Tag Archives: money

dividend-paying stocks

March 17, 2014 By in Constructing a Portfolio, Current Market Thoughts, Industry Analysis, Recent Market Action, Securities regulation, Utilities Tags: , , , , , , 1 Comment

Robert Rhodes of Rhodes Holdings LLC made one of his usual astute comments about my post last Thursday on utility stocks.  In this post, I’m going to elaborate on my view of buying stocks for their income.

Financial planning guides often mention that when selecting a stock because of its dividend, one should consider not only its current yield but also the potential for the payout to grow.  My impression is that the authors don’t just want to steer us away from too-good-to-be-true extremely high current yields, which are most often a sign that the market thinks the dividend is likely to be cut sharply or even eliminated.  I think they also believe it’s better for investors to pick a stock with, say a 3% current yield and the possibility of 8% annual growth in the payout vs. a stock with a relatively secure 6% yield and no dividend growth potential.

For a Millennial, who arguably has no business getting involved with income stocks, the expert advice is probably correct.  In contrast, for a senior citizen looking for income-generating investments to support retirement, the 3% yield + the promise of growth is certainly better than Treasuries.  But for a seventy-something a good argument can be made that the 6% current yield is the better choice.   At least, that’s what I’ve thought until very recently.

my reasoning?

The handy-dandy rule of 72 tells us that a 3% yield growing at 8% per year doubles in nine years (72/8).  It takes that long for the payout to equal the 6% dividend of the non-grower.  This also means someone who buys $100 worth of the 3% yielder collects $40.50 over the nine-year period, assuming the payout increases at a uniform rate.  The person who chooses the 6% yielder collects $54.  It takes the former another two years+ to draw even in terms of total income received.

Put a different way, the superiority of the 3% yielder with growth doesn’t come into bloom until over a decade after purchase.  That’s a long time.  It hasn’t been clear to me that financial planners fully appreciate how large/long the shift in income is away from the period a senior citizen may be young and healthy enough to enjoy the money.

Capital gains?  In theory, the steady-state 6% yielder has significantly less capital gains potential than the 3%er.  But who knows?  Arguably the senior citizen is more concerned with preservation of income than in making capital gains.  It’s also possible that the sprier utility won’t be able to sustain profit expansion for such a long time.

my change of heart

As I wrote last week, the negative effects of years of downward regulatory pressure on utility rates in mature areas, and the consequent corporate response of cutting maintenance/replacement are starting to become apparent.  It’s no longer clear to me that the dividend payments of no-growth utilities are as rock solid as I’ve been assuming.  So, yes, there’s a chance that the fast grower will slow down in short order.  But I now think there’s also a good chance that mature utilities will be forced to divert large amounts of cash flow away from shareholders in order to shore up creaky infrastructure.  So the mature utilities may be much riskier than they appear.

 

problems in emerging countries (i): economic

February 19, 2014 By in Balance of Payments, economic problems in emerging countries, emerging markets, securities markets Tags: , , , , , , , Leave a comment

There has been a lot of hand wringing lately about emerging markets.  Worries are two-fold:  economic problems and stock/bond market problems.  Today I’m going to write about the first, tomorrow the second.

Even when I was in school, there was a well-understood, coherent, all-encompassing theory of how a closed one-country system works economically.  There’s nothing like that, even today, for a multi-country system with open trade, differing political philosophies and involving countries at various states of economic development.

I guess I’m saying that what follows is highly simplified, although I think it still gets across what the basic forces at play are.

an emerging country

Suppose the citizens of  an emerging country, or the government for that matter, want to obtain goods made by another country.  Let’s also say the seller won’t accept the buyer’s local currency but wants to be paid either in its own currency or in some global standard, like dollars, or euros or renminbi.

The buyer has several choices.  It can:

–barter with the other country, avoiding the forex issue,

–sell domestic goods in international markets, obtain foreign currency that way and use it to buy the foreign goods,

–use foreign currency it has previously piled up somewhere,

–sell domestic assets, like farmland or mineral rights, to foreigners or

–borrow the foreign currency it needs.

