margin calls

When I looked at my Fidelity account this morning I saw two odd things:  a simplified interface, and a message sent to everyone with a margin account (my wife and my joint account with Fidelity is a margin account, although we don’t trade on margin).  The message was essentially a warning to be on the alert for potential margin calls.

I’ve never seen this before.  A caveat:  until I retired at the end of 2006 all the family money was in the mutual funds I was managing, in whatever vehicle my employer required.  Still, I didn’t see this in 2008-09.

Two conclusions:

–Fidelity is anticipating/seeing volume increases that are testing the limits of its software (probably mostly an issue of private-company-esque aversion to spending on software infrastructure)

–more interesting, aggregate equity in the accounts of its margin customers must be dangerously (for the customers) low.  Margin-driven selloffs are typically ugly–and very often mark a market bottom.  Here’s why:

margin trading

In its simplest form, a market participant establishes a margin portfolio by investing some of his own money and borrowing the rest from his broker.  He pays interest on the margin loan (Fidelity charges 5% – 9%+, depending on the amount) but all of the gains/losses from the stocks go to him.  The client does relinquish some control over the account to the broker.  In particular, the broker has the right to liquidate some/all of the portfolio, and use the proceeds to repay the loan, if the portfolio value minus the loan value falls below specified levels.

Before liquidating, the broker tells the client what is going to happen and gives him a short period of time to put enough new money (securities or cash) into the account to get the equity above the minimum amount.  This is a margin call.

If the client doesn’t meet the call, the broker begins to sell.  The broker has only one aim–not to get the best price for the client but to convert securities to cash as fast as possible.  Of course, potential buyers quickly figure out what’s going on and withdraw their bids.  Carnage ensues.

That’s what Fidelity was saying we’re on the cusp of this morning.

There are some very shrewd and successful margin traders.  Around the world, though, retail margin traders are regarded as the ultimate dumb money.  That’s why seeing forced selling from these portfolios is typically seen as a very positive sign for stocks.

 

 

 

is the US becoming “great again”?

At first glance, the performance of the S&P 500 would seem to say yes–the S&P 500 is up by 47% since the first trading day of January 2017.  That’s substantially better than Europe or Japan has done over the same time period.   On the other hand, the US–which caused the global financial crisis–was first out of the blocks in repairing ailing banks.

Look a little closer, however, and the evidence from the S&P is not so clear.  There are a number of factors involved:

–about half the earnings of the S&P come from outside the US

–major domestic industries like housing or autos have little representation in the S&P

–tech companies, which don’t employ a ton of people and many of which don’t need offices or showrooms, make up about a quarter of the index.

The Russell 2000, an index made up of mid-sized, mostly domestic firms, is–I think–a much better indicator of how things are going for the average American.

looking at US stocks

ytd

Russell 2000 = US-based, US-serving firms       flat

S&P 500 = half US/half foreign earnings         +3%

S&P 500 software = half US/half foreign earnings, no US plants needed      +13%

MSFT          +16%

Tesla        +100%

 

2 years

Russell 2000     +8%

S&P 500          +22%

S&P 500 software       +32%

MSFT          +98%

TSLA          +140%.

 

1/1/17 onward

Russell 2000          +23%

S&P 500          +47%

S&P 500 software        +75%

MSFT          +197%

TSLA          +270%

 

What’s going on?

To state the obvious, investors are much more interested in betting on forces of structural change than on the administration’s efforts to pump life into traditional industries.  It may also be that the market thinks, as I do, that the MAGA plan (if that’s the right word) will end up being a lot like Mr. Trump’s foray into Atlantic City gambling–where he profited personally but knew surprisingly little, with the result that the people who supported and trusted him lost almost everything.

What’s been running through my mind recently, though, is the resemblance between this US market and the Mexican bolsa in the 1980s.

More tomorrow.

 

 

 

 

 

Keeping Score for January 2020

I’ve just updated myKeeping Score page for January.   weaker world economy = interest rates lower for longer = more buoyancy in stock markets

a PS to today’s post

The Russell 2000, which is composed of medium-sized US-based firms serving mostly US customers is up by 4.5% over the past two years.  This compares with +16.5% for the S&P 500 and +25.5% for the NASDAQ, which are far more globally oriented.  (These are capital changes figures, which I plucked off Yahoo Finance.)

The latter two are 3.7x and 5.7x the return on the Russell 2000.  Attention grabbing, yes, but not the right way to sum up the situation.  More important is that these ratios happen because ex dividends the Russell has returned pretty close to zero.

starting out in 2020

The S&P 500 is trading at about 25x current earnings, with 10% eps growth in prospect, implying the market is trading at around 22.7x forward earnings.  During my working career, which covers 40+ years, high multiple/lower growth has virtually always been an unfavorable combination for market bulls.

Could the growth figure be too low, on the idea that forecasters give themselves some wiggle room at the beginning of the year?

For the 50% or so of earnings that come from the US, probably not.  This is partly due to the sheer length of the expansion since the recession of 2008-09 (pent up demand from the bad years has been satisfied, even in left-behind areas of the country–look at Walmart and dollar store sales).  It’s also a function of shoot-yourself-in-the-foot Washington policies the have ended up retarding growth–tariff wars, suppression of labor force expansion, tax cuts for those least likely to consume, no infrastructure spending, no concern about education…  So I find it hard to imagine positive surprises for most US-focused firms.

