Q2 Earnings: Good Enough

Posted on July 23, 2013 by tomdoerflinger

The second quarter S&P 500 bottom-up EPS estimate is around $27.00 and should creep higher during the rest of earnings season.  This is consistent with strategists’ full-year 2013 estimates of $108-110.  Results are not great but good enough for stocks to keep grinding higher, barring an exogenous shock.  Bears can find plenty to criticize in Q2 results, but I don’t find the critiques persuasive.  Yes, the positive surprises so far have been dominated by financials, but so what?  I don’t recall investors saying in the summer of 2008, “Well profits aren’t so bad if you ignore financials.”  Yes, revenue is weak,  but keep in mind that the weakest sector is energy, where revenue does not mean that much to investors; most other sectors are up low-single digit despite a strong dollar that is shaving about 2% off of multinationals’ revenue.  Yes, big tech companies mostly missed, but this has less to do with a dismal global economy than market share losses of incumbent players such as MSFT, INTC, ORCL, and IBM, to new technologies.

Results of well-managed multinationals such as Coca-Cola and McDonalds underscore the global economy is weak from Shanghai to Stockholm.  Nevertheless, quite a few big bellwether non-financials posted earnings that were acceptable or strong—in many cases better than over the past few quarters.  I am thinking of JNJ, BAX, GE, UNH, UTX, HAL, DD, HON, SLB, WHR, LMT, DOV, JCI, TXN, and GWW. There is no evidence that the underlying momentum of earnings is worse in Q2 than over the past couple of quarters.

S&P 500 profits should continue to rise next year from, say, $109 in 2013 to $116 in 2014. Share buy-backs can continue to contribute 150-200 bps of that that 6.6% increase. Admittedly, the macro outlook is mixed at best.  There is downside risk in China, and even if Europe is bottoming out demand will stay very soft for the next few quarters.  As I have been highlighting for over a year (and as delay of Obamacare’s employer mandate underscores) Obama’s anti-capitalist onslaught (remember “You didn’t build that”?) continues to throw a wet blanket on the economy. His latest salvo is the attack on coal.  And I won’t be shocked if he shoots down the Keystone XL pipeline, potential source of hundreds of good-paying blue collar union jobs.

Nevertheless, the U.S. has legitimate growth drivers, including housing, autos, and domestic energy production.  We won’t have big tax hikes in 2014 as we did in 2013.  And next year comparisons will be easier for certain big cyclical that have already been hit by the weakness in China; for example, this year CAT earnings will drop about 21% and FCX 17%.

What does all this mean for stock prices? They probably trend higher, though not in a straight line.  As we have seen in the valuation junk bonds and high-dividend-yield stocks, investors are “reaching for yield.”  With the payout ratio still low at about 32%, S&P 500 dividends are likely to rise faster than earnings, and investors will pay up for payouts. If the PE ratio were stable and the S&P 500 earned $116 in 2014, the index would be at 1800 a year from now.  If the PE climbs half a point to 16x, the index will be at 1850, implying a price gain of 9.5% and a total return of nearly 12%.  Not bad in a world of 2.5% bond yields and return-free money market funds.  But expect some volatility along the way.

Copyright 2013 Thomas Doerflinger.  All Rights Reserved.

Posted in Uncategorized | Tagged , , | Leave a comment

The China Syndrome: Will GDP Growth Top 5%?

Posted on July 12, 2013 by tomdoerflinger

Two months ago I attended a dinner of Wall Streeters at a proper club in midtown Manhattan; it called to mind the locker room scene in the movie Wall Street where Gordon Gekko wisely opines, “That’s the thing you gotta remember about WASPs – they love animals, they can’t stand people.”  Anyhow, in attendance at the dinner was my friend Bill, the Smartest Strategist on Wall Street.  Bill told me after the dinner, “Tom, the reason the ISM was so weak [it was 49 that month] is that China is slowing down.”

Bill was right, as usual.  I know almost nothing about China, except what I read in The Financial Times.  But what I read is pretty scary; if you apply a little logic it is reasonable to conclude China growth will be much worse than current consensus. Yesterday in an FT column, “wise man” Gavyn Davies made these salient points:

  • China will need to spend several years tackling a combination of excess credit and overinvestment.
  • China is in the midst of a classic credit bubble.  The ratio of total credit to GDP has climbed from 115% in 2008 to 173%, a danger level.
  • The debt service ratio in the economy, which the Bank for International Settlements says reliably signals risk of banking crisis, is around 39% (according to SocGen).  The danger level is 20-25%.
  • Much of the credit financed “low return” capital spending by local governments—i.e., the Chinese equivalent of Alaska’s “bridge to nowhere.”
  • The arithmetic to get a soft landing is “formidable.”  Private investment growth needs to slow to about 4% in the next decade from 10% in the last decade.
  • On the bright side, government has the money to capitalize the banks if necessary.

