Tag Archives: business

A world awash in money?: the Bain view

August 21, 2013 By in Bond Environment, Current Market Thoughts, economics, Strategy, Trading Tags: , , , , , , , , , Leave a comment

The other day I was reading a column in the Financial Times that referred to a study by the consulting company Bain.  Published late last year (I missed it then), it’s called A World Awash in Money.

Its basic premise is that the present condition of a “superabundance” of investment capital looking for a place to go to work is a permanent feature of the financial landscape.  Therefore, asset prices will remain higher than the consensus expects; interest rates will remain lower.

Three factors are involved:

–financial innovation, high-speed computing and increased use of leverage have allowed the pool of investment capital in the advanced economies to expand at a very rapid rate over the past couple of decades

–during the same time, GDP in the US and EU has been growing slowly, providing fewer new investment opportunities, and

–emerging economies like China will soon turn from being capital users to capital exporters, significantly increasing the amount of global capital searching for high-return projects to invest in.

In Bain’s view, this situation will have a number of important consequences:

1.  interest rates will remain (much) lower than the consensus expects

2.  in a capital-glutted world, bubbles like those in 1999-2000 and 2006-2007 have a high chance of recurring.  Therefore, investors must be ready to anticipate them and take defensive action

3.  investors will be forced to consider projects with extremely long duration (think: 20 or 30 years) to achieve superior returns

4.  the risks of investing in the developing world, where capital will be needed the most, will become more palatable to return-starved global investors

5.  achieving substantial real returns will require that both portfolio investors and company treasurers abandon their buy-and-hold, long-only mindset and become more like hedge funds.

 

I always find studies like this one interesting.  It’s not necessarily because they turn out to be correct.  It’s that they force you to think about the “big picture” and form an opinion on important investment issues.  In this case, it’s what happens if interest rates stay low.

I also find studies that argue, in effect, that the current state of the economic/financial world will persist for a long time to be particularly worrying.  In my experience, most times they come just before some dramatic and unanticipated change.

My take on the Bain study tomorrow.

housing boom and retail sales

August 19, 2013 By in Current Market Thoughts, economics, Industry Analysis, Recent Market Action, Retail Tags: , , , , , , , , Leave a comment

Last week, Macy’s, Kohl’s and Wal-Mart all reported disappointing 2Q13 results–leading to worries that economic growth in the US is beginning to slow.  In Wal-Mart’s case, I think the problem is structural, not cyclical.  The manufacturing  jobs much of the chain’s lower-income customer base has traditionally had have disappeared forever.  With them, fat paychecks have gone as well.

But what about Macy’s and Kohl’s?  Why are their results so at odds with general economic indicators?

One possibility is that the weakness in general merchandise they’re exhibiting is a result of the housing boom.

In most areas of the world, and over most periods of time–except for the US during the past few decades–a cyclical housing boom alters consumers’ retail spending patterns.  The change usually appears with a modest time lag.

After buying a new residence, the owners typically redirect their spending in two ways:

–more of their income goes into paying their mortgage, and

–they redirect what remains toward furnishing and decorating their new home.

So spending on furniture, kitchen appliances, paint, carpeting… rises.  Spending on restaurants, cellphones, clothing… falls.  The latter category doesn’t drop to zero.  But consumers cut back–both on big-ticket items and on shopping-as-entertainment, where the items in question aren’t unique or special.

The only exception to this pattern that I’m aware of comes close to home.  During the long period when interest rates in the US were in decline–from the early Eighties until now–falling interest rates made housing prices rise so quickly that new homeowners weren’t forced to cut back on spending.  They could borrow against their fast-appreciating home equity, instead.

It’s too early to tell for sure, but the lackluster sales we’re seeing from Macy’s and Kohl’s may just be a return to normal by US homeowners after an extended period of excess.  If so, the situation is a threat to department store profits, and stock prices, but not to the overall economy or stock market.

 

Wal-Mart (WMT)’s earnings miss: significance?

August 16, 2013 By in Current Market Thoughts, earnings conference calls, Industry Analysis, Retail, Stock ideas Tags: , , , , , , , , Leave a comment

the coview

Yesterday, WMT reported 2Q13 earnings results, which came in below company guidance.  WMT also revised down its expectations for the rest of the year.  That news followed a similarly disappointing result from Macy’s (M).

