funk that engulfed the Japanese economy hurt the stocks of all firms listed there.  There was no escape.

my thoughts

Thee aren’t a whole lot of relevant examples of this kind of situation to generalize from.  (Another might be the worldwide collapse in the price of mining commodities and of commodities stocks from 1982-86, which did not impede the upward progress of global stock markets from mid-1982 on.)

My hunch is that the contamination of “good” stocks in 1990s Japan is more a function of the continuing economic malaise in that country than of anything else.  What’s somewhat troubling is that the US today is very similar demographically to Japan back then, when lack of workforce growth was a significant contributor to Japan’s stagnation.  We have the same woes of extremely low interest rates and an impotent legislative arm tied to the status quo and unwilling to use fiscal policy to bolster the economy–another set of lead weights dragging Japan down.

 

At the end of the day, I’d argue that the US is inherently a much more dynamic country than others in the developed world.  Also, I see the commodities collapse as much more like an external shock than a sign of weakness in the domestic economy in the way the property collapse in Japan was.  So I see the chances that commodities/commodity stock softness will cripple the rest of the US stock market as low.  But there are enough similarities between us today and Japan 25 years ago to make me vaguely uneasy.

 

 

 

a tale of two markets …or three …or one?

October 2, 2015 By in Constructing a Portfolio, Current Market Thoughts, Keeping Score, oil and natural gas, Portfolio management, Strategy Tags: , , , , , , , Leave a comment

In yesterday’s Keeping Score, I outlined the performance by sector of the S&P 500 component sectors over the past one and three months.  Here’s the same information for 2015 to date, through the end of September:

 

Consumer discretionary          +2.9%

Staples          -2.9%

Healthcare          -3.3%

IT          -4.1%

S&P 500 (adjusted, as described below)          -4.3%

———————————–

S&P 500          -6.8%

Telecom          -7.4%

Financials          -8.4%

Utilities          -8.4%

———————————-

Industrials          -11.2%

Materials          -11.2%

Energy          -23.1% (ouch!!!).

 

Index performance falls pretty neatly into three categories:

–relative stars, which are clustered around/above the adjusted S&P 500.  These are, generally speaking, sectors with primarily a US/EU focus and which do well when economies are expanding and consumers are feeling good.  But they don’t depend on rip-roaring commodities-oriented, basic industry-based economic expansion.

–non-descripts, clustered around the index

–clunkers, either basic materials or the Industrial sector which serves basic industry (and also makes lawn mowers and other stuff for consumers)

my adjustment to the S&P

Energy (currently 6.9% of the S&P), Industrials (10.1%) and Materials (2,8%) make up about 20 percent of the S&P by market capitalization.  The three account for half the index’s losses so far this year, however.  The -4.3% return of the adjusted index is the aggregate performance of the other 80% of the S&P through the end of September.  Figure that a holder of those sectors has collected a dividend of around 2% and the total return of the adjusted index looks more like treading water than a catastrophe.

my thoughts

Of the clunkers, the simple story for Materials and Energy is that commodity producers are invariably their own worst enemies.  In good times, they plow their cash flow back into creating new capacity that ultimately floods the market with output and destroys pricing.  The most maladroit borrow the funds needed to shoot themselves in the foot.  Like the biblical seven years of famine following the seven years of plenty, we’re in the early stages of a long downturn.

Industrials are a little more complicated.  Many don’t make gigantic turbines or stamping or cutting machines that would fit comfortably in Soviet propaganda art.  Instead, they make paint, lamps, gardening equipment–any of the stuff consumers buy in a Home Depot.  I haven’t looked at the sector carefully enough to know whether some of the members are being punished unfairly (I suspect not, though, so I’m in no rush to find out.)

 

On a nine-month view, though, all the fear that seems to be pulsing through Wall Street seems misplaced.

 

why three markets?

Recent problems with Healthcare don’t reveal themselves in this performance analysis.  The straightforward explanation is that the current swoon is about valuation, and represents simply giveback of earlier outperformance.  Although/because I hold a lot of a healthcare mutual fund run by a super-competent former colleague, I don’t pay enough attention to this sector to have a strong opinion.  I do think, however, that Americans don’t take kindly to firms that make extortionate profits from the misery of others.  Recent revelations that acquisitive drug firms, spurred on by hedge fund backers, have aggressively raised the prices of drugs they’ve bought is probably inviting political backlash.  In any event, I think Healthcare will go its own way.

 

is this a stable situation?

In other words, will Wall Street simply shrug off the woes of the clunkers by shifting into other sectors, which has been the case so far?  Or will the problems of the 20% eventually drag down the rest?

To me, the answer isn’t obvious.

 

More on  Monday.