If the country routinely generates enough foreign exchange to meet its needs (think:  oil exporters), there’s no problem.  It can buy all the foreign goods it wants.  But that’s not normally the case.  Emerging countries routinely run trade deficits (that is, they buy more stuff from foreigners than foreigners buy from them).  To make up the difference, they borrow any extra foreign currency they require.  [an aside:  it’s also possible that the government of the country we’re talking about runs a budget deficit, meaning it spends more than it takes in.  That’s also a problem, but it’s not what we’re talking about here.)

In economic boom times, investors tend not to worry too much about how and when they’re going to be repaid.  (In fact, a generation ago international banks deliberately made loans to emerging countries that they knew could not be repaid.  The banks figured they’d collect big fees when the loans were restructured.  The possibility of default never entered their heads.)

In leaner times, investors look more carefully.  They make a (crucial) distinction between borrowing that pays for factories that will manufacture goods for local use or export, and borrowing that pays for purchases that produce no economic return (think: flat screen TVs, gold jewelry or military gear).  Building factories that will generate foreign exchange in a year or two is ok.  Borrowing to buy consumer items isn’t.

Lenders may initially be willing to make loans that are payable in local currency.  As/when the country begins to have a chronic trade deficit, lenders are no longer willing to do so  They shift to loans repayable in dollars…, which makes the foreign currency problem worse.

In cases where lenders see the probability getting their money back declining, new lending dries up.  The local currency begins to weaken.  The government has to raise interest rates–this supports the local currency and cuts into demand for foreign goods by slowing overall economic activity.  This is all toxic stuff politically.  Sometimes (think:  Argentina) local governments find any form of austerity to be impossible.

In my experience locals sense the beginning of a downward spiral long before the international investing community does.  Capital flight begins.  This makes the situation worse.

loose worldwide money policy

One of the side effects of qualitative easing in the US + Abenomics in Japan + Chinese efforts to promote the renminbi as a world currency has been to flood the world with money.  A lot of that has found its way into sketchy emerging countries that are economically unstable and on the verge of a currency crisis.  It appears many yield-chasing investors were unaware of the risks they were taking.  The presence of relatively high yields was all they saw.  Others were playing the greater-fool theory, figuring they could sell before the music stopped.

When the Fed began to talk about an end to tapering, the latter group knew the game was up and began not only to cease new lending to,but also to extract their money from, what has since become known as the Fragile Five.   That has led to weakening currencies, lower securities prices and a higher cost of lending in these countries.

fixed income speculation and tapering

February 13, 2014 By in bond market, contingent convertibles, Current Market Thoughts, junk bonds, pik bonds Tags: , , , , , , , , , 1 Comment

One of the earliest attempts by technical analysts in the US to link their work to economic variables was in charting the relationship between growth in the domestic money supply and stock market advance.

This wasn’t Milton Friedman.

This was–and is–a common sense attempt to create a barometer to measure the degree of speculation inherent in the stock market.  The idea is that the economy needs a certain amount of money to grease the wheels of commerce–to keep factories humming, meet payrolls, build inventories.  Anything in excess of that amount will inevitably find its way into financial speculation in equities, real estate and commodities.  Speculation, in turn, will lead to intervention by the Fed , “to take away the punch bowl,” as William M. Martin, a former Fed Chairman put it.  (Or, in the most recent case, where the punch bowl was heavily spiked and stayed out forever, a near-meltdown of the world financial system.)  So it’s an early warning indicator of a market decline.

Although still used by at least one famous hedge fund, this simple rule has lost much of its usefulness in a globalized world with supply chain management systems, ubiquitous, but only semi-visible derivative contracts and the increased prominence of businesses based on intellectual property.

I think, however, that the Fed is using this rule, but has reversed the inference, as part of its rationale for tapering.  I think the Fed sees increasing speculative activity in fixed income markets as evidence that there’s too much money sloshing around in the world.  (I know I am.)