It gets worse.  The latest figures on exports and imports were much weaker than expected, which is not surprising because all of China’s major markets are growing slowly, if at all.  The FT quotes a “spokesman for the customs administration” as saying, “Our country is facing serious challenges.”

So, to summarize, the two major drivers of China’s growth, exports and investment, are slowing sharply.  A credit bubble is being popped.  And much of the credit growth of the past few years funded government projects which, by definition, were made at least partly for political not economic reasons.

Even if the government has the capital needed to prevent a “China Syndrome” meltdown, we can expect Wall Street economists to keep ratcheting down their forecasts—a lot.  For the past couple of years the major Wall Street houses have been playing a dainty parlor game of cutting their China GDP growth forecasts 10 or 20 bps at a time—7.5%, 7.4%, 7.2%.  My guess is that, before they are done cutting, they will be debating whether growth is above or below 5%.  Even competent, well-managed governments of giant, sprawling nations that are simultaneously grappling with a credit bubble, overinvestment by governments, and a sharp slowdown in exports should not be expected to engineer an oh-so-soft landing in GDP growth.

Copyright 2013 Thomas Doerflinger.  All Rights  Reserved.

Posted in Uncategorized | Tagged , , | Leave a comment

Regime Change: What the Bond / Gold Rout Means for Stocks

Posted on July 5, 2013 by tomdoerflinger

For well over a year I have been bullish on stocks, arguing it made little sense to own a bond yielding 2% instead of well-managed blue chip stocks yielding 2-5% with dividend growth of 5-12%. If all went well, I argued, a “valuation levitation” was likely.  With the S&P 500 up 11.7% in the first half of this year, it has happened.  To coin a cliché, the easy money has been made.  What now?  Over the next couple of years the public, with apologies to Dr. Strangelove, will stop worrying and learn to love equities. This process has already started and will push up PE ratios at least modestly, making stocks a good investment over the next 2-3 years.

Since March 2009 the S&P 500 has more than doubled even as investors ran away from stocks; there were net outflows of $258 billion from equity mutual funds and $654 billion net inflows into bond funds.  Individuals particularly hated U.S. equities, selling $353 billion in domestic equity funds, but they loved gold.  Investors didn’t worry about missing the bull market in stocks because they were making good money in bonds and gold. But now the “safe haven” status of bonds and gold has been shattered, necessitating a rethink. Over the next couple of years stocks will become respectable again as we shift to a new investment regime.

The ABEI Regime (2001-2013) . . .

Abei is not a city in the Middle East; it stands for Anything But Equity Investing.  The bursting of the tech bubble, 2000-2002, discredited long-term investing in equities — a view that was confirmed by the 2008 crash.  So investors flocked to:

  • Residential real estate (until 2008).
  • Commercial real estate.
  • Bonds.
  • Gold (Remind me again—is it a hedge against inflation or deflation?)
  • Other commodities, ranging from platinum to timber land.
  • Private Equity
  • Hedge funds.  To avoid the risk of long only investing, most funds actively trade—long / short pair trades; distressed debt; risk arb; macro bets on gold, currencies, etc.; and (it turns out) quite a bit of insider trading.

ABEI has driven a cultural shift in the markets that younger investors don’t appreciate.  There is today an absurd fixation on macro issues, such as Wall Street’s current “taper tantrum.”  ETFs facilitate aggressive trades in obscure macro variables that were out of reach of most investors a few years ago.   Brokerage firms have shifted their focus from researching long-term growth opportunities to spotting short-term trades.  At the morning meeting, salesmen are less interested in Starbucks’ growth rate than how SBUX options will trade when the company reports same store sales on Wednesday.  The Street’s new short-term ethos is nicely captured in the entertaining book Buy Side by former hedge fund trader Turney Duff, a man of many vices (cigarettes, booze, coke, pot, hookers, porn) and considerable literary talent.  Duff describes the often zany interaction between traders at “buy side” money management companies and the “sell side” (brokerage firm) salesmen and sales traders who help them make money for their investors—or at least live well in Manhattan while failing to do so.