Media comment has interpreted these reports as signaling the domestic economic recovery is stalling out, that “pent-up demand” –catch-up buying resulting from purchases postponed during the Great Recession has finally been exhausted.  Now, the talking heads opine, the true “fragile” state of the US economy is finally being revealed.  This realization is why the stock market declined sharply yesterday.

why I think the consensus is wrong

This interpretation may turn out to be the correct one.  But it’s not the only way to look at things.  In fact, in this case, I think the media view is wrong.  Here’s why:

1.  Interest rates went up yesterday.  The 10-year Treasury reached a yield of 2.77% on Thursday; the 30-year, 3.81%.  Both are highs for the year.  In other words, the bond market isn’t seeing economic weakness.  It’s seeing strength that will eventually lead to the Fed raising interest rates.

2.  WMT’s main business is selling food and general merchandise for cheap in no-frills stores targeted at middle- and low-income households.

When Sam Walton started doing this some 40 years ago, WMT had the field to itself.  But success spawned imitators.  In particular, recently, and especially during the recession, the dollar stores have been taking market share away from WMT.  In a way, this a replay of the competition between mainline department stores and specialty retailers that emerged in the 1970s-1980s.

3.  During recessions, people change their buying patterns.  They put off buying big-ticket items.  And they trade down to cheaper alternatives for everyday necessities.  When recession ends, they normally trade back up.  For the affluent, that is already happening.  For average and lower-income Americans, as I read the results from manufacturers of staples, that hasn’t occurred yet.

4.  About 30% of WMT’s traditional customers are low-income Americans.  I read the WMT earnings report as saying that economic recovery hasn’t yet reached this part of the company’s customer base.

This, I think, is the real news in the WMT results.  I think the earnings miss is evidence in favor of the idea that high unemployment in the US is a structural phenomenon that low interest rates can’t cure.  Action by congress and the administration is needed, instead.  But suggesting this is opening a can of worms that talking heads–and the securities analysts who feed them information–would rather not touch.  Easier to say (counterfactually, in my view) that the overall economy is cooling off.

my bottom line:  as a citizen, I have a strong opinion on the structural/cyclical unemployment issue. I think WMT’s weakness is a company-specific issue, not a macroeconomic one.

As an investor, however, there’s no need to either have an opinion on this issue or to make your view a major feature of your portfolio.  Just avoid low-end general retail.

Look, instead, for niche retailers who are showing strong same store sales growth   …or avoid retail altogether.  There’s no rule that says you always have to have retail stocks in your holdings.

thinking about Consumer Staples stocks

August 15, 2013 By in Consumer Staples, Current Market Thoughts, Industry Analysis, Stock ideas, Uncategorized Tags: , , , , , , , Leave a comment

Consumer Staples

I had lunch yesterday on eastern Long Island with my friend Richard, who is an astute investor despite being handicapped by being a physician.  Among other things, we talked about Consumer Staples.  He’s a big fan.  …me, not so much.  Anyway, I decided to write about this sector today.

starting with the nuts and bolts:

–the S&P 500 Consumer Staples sector makes up 10.3% of the total capitalization of the S&P 500 index.  That puts it about in the middle as far as size goes.  (IT, at an 18.1% weighting, is the biggest sector;  Telecom, at 2.5%, is the smallest.)

–the Consumer Staples sector has 40 constituents.  Procter and Gamble, Coca-Cola and Philip Morris are the biggest three.  Of them, only P&G cracks the top ten for the S&P as a whole.

–as the sector name suggests, members provide everyday necessities, like groceries, whose purchase isn’t easy to postpone.  It contrasts with Consumer Discretionary, which deals in items like entertainment or restaurant meals, that people can go without for a while.

steady growth → defensive industry

True, every sector has some sensitivity to economic conditions, even Utilities and Staples.  But in these two cases, the sensitivity is small.

In bad times, people may buy one bar of soap instead of a three-pack, or a store brand rather than a deluxe offering.  But they continue to buy something.  That’s not the case with big-ticket items, like refrigerators, autos, houses, industrial machinery, hotels…

As a result, earnings for Staples companies hold up better than for most other sectors in recession.   Knowing this, investors flock to the sector in bad times–and away from it toward more cyclically-sensitive areas when recovery is underway.

a global, but mature, industry…

…except for in emerging markets.  Staples companies tend to grow by taking market share away from their rivals, rather than by finding new customers who have, say, never used shampoo before.  Yes, these firms can raise prices under most conditions (not so much currently) but generally by no more than overall inflation.  So eye-popping profit growth is rare.

sensitive to currency and to input costs

That’s because they can’t raise prices quickly.

a play on the €?

