Category Archives: Vocabulary

corporate taxes, consumer spending and the stock market

December 18, 2017 By in consumer confidence, corporate income tax reform, corporate tax reform in the US, income tax rates, Industry Analysis, Retail, Strategy, strong earnings, taxes, Uncategorized Tags: , , , , , , , 1 Comment

It looks as if the top Federal corporate tax rate will be declining from the current world-high 35% to a more median-ish 20% or so.  The consensus guess, which I think is as good as any, is that this change will mean about a 15% one-time increase in profits reported by S&P 500 stocks next year.

However, Wall Street has held the strong belief for a long time that this would happen in a Trump administration.  Arguably (and this is my opinion, too), one big reason for the strength in US publicly traded stocks this year has been that the benefits of corporate tax reform are being steadily, and increasingly, factored into stock quotes.  The action of computers reading news reports about passage is likely, I think, to be the last gasp of tax news bolstering stocks.  And even that bump is likely to be relatively mild.

In fact, one effect of the increased economic stimulus that may come from lower domestic corporate taxes is that the Federal Reserve will feel freer to lean against this strength by moving interest rates up from the current emergency-room lows more quickly than the consensus expects.  Although weening the economy from the addiction to very low-cost borrowing is an unambiguous long-term positive, the increasing attractiveness of fixed income will serve as a brake on nearer-term enthusiasm for stocks.

 

What I do find very bullish for stocks, though, is the surprising strength of consumer spending, both online and in physical stores, this holiday season.  We are now nine years past the worst of the recession, which saw deeply frightening and scarring events–bank failures, massive layoffs, the collapse of world trade.  It seems to me that the consumer spending we are now seeing in the US means that, after almost a decade, people are seeing recession in the rear view mirror for the first time.  I think this has very positive implications for the Consumer discretionary sector–and retail in particular–in 2018.

the structure of the S&P 500, and why it matters…

December 11, 2017 By in closet indexing, index funds, indexing, Standard and Poors 500, Uncategorized Tags: , , , 1 Comment

…to us as individual investors, for the portion of our assets we choose to manage actively.

As of the close of trade in New York last Friday, the Standard and Poors 500 was weighted, by sector, as follows:

IT      24.0%

Financials      14.8%

Healthcare      14.1%

Consumer discretionary     12.1%

Industrials     10.1%

Staples      8.1%

Energy      5.8%

Utilities         3.1%

Materials     3.0%

Real estate     2.9%

Telecom      2.0%.

The goal of active managers is to have better results than the index (I could say “an index fund,” but the two are the same, less the small fees an index fund purveyor charges).  We’ll only have different results if we have different holdings than the S&P.  And if our holdings aren’t different–either different names or different weightings (or both)–we can’t be better.  In order to be different our first job is to know what the index looks like.  The list above is a first cut.

Let’s rearrange it to show the sectors in order from the most sensitive to general economic activity to the least.  I’m going to divide the sectors into three groups, from those that do best in a red-hot world economy, those that will still do well with so-so growth, and those that have the most defensive characteristics–meaning they do their best relative to the index when economies are contracting.

 

most economically sensitive

Materials      3.0%

Industrials      10.1%

Energy     5.8%

————————————-total = 18.9%

economically sensitive

IT      24%

Consumer discretionary     12.1%

Financials      14.1%

Real estate         2.9%

————————————-total = 53.1%

defensive

Healthcare     14.1%

Staples     8.1%

Telecom      2.0%

Utilities     3.1%

————————————-total = 27.3%.

I’ve stuck Energy in the most sensitive segment.  Recently it’s been marching to its own drummer, as the big integrated oils restructure and as the crude oil price yo-yos up and down.  Ultimately, though, I think in today’s world oil is just another industrial commodity that’s not that different from steel or aluminum.  Put it somewhere else if you disagree.

This isn’t the only reordering we could make.  We could also arrange the index by market capitalization in order to either emphasize big stocks or small ones in our holdings.  But this is the most common one professionals, and their institutional customers, use.  Personally, I think it’s also the most useful way to think about the index.

 

To my mind, the most striking thing about the S&P 500 is that it is mostly geared to a rising economy.  If we think recession is brewing, tiny changes in holdings aren’t going to make much of a difference in relative performance.

Another–very important–point is that if you have a portfolio that’s, say, 10% Healthcare, and your benchmark is the S&P 500, you’re betting against Healthcare as a sector, not on it.

 

 

 

 

 

 

 

Broadcom (AVGO) and Qualcomm (QCOM)

November 6, 2017 By in mergers and acquisitions, Technology, Uncategorized, white knight Tags: , , , , 1 Comment

(Note:  the company formerly known as Avago agreed to buy Broadcom for $37 billion in mid-2015.  Avago retained its ticker symbol:  AVGO, but took on the Broadcom name.  Hence, the mismatch between name and ticker.  That deal is on the verge of closing now. Presumably AVGO’s recent decision to move its corporate headquarters from Singapore to the US is a condition for approval by Washington.)

AVGO and QCOM

AVGO is a company that has very successfully grown by acquisition (my family and I have owned shares for some time).  Its specialty, as I see it, is to find firms with excellent technology that are somehow unable to make money from either their intellectual property or their processing knowhow.  AVGO straightens them out.