During the ABEI regime influential institutions, such as Ivy League endowment funds, shifted from U.S. equities to the above-named alternatives, particularly hedge funds and private equity.  For example, Harvard’s allocation to domestic stocks fell from 38% in 1995 to 11% in 2013.  The current allocation of Yale and Princeton to domestic equities is even lower at around 7%.  Stuck in illiquid assets, they are missing out on the rally in U.S. equities.

. . . and Four Reasons Why ABEI is Fading

Reason Number 1.  Investing is about the future, not the past.  If I look at the stocks I own – CAT, PM, SBUX, whatever – it is not their fault that stocks collapsed in 2000-2002 because they became overvalued.  Nor is it their fault that in 2008 the financial system almost collapsed due to a housing bubble created by Washington with ample help from Wall Street and Main Street.  Stocks may be volatile, but with everyone on the lookout for the next bubble, they are actually less risky than before 2000.  And if you own stocks for long-term dividend growth, price volatility doesn’t matter much.  Even during the 2008-2009 crash, more S&P 500 firms raised than cut dividends.

Reason Number 2.  Macro bets are little more than gambling because no one except George Soros can make money anticipating macro trends and investor psychology. Even the Fed, with its platoons of economists and unlimited access to financial information, has failed to anticipate the last three recessions.  Currently some big-name fund managers, such as John Paulson and David Einhorn, are losing big money in gold.  And the crown is slipping from the brow of “Bond King” Bill Gross, who proclaimed nearly a year ago that the “cult of equities” was dead because stocks are a “Ponzi scheme.”  Stocks are up 18% since Bill shared his insights with the public.  (For why Bill was wrong, see our Aug. 3, 2012 post, “Another Stock Market Buy Signal from Bill Gross?“)

Reason Number 3.  From the point of view of shareholders, large U.S. companies have rarely been better managed.  Companies cleaned up their corporate governance act after Sarbanes Oxley was passed in 2002, and they became even leaner and meaner after the 2008 liquidity scare.  Margins have never been higher and firms are judiciously allocating free cash flow toward capex, M&A, dividends and buy-backs in a very shareholder friendly manner.  Corporate tax reform that liberated overseas cash would further enhance this theme.

Reason Number 4.  Hedge funds have several serious flaws that are gradually becoming recognized.  They are tax inefficient because gains are taxed annually as ordinary income, not eventually at a lower capital gains rate.  Second, trading strategies that try to exploit short-term market inefficiencies fail to benefit from the fact that stock prices really do rise over time – for example, at a 6.7% annual rate since 1966 (not including dividend yield, which averaged 3.0% since 1966).  Hedge funds are also illiquid and expensive.

Bottom line:  As the alternatives lose their luster stocks will become more popular with investors and, assuming inflation and rates stay low, the PE ratio will trend higher.  Rising PE on rising EPS is a potent combination; it is multiplicative, not additive.  (Eg., if PE rises 10% and EPS 20%, price rises 32%, not 30%).  If the S&P 500 earned $124 in 2015 and the trailing PE rose from the current 15.2x to a very reasonable 17x, the year-end 2015 price would be 2111, up 32% from the current level.  Throw in dividends and you’re looking at a total return of nearly 40% in two and a half years.

Historical Perspective:  Stock Market Regimes Since 1950

1950s:  A Hedge Against Inflation.  With bond yields very low in the 1950s investors—still scarred by the 1929 crash—cautiously crept back into stocks, which rose 258% as the trailing PE on GAAP EPS rose from 7x to 17x.  The market mantra was that you had to be in stocks as a “hedge against inflation” (which is mostly true as long as inflation is not too high).

1962-1972:  Stocks a Go-Go  In the sixties, stocks went from necessary to sexy.  Financiers started to create what the media called “high-flying conglomerates” that flattered their earnings by using their high-PE shares to acquire companies with lower PEs.  Conglomerates’ glamour was tarnished by poor performance during the 1970 recession, but investors moved on to “one decision growth stocks” in 1971 and 1972.  The “nifty fifty” were mostly tech, healthcare, and consumer growth issues that were, in many cases, excellent companies. But they became too expensive (median PE: 41x) and collapsed when inflation spiked in 1973.

1970s: Inflation and the “Death of Equities.”  Stocks were a terrible investment during the inflationary 1970s; the S&P 500 was no higher in 1982 than 1972, meaning its inflation-adjusted price fell 57%.  Corporate America was over-regulated and poorly managed (why bother cutting costs when you can raise prices?), and risk capital nearly dried up as capital gains taxes soared.  With investors fleeing equities in favor of real estate, gold, industrial commodities, and collectibles, Business Week flashed an early “buy” signal with its 1979 cover story, the “Death of Equities.”