Three areas worry me:

—pik bonds.    Pik stands for payment-in-kind.  It’s a type of junk bond where the issuer has shaky cash flows and may not be able to afford to make interest payments on its debt.  So lenders allow the firm to pay interest “in kind,” meaning issuing more junk bonds to cover the interest expense.  As is always the case in investment banking, there are variations on the theme:  the bond may be pik from inception; the issuer may have the right to convert the bonds from cash to pik, if he needs to; or the issuer may be able to “toggle” back and forth between cash and pik as he desires.

In my limited junk bond experience, pik bonds only rear their heads at bond market peaks.  And they’re here again.

—contingent convertibles, or “cocos.’   The original cocos, spawned by the financial crisis, are bonds issued by financial companies that can be forcibly converted into equity–thus shoring up regulatory capital–if the issuer gets into financial trouble.  In my view, the buyer is exposed to all the downside of owning an equity with few of the rewards.

According to the Financial Times, a new variation on the coco theme has recently appeared.  The new securities are called “sudden death” or “wipeout” bonds.   Their attraction is that they pay coupons of around 8%.  The catch is that if the issuer’s regulatory capital falls below a ratio specified in the bond indenture–so far its been if a bank’s Tier One equity ratio falls below 7%–then coco holders lose all their money.  

To me, this looks like an equity put dressing it up in bond clothing so fixed income managers can buy it.

—the Fragile Five.  2014 opened to a bout of bondholder angst about their positions in the debt of places like Argentina.  Argentina?   Really?  Isn’t this the same place that nationalized Repsol in 2012?   …the same place that defaulted on its sovereign debt in 2001?   …where capital flight has accelerated to the point that the government has shut down online shopping to prevent money from leaving the country?  Talk about risky.

I think these areas worry the Fed, too.  They’re why I think we’d have to see considerable economic weakness in the US before tapering comes to a halt.

what’s wrong with having Congress audit the Fed?

February 12, 2014 By in Portfolio management, Strategy Tags: , , , , , , Leave a comment

I was driving in southern New Jersey yesterday, where car radio reception is spotty.  So I ended up, as usual, listening to Bloomberg Radio on Sirius.  So I heard a lot of Janet Yellen’s testimony before Congress.

Ms. Yellen has a terrible speaking voice.

It’s hard for me to judge how much of the apparent lack of basic economic/financial knowledge evinced by members of the House Committee on Financial Services was real, and how much was political theater aimed at advancing political agendas.  Michael McKee, who formerly covered Congress and who I think is one of the brightest spots on Bloomberg Radio, believes the former.

Anyway, to auditing the Fed.

Let’s be clear.  This isn’t about auditing in the sense of making sure the financial statements are pertinent and accurate.  Nor is it about making sure that every expenditure is documented and every penny accounted for.

It’s about a Rand Paul proposal to give the Government Accountability Office, an arm of Congress, the ability to publicly second-guess the decisions of the Fed on monetary policy.  GAO activity would presumably include not only public criticism of the soundness of policy itself, but also questioning of the Fed policymakers’ opinions and their professional qualifications.  This would be the first step in restricting the independence of the Fed and making it subject to the will of Congress.

What’s wrong with that?

Two things:

–if members of the Fed become targets of public Congressional pillorying, then the list of highly qualified economists lining up to make careers in public service at the Fed will shrink to nothing.  We could end up with unlicensed people driving the school bus.

–the Federal government has currently borrowed $17 trillion+, at relatively low rates of interest.

The primary concern of lenders to the US is that they will be paid back in full.  One of the primary criteria they consider is whether a given sovereign borrower has a monetary authority run by highly skilled economists, free of political influence.  They know that politicians are often short-sighted and in tough times may try to wangle out of their repayment obligations. ( The standard way of doing this is by running an over-loose policy that creates  inflation, reducing the real value of what they owe.)  A strong, independent central bank is lenders’ assurance that this won’t happen.