QCOM, a firm I’ve known since the mid-1990s, seems to fit the bill.  The company makes mobile processors for cellphones.  It also collects license fees for allowing others to use its fundamental and important cellphone intellectual property.  QCOM has been in public disputes over the past couple of years with the Chinese government, which has forced lower royalty payments, and with key customer Apple, which is threatening to design out QCOM chips from its future phones.  As I see it, these disputes are the reason the QCOM stock price has stagnated over the recent past.

the offer

AVGO is offering $70 a share in cash and stock for QCOM, a substantial premium to where QCOM shares were trading before rumors of the offer began to circulate.  The current price for QCOM (I’m writing this at around 10:30) of $63.90 suggests that the market has doubts about the chances for AVGO’s success.

Standard tactics would be for QCOM to seek another buyer, one that would keep current management in place.  Since an overly pugnacious management has arguably been QCOM’s main problem, my guess is that a second bidder is unlikely to emerge.

If I were to try to participate in this contest (I don’t think I will), it would be to buy more AVGO.  I believe AVGO’s assertion that the acquisition would be accretive in year one.  So it’s likely to go up if the bid is successful.  If not, downward pressure from arbitrageurs would abate.  On the other hand, I don’t see 10% upside as enough to take the risk QCOM will find a way to derail the bid.  After all, it has already found a way to anger Beijing and 1 Infinite Loop.

GE, death cross and golden cross

November 2, 2017 By in golden cross/dead cross, Technical Analysis, Uncategorized Tags: , , , , 1 Comment

In one of his early books, Peter Lynch, famed manager of the Fidelity Magellan Fund (during the time when that fund had the strongest record among domestic growth funds), wrote that no one ever gets fired for buying IBM.

That is to say, many run-of-the-mill portfolio managers will stick with “safe” high-client-recognition large cap names long past their sell-by dates.  Why?   …because they think there’s less career risk for them in doing so than there is in holding earlier stage names where there’s much more upside but a bigger chance of going down in flames.  In my experience, that risk comes less from the company itself than from the PM’s not doing the continual securities analysis needed to monitor a smaller firm’s prospects.

The “safe” strategy, according to Lynch, generates at best mediocrity.

GE is a fascinating case (of the train wreck genre) in point.

As I see it, the company grew by only about 10% a year in what one might call its last  “glory days” in the 1990s.  That lackluster performance was fueled in large part by the creation of a finance division that specialized in lending to less than pristine customers.  On a stand-alone basis, the earnings from such a business typically garner only a substantially below-market multiple.  But it seems to me that GE boosters, led on by cheerleader CEO Jack Welch, never connected the dots and continued to pay super-generously for these results.

Welch’s successor had the unenviable task of straightening out the lumpy, aging conglomerate he left behind.  New management wound down the risky finance operations, but then decided to bet the farm on the consensus view at the turn of the century that the world faces a structural shortage of oil.  Ouch.

 

I have no current interest in GE as a stock.  My hunch, however, is that if I looked into the company I’d end up being more a buyer than a seller.  That’s for no other reason than it has been a dismal operating performer for a quarter century and there must be something of value inside a stock that has been beaten down so much over the past decade plus.

What prompted me to write this post, then?

 

dead cross and golden cross

I saw an article about GE by a technical analyst who asserts the stock is flirting with disaster. His argument is that a short-term moving average of GE’s stock price is just about to break below its long-term moving average.  Technicians call this a “dead cross,” a sign that investors are abandoning hope and will likely begin to dump the stock out without regard to price.

I have no belief in most technical indicators, including this one.  I like the name, though.  And if this prediction proves correct, I think it would provide a very good buying opportunity.

The opposite of the dead cross, by the way, is the “golden cross,” where the short-term moving average breaks above the long-term moving average.  This supposedly leads to strong buying action.

is the S&P expensive?

September 18, 2017 By in Current Market Thoughts, Strategy, strong earnings, Uncategorized Tags: , , 1 Comment

I’ve been reading a lot of commentary recently that maintains stocks are generally expensive.  Sometimes the commentators even recommend selling, although in true Wall Street strategist style, they’re not very specific about how much to sell or how deep they think the downside risk is.

The standard argument is that if you compare the PE ratio of the S&P today with its past, the current number, just about 25x, is unusually high.

That’s correct.

What I haven’t see anyone do, however, is consider the price of stocks against the price of alternative liquid investments–cash and bonds.  That would tell you what to do with the money if you sell stocks.  It would also tell you that bonds are much more expensive than stocks.

The yield on the 10-year Treasury is currently 2.23%.  That’s the equivalent of a PE of about 44x.  The return on cash is worse.  Cash, however, protects principal from capital loss, except in the most dire circumstances–ones where you’re thinking you should have bought canned goods and a cabin in the woods..

In addition, I think the most likely course for interest rates in the US is for them to rise.  When this has happened in the past, bond prices have fallen while stocks have gone basically sideways.  There’s no guarantee this will happen with stocks again.  But rising rates are always bad news for bonds.

What is surprising to me about current market movements is that stocks continue to be so strong during a time of typical seasonal weakness.