1980s:  Rebirth of Equities  The collapse of inflation in 1981-83, and a surge in corporate takeovers (many financed with new-issue junk bonds invented by Michael Milken) drove stock prices up 227%. But high real interest, stock market volatility caused by program trading, and the 1987 stock market crash kept the public on the sidelines.

1990s:  Stock Market Mania  Very low interest rates after the 1990-91 recession pushed individual investors back into stocks, and by the late 1990s they were enthralled by the Internet and TMT (tech, media, telecom) stocks.  As money poured into index funds valuations of large-cap stocks hit excessive heights; by March, 2000 the S&P 500 trailing PE was 26x.  The ensuing crash was arguably worse than the 1930s or 1970s, because many Internet companies and widely held large-cap issues – such as Nortel, Lucent, Worldcom, Enron, Sun Micro, and Global Crossing – did not merely decline in price; the companies crashed and burned.

2001-13:  ABEI  (Anything But Equity Investing)—see above.

2013-20??:  Stay Tuned

Copyright 2013 Thomas Doerflinger.  All Rights Reserved.

Posted in Uncategorized | Tagged , , , , , | Leave a comment

Digitization: Are Universities the Next Newspapers?

Posted on July 1, 2013 by tomdoerflinger

Back in the 1990s I used to write thematic investing reports on winners and losers from the advent of the Internet.  One day I had a minor epiphany.  Why, I wondered, would anyone pay to place in the local newspaper a three line “classified ad” for a “Blue 1995 Chevrolet in good condition with 55,000 miles  New transmission” when they could run an Internet ad with several color pictures and full details on condition, options, location, etc.?  Newspapers, I decided, were toast.  Lots of fixed costs, declining revenue.  It may seem obvious, but not to everyone; since 2000 “value investors” have gradually ridden NYT down from 40 to 10 and GCI from 70 to 25.

Here is the analogous question for higher education: Every September, college students across the U.S. file into lecture halls to listen to the 1st of 24 lectures on Econ 101.  From Maine to Alaska they hear the same stuff—supply and demand, indifference curves, comparative advantage, components of GDP, etc.  Obvious question: Why not have one really great professor deliver the lectures over the Web while on-campus professors teach small classes to help students master the material?  Like the online auto ad, it would be cheaper and better.

It will happen, but the transition will be messy.  In the case of newspapers, ads are a pure commodity, so outside “disrupters” such as Craigslist could quickly grab market share. By contrast, the better universities have strong “brands;” they confer valuable credentials; and they are largely run by professors who have a vested interest in the status quo. The faculties of San Jose State College, Duke, and Amherst have all resisted the introduction of online courses.  Professors not only want to keep their jobs; they also have what psychologists call a “high need for autonomy.” They didn’t spend years getting a PhD to help teach someone else’s course.

But universities have a big problem newspapers did not: Customers can no longer afford their product.  The $1 trillion in educational debt is hard to service, let alone pay off, when unemployment is elevated and Obamacare will force young people to overpay for mandatory health insurance.  A year at Princeton costs $56,000; my crude calculation, which excludes both investment returns and tuition inflation, is that if Bill and Sarah have a 34% combined Federal and state tax rate, they need to generate over $1 million pre-tax to send three kids to Princeton. That’s $50,000 per year if they save for 20 years. Not many people can afford to do that when they also need to save for retirement.

Universities, unlike newspapers, also face a big and immediate demographic reality, which they could view as an opportunity but probably won’t. Young people already live online and won’t mind getting their lectures over the Web. Entering freshmen have few preconceptions about what a “standard” university curriculum consists of.  If they file into their first Econ 101 lecture and see a dynamic Nobel Prize winner from MIT hold forth on Supply and Demand, they are not going to complain.

Bottom line: Significant digitization of higher education is both feasible and inevitable.  Established universities should use online lectures for basic courses while professors devote their energy to small classes and one-on-one mentoring.  There are also huge savings to be had by slashing the number of administrators. But, like other organizations, universities won’t change until they must.  In my experience, industry insiders, whether in the auto industry or on Wall Street, are always “the last to know” that their industry needs radical restructuring.  The catalyst for change in academia will probably be the appearance of much cheaper start-ups that utilize the Web and the failure of a few small and respected liberal arts colleges.

Copyright 2013 Thomas Doerflinger.  All Rights Reserved.