The sector tends to have large EU exposure.

And that’s a potential reason to be interested in the sector today.  If the € beings to rise against the $, which I think is likely, EU-oriented Staples companies should start to show surprisingly strong earnings gains.  That will come both from better unit volume growth as the EU recovers from recession and–more importantly–from the higher value in $ of their € profits.

I haven’t acted on this though yet.  But I’m considering it.

Bill Ackman, J C Penney (JCP)’s largest shareholder, is leaving the board. What does this mean?

August 14, 2013 By in Current Market Thoughts, Portfolio management, Private equity, Retail, Stock ideas Tags: , , , , , , , 3 Comments

the JCP board and its CEO search

Bill Ackman is the activist investor who initially targeted (no pun intended) JCP as a serial laggard that could be made to perform better.  Recently, he has argued with the rest of that company’s board–at first in private–about the pace of JCP’s search for a new CEO.  Ackman believes the search could/should be done in two months.  The rest of the board seems to be thinking in terms of nine.

Last week he made public a letter he wrote to the board, which he concluded with, “We can’t afford to wait.”

This week, after being criticized by many, he resigned from the JCP board.

Certainly. the spat between the board and its largest shareholder won’t speed the flow of CEO candidates knocking on JCP’s door.  On the other hand, it won’t deter very many, either, in my view.  What it does do is raise the price the new CEO can command.

The media have portrayed Mr. Ackman as a shallow, petulant Ivy-Leaguer having a mini-tantrum because he isn’t getting his way.  Entertaining and gossipy as that may sound, the media assessment is probably not right.  In fact, Mr. Ackman may prefer that people view the affair this way, because is suggests that everything else, save Mr. Ackman’s personality, is all right.

It isn’t.

what’s really going on

Two possibilities, one based on back-of-the envelope calculations, the other pure conjecture.  Both are based on the idea that the fact of the board disagreement has information in it–and that it’s not gossip column fare.

1.  a castle in the air

Let’s say the properties JCP controls are worth $5 billion.  That’s halfway between brokerage house estimates (which may ultimately come from Mr. Ackman) and the recently announced, but incomplete, Cushman and Wakefield assessment of $4.06 billion.

If we think the rental yield on these assets should be 7%, then the annual rental income from them should be $350 million.  That’s the amount a third-party would pay to do business on those properties.

How much does JCP pay?  I don’t know.  Certainly it’s substantially less than $350 million.  Let’s say JCP actually pays $50 million. This means that in a sense JCP real estate subsidizes the department store operations by the difference between what it could get by renting the properties to someone else vs. operating JCP stores on them.  According to what I’ve written so far, that subsidy is $300 million.  After income tax, that amounts to about $200 million.

Why is this important?

In 2010, the last year before Mr. Ackman brought in Ron Johnson to run the company, JCP made $378 million in net income.  If my numbers are anywhere near correct, over half JCP’s profits came from owning real estate.  In 2011, selling stuff lost money.

Strip away real estate gains over a long period and JCP’s retailing profits look very highly cyclical.  That makes sense, because JCP’s traditional market has been less affluent consumers, whose incomes are the most cyclical.  The company may suffer a lot during recession but makes up for that by making a relative killing as recovery gets into year three or four.

In other words, JCP should be cleaning up now.  Instead, it’s piling up enormous losses.  This spells potential trouble as/when the economic cycle turns down, and–if past form runs true–profits evaporate.

Maybe this is the source of Mr. Ackman’s sense of urgency.

2.  pure speculation

Maybe Mr. Ackman’s chief worry isn’t his projected timeline for JCP’s profits but the structure of the fund he put together to invest in the company.  He’s told reporters that his cost basis in JCP stock is $25.  But he may have financial leverage or options or other derivative instruments that make the risk/reward clock tick faster for his fund than for JCP itself.

Whatever the cause of Mr. Ackman’s behavior over the past few weeks, it’s almost certainly not simply pique.