bonds …a threat to stocks?

I read an odd article in the Wall Street Journal yesterday, an opinion piece that in the US bonds are a current threat to stocks.  Although not explicitly stated, the idea seems to be that the US is in the grip of cult-like devotion to stocks.  One day, however, after a series of Fed monetary policy tightening steps, the blinders we’re wearing will drop off.  We’ll suddenly see that higher yields have made bonds an attractive alternative to equities   …and there’ll be a severe correction in the stock market as we all reallocate our portfolios.

What I find odd about this picture:

–the dividend yield on the S&P 500 is just about 2%, which compares with the yield of 2.3% on a 10-year Treasury bond.  So Treasuries aren’t significantly more attractive than stocks today, especially since we know that rates are headed up–meaning bond prices are headed down.  Actually, bonds have been seriously overvalued against stocks for years, although they are less so today than in years past

–from 2009 onward, individual investors have steadily reallocated away from stocks to the perceived safety of bonds, thereby missing out on the bull market in stocks.  If anything there’s cult-like devotion to bonds, not stocks

–past periods of Fed interest rate hikes have been marked by falling bond prices and stock prices moving sideways.  So stocks have been the better bet while rates are moving upward.  Maybe this time will be different, but those last five words are among the scariest an investor can utter.

 

Still, there’s the kernel of an important idea in the article.

At some point, through some combination of stock market rises and bond market falls, bonds will no longer be heavily overvalued vs. stocks and become serious competition for investor savings.

Where is that point?  What is the yield level where holders of stocks will seriously consider reallocating to bonds?

I’m not sure.

Two thoughts, though:

–I think the typical total return on holding stocks will continue be around 8% annually.  For me, the return on bonds has got to be at least 4% before they have any appeal.  So the Fed has a lot of interest-rate boosting work to do before I’d feel any urge to reallocate

–movement in yield for the 10-year Treasury from 2.3% to 4.0% means that the price of today’s bonds will go down.  So, while there is a clear argument for holding cash during a period of interest rate hikes, I don’t see any for holding bonds–and particularly none for holding bonds on the idea that stocks might fall in price as rates rise

Of course, I’m an inveterate holder of stocks.  And this is an interesting question to ask yourself.  What yield on bonds would make them attractive to you?

 

 

Employment Situation, May 2017

As usual, at 8:30 edt this morning, the Bureau of Labor Statistics of the Labor Department released its monthly Employment Situation.

The May results were ok, but not great.

The economy added 138,000 new jobs during the month, a reasonable number although one below recent reporting trends.  In addition, results for March and April were revised down by a total of 66,000.  Ouch!

Wage growth remains at an inflation-beating pace of +2.5% but continues to show none of the acceleration one might be hoping for,  given that the unemployment rate has fallen another notch to 4.3%.

my take

Let’s separate what’s going on from why it’s happening.

On the second question, I have inklings/prejudices but nothing that I’d care to act on.  My guess/fear is that jobs are being created, but in lower tax-rate foreign jurisdictions (meaning just about anywhere other than the US), and that machines are substituting for domestic labor, thereby keeping wages low.  If that were so, it would imply US employers believe President Trump won’t be able to advance his tax and infrastructure agenda.

But, really, who knows.

On the first, the signs are that after eight years, the US is finally at full employment again.  This would imply what other indicators seem to be showing–that’s there’s no reason to bet that there’ll be any “pent-up,” cyclically unfulfilled demand showing itself in surprisingly strong future consumer spending.

If so, the stock market should move away from cyclical ideas to secular growth and structural change beneficiaries.  In addition, overall annual upward movement in the broad indices should be limited to, at best, 1.5x the growth in nominal GDP.

The way I see things, this is the way Wall Street has been acting since early in 2017.  So this ES report is not new news.  Rather it’s confirmation of the direction the market has already recently taken.

 

 

Warren Buffett and Amazon (AMZN)

I read a recent comment Warren Buffett made expressing his regret at never having bought AMZN.