Posted in Uncategorized | Tagged , , , | Leave a comment

ObamaCare is Hurting Hiring

Posted on June 21, 2013 by tomdoerflinger

On its website the law firm Littler Mendelson proclaims, “With over 55 offices in major metropolitan areas nationwide, more than 950 Littler attorneys provide the firm’s clients with representation and daily advice concerning dozens of different areas of labor and employment law.”  Its bread and butter is helping clients cope with government rules, so we can be sure it is not ideologically hostile to new regulations.  Which makes its survey of how small businesses are preparing for ObamaCare all the more credible and revealing.

Small Business Speaks

The firm commissioned a Gallup poll of 603 small business owners (revenue under $20 million) to discover how they viewed ObamaCare and were planning for the new law.  Bottom line: the firms are scared stiff and have already cut back on hiring and business expansion.  A Littler Mendelson partner claimed to be “startled” by the results, but I am not at all surprised. For the past few years I have been going on about how ObamaCare and other new regulations would discourage hiring.  For example, last July I showed why the law “makes it far more costly and complex for all small businesses to hire workers.  Figuring out healthcare rules has become as daunting as calculating your taxes, maybe more so.”  (See “The Other Keynesian Paradigm,” July 9, 2012.)

ObamaCare not only raises the cost of labor but increases the legal risks of hiring.  Make one mistake in interpreting the thousands of pages of legalese and your friendly IRS agent could hit you with a huge fine. The recent IRS scandal, showing the agency to be corrupt and incompetent, increases the perceived risk of hiring.  Here are key findings of the Littler Mendelson survey, as reported by CNBC:

  • 19% of businesses answered “yes” when asked if they had “reduced the number of employees you have in your business as a specific result” of ObamaCare.
  • 41% have frozen hiring because of ObamaCare.
  • 38% said they “have pulled back on their plans to grow their business” because of the law.
  • 48% think the law will hurt their profitability; just 9% think it will be good for their business.
  • 55% believe ObamaCare will raise healthcare costs; just 5% said it will cut costs.
  • 52% expected the law to reduce the quality of health care; 13% think it will improve quality.

Weak Hiring to Make for a Tepid Taper

With ObamaCare deadlines fast approaching, media attention will increase, and its negative impact on hiring will likely get worse.  But as the Littler survey shows, it is already having a big impact, which is reflected in hiring data.  Taking a cue from Larry Kudlow, here is the 3-month moving average of payroll employment growth over the past half year, starting with the three months ending December 2012:

  • Dec.   209,000
  • Jan.    205,000
  • Feb.   233,000
  • Mar.  207,000
  • Apr.  208,000
  • May  155,000

Do you see any momentum there?  Neither do I.  Even though the Fed’s moves hinge on employment trends, Wall Street economists are, with a few honorable exceptions, pretty much ignoring Obamacare’s impact on hiring.  But the Littler survey indicates small business hiring will remain weak. Meanwhile, large corporations with global exposure will be unnerved by China’s credit crunch, financial volatility and political unrest in other emerging markets, ongoing recession/stagnation in Europe, and the plunging Japanese Yen.  All of which  suggests we will get a very tepid taper, along with continued high readings of O-Poverty and O-Ineqauality.

Copyright 2013 Thomas Doerflinger.  All Rights Reserved.

Posted in Uncategorized | Tagged , , , , | Leave a comment

Create Your Own Conglomerate

Posted on June 10, 2013 by tomdoerflinger

Short-take:  Index funds are inexpensive but they are riskier than they appear, and individuals tend to dump them during panics because they don’t know what they own.  Superior after-tax returns are achieved by working with an investment advisor to create a diversified “conglomerate” of stocks you actually understand.  Hang on as long as they are doing well; sell the losers not the winners.

The Trouble with Index Funds

The Wall Street Journal carried a sad story about how active portfolio managers are losing share to passively managed funds, which are cheaper.  It is actually a big mistake for individual investors to flock to index funds, for two reasons.

Index funds are less “passive” than they appear.  An S&P 500 Fund is risky because the index is managed to be “representative” of the market, which means S&P adds stocks in excessively popular sectors that may eventually crash.  Between 1990 and 2003 the number of tech stocks increased from 44 to 83; in the late 1990s S&P added many “hot” tech stocks after they had soared in price.  So investors got the downside but not the upside.  Similarly, because of numerous mergers and new names being added, the financial sector’s weight soared from 7% of market cap in 1990 to 21% in 2004, making index investors highly vulnerable to the financial crisis.