Prospects are probably better for the non-US half.  How so?  In the EU early signs are emerging that structural change is occurring, forced by a long period of stagnation.  The region is also several years behind the US in recovering from the recession, so one would expect that the same uptick for ordinary citizens we’ve recently seen in the US.  Firms seeking to relocate from the US and the UK are another possible plus.  In addition, Mr. Trump’s life-long addiction to risky, superficially attractive but ultimately destructive, ventures (think:  Atlantic City casinos) may finally achieve the weaker dollar he desires–implying the domestic currency value of foreign earnings may turn out to be higher than the consensus expects.

 

The biggest saving grace for stocks may be the relative unattractiveness of fixed income, the main investment alternative.  The 10-year Treasury is yielding 1.81% as I’m writing this  That’s 10 basis points below the dividend yield on the S&P 500, which sports an earnings yield (1/PE) of 4.  I say “may” because, other than Japan, the world has little practical experience with the behavior of stocks while interest rates are ultra-low.  In Japan, where rates have flirted with zero for several decades, PE ratios have declined from an initial 50 or so into the low 20s. Yes, Japan is also the prime example of the economic destructiveness of anti-immigration, anti-trade, defend-the-status-quo policies Washington is now espousing. On the other hand, it’s still a samurai-mentality (yearning for the pre-Black Ship past) culture, the population is much older than in the US and the national government is a voracious buyer of equities.   So there are big differences.  Still, ithe analogy with Japan holds–that is, if the differences don’t matter so much in the short term–then PEs here would be bouncing along the bottom and should be stable unless the Fed Funds rate begins to rise.

That’s my best guess.

 

The consensus was of viewing last year for the S&P is that all the running was in American tech industries.   Another way of looking at the results is that the big winners were multinational firms traded in the US but with worldwide markets and very small domestic manufacturing and distribution footprints.   They are secular change beneficiaries located in a country whose national government is now adamantly opposing that change.  In other words, the winners were bets on the company but against the country.  Look at, for example,  AMZN (+15%) vs. MSFT (+60%) over the past year.

The biggest issue I see with the 2019 winners is that on a PE to growth basis they seem expensive to me.  Some, especially newer, smaller firms seem wildly so.  But I don’t see the situation changing until rates begin to rise.

 

Having said that, low rates are an antidote to government dysfunction, so I don’t see them going up any time soon.  So my practical bottom line ends up being one of the gallows humor conclusions that Wall Streeters seem to love:  the more unhinged Mr. Trump talks and acts–the threat of bombing Iranian cultural sites, which other governments have politely pointed out would be a war crime, is a good example–the better the tech sector will do.  As a citizen, I hope for a (new testament) road-to-Damascus event for him; as an investor, I know that would be a sell signal.

 

 

 

 

 

 

 

 

Keeping Score, September 2019

I’ve just updated my Keeping Score page for September 2019.  No sign so far of the traditional actively-managed mutual fund selloff in advance of the Halloween yearend.  I wonder why.  Is this a function of the AI era?   …the fact that passive money under management exceeds actively managed?   …is selling just late?

Will no selloff now mean no 4Q rally?    …that would be my guess.

$30 billion in new tariffs–implications

Yesterday Mr. Trump announced by tweet that he intends to impose a 10% duty, effective next month, on all US imports from China that are not yet under tariff.  That’s about $300 billion worth, which would produce an extra $30 billion in tax revenue for the government, were imports to continue at the pre-tariff rates.

What’s different about the current move is that tariffs will be predominantly on final goods, that is, stuff that’s completely made and ready for sale, things like like toys and everyday clothing.  For the first time, tariffs won’t be disguised.  Up until now, they’ve been mostly on raw materials or parts, where the connection between the tax and price increases of the final product is obscured–the political fallout therefore milder.   The new round will be more visible.

 

Standard microeconomics will apply:

–the cost of the new tax will be borne in part by US companies and in part by consumers, depending on how much market power each has

–over some period of time, companies and consumers will both look for lower-price substitutes for items being taxed.  Firms will, say, offer lower quality merchandise at the current price point; consumers will either buy fewer items or shift to cheaper merchandise

 

The new tariff amounts to a subtraction of about $250 from family discretionary income, meaning income after taxes and all necessities are taken care of.  That’s not a big number.  As with the other Trump tariffs, however, average Americans will be disproportionately hurt.  The bottom 20% by income have less than nothing after necessities now, so they will be the worst off.  Residents of the poorest states–eight of the bottom ten voted for Trump–as well.  So too anyone on a fixed income.

 

Netting out the positive effect of the 2017 income tax cut, the only winners are the top 1%, traditional Republican voters.  Other Trump supporters appear to be the biggest losers, although far they don’t appear to have connected the dots.  Nor does anyone in Congress seem to be questioning the administration rationale that national security does not require better infrastructure and education but does demand more expensive t-shirts and toys.

 

The stock market selloff underway today doesn’t seem to me to be warranted by the new tariff.  And it’s not exactly news that Washington is dysfunctional:  we’re led by a man who thinks our independence was won by controlling the airports; the leading opposition candidate somehow mistakenly thought his businessman/repairman/car salesman father was a laborer in the Pennsylvania coal mines.  So the most likely explanation is that in August human traders/portfolio managers head for the beaches, leaving newspaper-reading robots in control of Wall Street.

If that’s correct, the thing to do is to look for stocks to buy where the selloff appears crazy, getting the money from clunkers, which typically hold up in times like this or from winners whose size has gotten too big.