Implementing the Rand proposal calls this into question.  The response by lenders would be to demand higher interest rates in compensation for the additional risk.  If we assume this would raise the interest rate the government would pay by 50 basis points (I’m making this figure up, but it seems like a good guess to me), that would mean an extra $85 billion a year in interest expense.  This wouldn’t happen right away, and the rise would predominantly be on the longer end of the yield curve, but still…

The US$ is the world’s reserve currency.  This gets us lower borrowing costs and easier access to funds since we’re the bank.  The rest of the world isn’t thrilled by this, but willing to put up with the current system.  That’s in large measure because of the independence of the Fed.  Lose that and creating a replacement (the renminbi?) becomes an urgent concern for the rest of the world.  Again, higher borrowing costs for the US–not right away, but suddenly the possibility has to be on investors’ radar screens.

my recent Pink Sheet experience

February 11, 2014 By in buying and selling, pink sheets, Trading Tags: , , , , , Leave a comment

what the Pink Sheets are

I’ve written about the Pink Sheets before, in much greater detail than here.

Basically they’re an electronic marketplace for trading equities not registered with the SEC.  Some are stocks of foreign issuers and the Pink Sheets is the main place they’re traded.  Others are domestic.  Some of the latter are small, illiquid and haven’t filed financials (if they have any) with the SEC.  This second group, and the rough-and-tumble trading that sometimes occurs with both, are the source of the Pink Sheets’ shady reputation.

In the pre-computer days, quotes for such stocks were delivered to traders in daily lists printed on long strips of pink paper.  That was to distinguish them from quotes for bonds of similar ilk, which were printed on blue paper.  Hence the name.

anyway, what happened–

About an hour before the close in Hong Kong last Wednesday, the Macau casino regulator issued its report of the total amount lost by gamblers in SAR in January.  The figure was a surprisingly weak +7%, year-on-year.  The Macau casino stocks sold off immediately, and were down at the close by about 10% from their pre-announcement levels.  At the New York open, WYNN and LVS sold off  by more than 5% as well.

As the New York morning progressed, reports began to circulate that the Macau market had actually been strong–that the apparently weakness was caused solely by the timing of the Lunar New Year.  The US stocks rallied.

During the afternoon, I checked the Pink Sheet quote for Sands China (SCHYY).  I noted that average daily volume is US$1.6 million vs. US$145 million for HK:  1928 in Hong Kong.  More important, the stock hadn’t budged an inch; it was still stuck at the Hong Kong close.   Weird.

So I bought 150 shares.  Yes, it was a risky thing to do.  It took maybe ten minutes for my (puny) limit order to be filled, another warning sign.  But I was curious.

The Macau gambling stocks rose on Thursday in Hong Kong by around 10%.

SCHYY mirrored the Hong Kong close.  I sold as fast as I could.

The following day, Friday, the Macau gambling stocks were flat to down in Hong Kong.

here’s the interesting part:

SCHYY opened down 3%, at $76.53, on 21, 952 shares.

After that one trade, the market became 200 shares bid at $74.29, 300 shares offered at $76.29.

In other words, liquidity dried up completely.

The stock traded about 10,000 shares during the rest of the day, at what the chart shows as prices below $75.

Monday, the stock traded only 6,866 shares, or about $500,000 worth of stock, all day.

what you should notice

–no mutual fund or pension plan portfolio manager is going to buy SCHYY.  It’s just too illiquid.  So there’s going to be no buying support for the stock from this quarter.  (Let’s say an average position size for one of these professionals is $10 million and that they thought they could be a a quarter of the daily volume without anyone figuring out they were in the market (fat chance).  Even if so, it would take a month+ to buy or liquidate.)

–after the big (for SCHYY) opening trade, market makers widened the bid-asked spread to almost 3% and pushed the market down.  They also committed themselves to only trading a tiny amount of stock at the price they showed–meaning the market would sink further if more stock followed the next trade.

All this is designed to signal they’re only willing to take more stock on their books at a heavily discounted price–that is, to stop the selling.  As the rest of the day showed, this tactic was successful.

–in most cases, the best course of action for a seller who thinks he must get out of the stock for some fundamental reason is to accept the discounted price and be the first out the door.  Yes, selling will be ugly.  But that’s better than having the market 10% lower, with you having sold nothing.

Welcome to the Pink Sheets!!