Second, index fund investors tend to think of their holdings as a single asset class, rather than individual enterprises that pay dividends every quarter and can deal with adversity. When the whole world is bearish at the bottom of bear markets, individuals tend to sell, and fail to get back in until stocks have recovered.  Consequently they vastly under-perform the market averages, as Dalbar has demonstrated through extensive research into the returns of mutual fund holders.  For example, ICI data shows that individuals were aggressively selling, not buying, equity mutual funds during the huge bull market of the past four years.

So in the real world index funds are a very expensive way to save on fees.  Individuals are likely to achieve superior long-term after-tax returns if they team up with a knowledgeable investment advisor to assemble a group of companies they understand.  To channel New York Yankee catcher Yogi Berra (“Ninety percent of this game is half-mental.”), 80% of investing is 100% mental; the other 20% is emotion. If you know what you own you are less likely to panic at the bottom.  Think of your stocks not as a “portfolio” to be traded, but rather as divisions of a “conglomerate.”  Buy shares of 20-40 strong, high quality companies with good growth prospects. They should be “leaders in their field” but usually not “hot stocks” that everyone is talking about. Most of them should pay decent dividends, but include a few smaller growth stocks without payouts.  It is important to diversify across the major sectors (consumer, tech, healthcare, energy, industrials, utilities / telecom), finance) because:

  • Diversification cuts risk.  Most stock market debacles involve overexposure in one sector – think glamour growth stocks in 1972, energy in 1980, tech in 1999, financials in 2007.
  • You get a better feel for the stock market and the economy if you have exposure to all sectors.
  • At least part of your portfolio will always be doing relatively well, so you’re less likely to become frustrated and dump stocks because “nothing is working.”

Here Are A Few Do’s…

Keep the winners, even if the stocks become a bit expensive, and sell the losers.

Try to get exposure to potent long-term themes, such as the fracking revolution; rise of the Asian Middle Class; and rising income inequality.

Keep turnover low to reduce tax expense.  The media pays amazingly little attention to after-tax returns; performance figures are never after-tax.  Long-term investors get two benefits—a lower tax rate and tax deferral until gains are taken.  Consider two investors, Long-term Jim and Short-term Bill, who invest $100,000.  Both get pre-tax returns of 10%, but Jim pays a 20% tax after 20 years while Bill pays a 30% tax every year.  At the end of 20 years, Jim has $558,200 and Bill has $386,968 or 31% less.

In monitoring your stocks, don’t just focus on stock price.  Sit down with your advisor to track growth of EPS, revenue, and dividends; companies’ strategies and M&A Activity; and PE ratios.   If EPS rises, so will stock price, eventually.  Again, if you know your companies you are less likely to dump stocks during a panic.

…and Don’ts

Don’t try to time the market.  Equity prices are a function of GDP, profits, interest rates, investor psychology, and “exogenous shocks” (think 9/11 or Pearl Harbor)–none of which are forecastable.

Don’t do short-term trades in individual stocks.  Do you really think you have better insight into XYZ’s prospects than the hedge fund managers in Greenwich who just got calls from the Wall Street analyst who just finished a meeting with the CFO to discuss the analyst’s new 180-line earnings model?

Forget about fancy asset allocation strategies.  It’s just market timing in drag, with clear thinking subverted by preconceived “benchmark” allocations.  Example: a celebrated private bank might tell clients it is bullish and “overweight equities,” which means an allocation of 47% bonds / 33% equities / 20% other stuff. Sorry guys; that ain’t bullish on equities.

Don’t try to buy just a few great stocks. Way too risky; as a public investor you don’t know enough about companies to own just a few.  Even the bluest blue chips can stink and sink; look at GE, Lucent, Sun Micro and Digital Equipment.

Don’t average down by buying stocks that decline more than the market.  Mr. Market is smart and probably knows something you don’t.

The CNBC dEffect

The media is no help.  I have a high regard for the folks at CNBC and Bloomberg and I do extract useful insights and information from their programming.  But for the investor much of it is disinformation:

  • Hours and hours of macro hand-wringing about “Fed tapering,” “Abenomics,” and the latest Euro-disaster;
  • Over-hyping market moves.
  • Breathless updates on un-investable stocks such as Zynga, Groupon and J.C. Penney.
  • Silly chatter about short-term “trading opportunities.”

Remarkably absent is smart discussion of good companies with strong business franchises, benefiting from potent long-term trends, that can make investors rich over time.  I guess it’s too boring.

For more on this topic, see earlier posts dated July 23, 2012, Nov. 19, 2012, and Nov. 21, 2012

Copyright 2013 Thomas Doerflinger.  All Rights Reserved.