As far as I can see–and I’ve never met Mr. Buffett–he’s an urbane, sophisticated, complex individual who chooses a down-home persona to market himself to the world.  I don’t regard anything he says that involves the stock market as being a stray, off-the-cuff remark.  I wonder what he meant.

the top ten

As of March 31st, Berkshire Hathaway’s top ten holdings are, in order:

Kraft Heinz

Wells Fargo

Apple

Coca Cola

American Express

IBM (adjusted down for Buffett’s announced intention to pare his holding by 30%)

Phillips 66

US Bancorp

Charter Communications

Moody’s.

Source:  CNBC (a format that allows easy sorting of the SEC data)

The list comprises 80% of Berkshire’s equities.

 

Yes, despite Buffett’s well-advertised aversion to tech, there are two IT names in the top ten.  But IBM is cutting edge tech circa 1975 and AAPL is a high-end smartphone company looking for a new world to conquer.

the Buffett approach

All these firms do have the signature Buffett look:  they have all spent tons of money developing important consumer-facing brand names.  While that spending has created an enduring consumer franchise, there is no hint of the existence of this key asset on the balance sheet.  Rather, the all-important brand-building expenditure is accounted for as a subtraction from asset value.

The one possible exception to this is Charter, whose cable networks rather than sterling service and extensive advertising give it near-monopoly access to customers.  Here again, however, the ability to gradually write off the cost of constructing those networks through depreciation argues that the balance sheet severely understates their true worth.

The formula, in brief:  the “hidden” value of extensive well-staffed distribution networks plus iconic brands built through extensive spending on advertising and promotion.

limitations

The obvious limitations of this approach are:  that while novel in the 1950s, the whole world has since adopted Buffett’s once-pioneering approach; this would be great if there were no internet undermining the value of traditional brand names and distribution networks.

In other words, a software-driven, internet-based firm like AMZN seems to me to be the last thing that would ever be on the Buffett radar.  It also seems to me that taking AMZN seriously would mean rethinking the the whole Buffett investment approach–not the valuation discipline, but the idea of the value of traditional intangibles–and recasting it in a much techier way.

why not adapt?

Why not do so anyway, instead of kind of limping to the finish line?

Maybe it’s because that doing so would attack the heart of the intangible brand value of Berkshire Hathaway itself–and that attack would come not just from a nobody but from the brand’s most credible spokesperson, the Sage of Omaha himself.

 

what about last Wednesday?

That’s the day the S&P 500 took a dramatic 2% plunge, with recent market leaders doing considerably worse than that, right after the index had reached a high of 2400.

Despite closing a hair’s breadth above the lows–normally a bad sign–the market reversed course on Thursday and has been steadily climbing since.  The prior leadership–globally-oriented secular growth areas like technology–has also reasserted itself.

My thoughts:

–generally speaking, the market is proceeding on a post-Trump rally/anti-Trump agenda course.  Emphasis is on companies with global reach rather than domestic focus, and secular change beneficiaries rather than winners from potential government action that have little other appeal

–while trying to figure out whether the market is expensive or cheap in absolute terms is extremely difficult–and acting on such thoughts is to be avoided whenever possible–the valuation of the S&P in general looks stretched to me.  Tech especially so.  This is especially true if corporate tax reform ends up being a non-starter.  My best guess is that the market flattens out rather than goes down.  But as I wrote a second or two ago absolute direction predictions are fraught with peril

–tech is up by 17.0% this year through last Friday, in a market that’s up 6.4%.  Over the past 12 months, tech is up by 35.2% vs. a gain of 16.8% for the S&P.  Rotation into second-line names appears to me to be under way, suggesting I’m not alone in my valuation concerns

–currency movements are important to note:  the € is up by about 10% this year against the $, other major currencies by about half that amount.  Why this is happening is less important, I think, than that it is–because it implies $-oriented investors will continue to favor global names

–the next move?  I think it will eventually be back into Trump-motivated issues.  For right now, though, it’s probably more important to identify and eliminate faltering tech names among our holdings (on the argument that if they can’t perform in the current environment, when will they?).  My biggest worry is that “eventually” may be a long time in coming.