Posted in Uncategorized | Tagged , , , , | Leave a comment

Diversity Perversity at Princeton

Posted on May 29, 2013 by tomdoerflinger

My alma mater is a fine institution committed to educational excellence. Which makes it all the weirder that Princeton cannot recognize its own deep and debilitating liberal bias, rendering it about as intellectually diverse as North Korea.  The latest issue of the Princeton Alumni Weekly offers up a self-serving paean to “diversity” followed by a laughably predicable liberal litany. Consider:

Page 4:  Article written by President Tighman titled  A Renewed Commitment to Diversity

She laments that, while the undergraduate body has finally become “diverse,” “progress has been much slower among graduate students, postdoctoral fellows, faculty and administrators, due in large part to the decentralized nature of their recruitment.”  She implies, without evidence, that this reflects “inequity” rather than the abilities and preferences of potential applicants. In reality the clustering of demographic groups in particular occupations is by no means prima facie evidence of discrimination.  The brilliant economist Thomas Sowell – did I mention he is black? – once observed:

During decades of watching both collegiate and professional football, I have seen hundreds of touchdowns scored by black players — but not one extra point kicked by a black player. Is this because blacks are genetically incapable of kicking a football or because racists won’t let blacks kick a football? Most of us would consider either of these explanations ridiculous….

Tilghman opines that “….diversity and excellence are inextricably linked.  Creativity and innovation, forged, in part, by vigorous debate, are most likely to occur when the broadest range of perspectives are brought together.”  Alas, PAW betrays a remarkably narrow “range of perspectives:”

Pages 5-7:  six letters on being gay at Princeton

Page 8:   two letters on “Bearing street harassment” [of women]. . . One correspondent claims “There is still a long way to go before women and girls feel safe and empowered in America.”

Page 9:  A student remarks,   “The Freshman Seminar ‘Race, Class, and the Selective College Experience’ made me aware of how blessed I was to receive an excellent education.  Since then, I have been studying educational injustices and ways to rectify them.”  (Is domination of urban school systems by teachers unions an “educational injustice?”)

Page 18.   Article titled Inequality’s Effect on Children’s Health.

Page 20:   Article titled Class Begins to Paint Picture of Princeton’s Ties to Slavery

Page 44:   Article titled LGBT conference welcomes ‘every voice’

Page 45:  Article titled Panelists: Fight for marriage equality is only a beginning

Page 48:   Book Review titled  A philosopher defends the nanny state…..She believes that banning cigarettes and 32 ounce sodas might be appropriate in order to “advance people’s well-being through regulation.”  (Why not ban sodomy as well?  After all, AIDS is a communicable disease while cancer and diabetes are not. Editor’s note: I am being facetious.)

Against these nine liberal items (which actually miss a couple of PAW favorites, such as “climate change” and evil Israel), there is exactly one “conservative” article, on Catholicism.  That’s “diversity,” Princeton Style.

Delivering Diversity

If the University actually took diversity seriously, it would stage regular debates between progressive faculty members and reactionary, benighted, unscientific conservatives on such topics as:

  • Resolved:   Obamanomics has hurt the young, the poor, and the non-white.
  • Resolved:   Global CO2 Levels Fail to Explain Recent Temperature Trends
  • Resolved:   Europe Exemplifies the Failure of Socialism
  • Resolved:   Affirmative Action hurts minorities
  • Resolved:   The Tea Party is right; big government expunges individual liberty.
  • Resolved:   Liberal social policy has been a disaster for inner cities
  • Resolved:   The Community Reinvestment Act caused the housing bubble
  • Resolved:   Israel treats Palestinians better than Arab nations do

On the day following these debates, the key points of each side should be published in a prominent ad in The Daily Princetonian.

Copyright Thomas Doerflinger 2013.  All Rights Reserved.

Posted in Uncategorized | Tagged , , , , | Leave a comment

Note from the Northwest

Posted on May 26, 2013 by tomdoerflinger

If you wonder what the U.S. would look like if Obama had his way, go to Portland Oregon.  It’s a great place to live if you have a trust fund or a government job, but good luck if you’re unemployed and need a paycheck.  In 2010 the state raised the income tax on “rich” people (you’re rich in in Oregon if you make $125K) to 9.5%, but Democrats want to raise it again to fill yet another budget gap.  Downtown Portland is quiet and rather empty; many pedestrians are young and impecunious, working part-time at best—not a few in the city’s numerous strip clubs.  There are not many tourists (or tourist attractions) and little new construction. You’ll find a few handsome office buildings, but many are owned by the government or by non-profits such as foundations. Downtown’s major growth business is food trucks serving the cuisine of seven continents. A large settlement of homeless people has taken up residence under a bridge.  The manager of our hotel said the local economy is “Terrible; it needs an overhaul.  We are hiring a lot of over-qualified college graduates.”  The middle-aged gentleman who retrieved our car from valet parking at 4:00 AM seemed like he should be working in a bank.

In Portland it’s fashionable to ride a bicycle or walk around carrying a kayak paddle; the really cool people do both at the same time — usually en route to the Columbia River which, by western standards, is a big and impressive waterway despite eight unsightly bridges.  Portland is a great city for gardens (but a little depressing for visitors who, like myself, try to garden on the East Coast).  Stuff grows bigger in Portland. Much bigger.  The Rhododendrons aren’t shrubs but small trees you can walk under, with blooms as big as basketballs.  Hostas and other perennials grow into sizeable bushes.  And the vegetative variety is extraordinary, ranging from giant conifers to small palm trees.

From Portland, drive 175 miles north on Interstate 5 to the more capitalistic climes of Seattle, which is in a state with no income tax and unemployment a full 100 bps lower than Oregon.  (Washington dodged a billionaire’s bullet in 2010 when it  rejected Bill Gates Sr.’s push for an income tax on the “rich.”)  Seattle is prosperous and growing.  Downtown is busy, with lots of new construction.  The bar at the Four Season Hotel is packed at happy hour.  New bars and clubs are opening up in the semi-hip neighborhood of Belltown.  Big ferryboats are jammed with commuters coming in from Bainbridge Island, a tony suburb with multiple marinas and a surfeit of cooking, craft, and clothing stores. SAM (the Seattle Art Museum) had a good show of old masters, including a Rembrandt and some excellent Dutch still lifes, on loan from London’s Kenwood House which is undergoing restoration.  On Pier 59 the aquarium offers a double feature of sea otters and river otters; the median age of the clientele is about five.

And Seattle has one of America’s most successful organically grown (in every sense of the term) civic attractions—Pike Place Market, a multi-level labyrinth of shops and stalls selling the abundant bounty of the Northwest: flowers, seafood, fruit, vegetables, fresh meat, cold cuts, pastries, pirogues, smoothies, candy, spices and (my favorite) newspapers. Halibut season had just started when we arrived. There are several good restaurants, including the original Starbucks.  Like a well-fed amoeba, the Market is dividing and expanding, swallowing block after block.  Comparing the two cities, inequality is greater in prosperous Seattle, but you don’t need a trust fund or a government job to avoid sleeping under a bridge.

Copyright Thomas Doerflinger 2013.  All Rights Reserved.

Posted in Uncategorized | Tagged , , , , | Leave a comment

Liquidity Over Corporate Results? Climbing the FT’s Wall of Worry

Posted on May 14, 2013 by tomdoerflinger

The folks at the Financial Times are trying to make sense of the U.S. stock market rally, which, it is fair to say, has surprised them.  Here is their take and my brief response:

  • The state of the world economy is “underwhelming at best” with Europe in recession, China slowing, and U.S. growth only “bland.”  Dr. Tom’s response:  I agree.
  • U.S. earnings growth is “respectable” but generated by cost-cutting, not revenue growth, and may be unsustainable.  Companies cannot “cut their way to growth” forever.  Dr. Tom:  Profit growth is closer to “weak” than “respectable” but is not bad for this point in the business cycle.  For the past 20 years I have been hearing that the “cost-cutting story is over” but it never is.  Meanwhile U.S. GDP growth may pick up over the next few quarters.  See below.  (Note that Q1 revenue growth is not as bad as the aggregate figure sounds, because it is dragged down by a big drop in energy; most other sectors are up low-single-digit.)
  • Companies are relevering, as Apple illustrates.  Dr. Tom:  Apple is a special case.  Most large firms companies are not aggressively relevering.  Some observers (e.g., Bill Gross) overestimate how much low rates are boosting earnings of large firms, many of whom have more cash than debt and so are actually hurt by low rates.
  • Defensive stocks are outperforming, which reflects the weak macro environment.  Dr. Tom:  Partly true, but it also reflects their relatively high dividend yields.
  • The main reason for the rally is “central bank speak:”  “Central banks want companies to borrow, and investors to buy risky assets.”  There is a “disconnect between stocks and the world economy.”  Dr. Tom:  The disconnect is common and normal; see below.
  • A corollary of the above:  when central banks finally raise rates, stock prices could crater.  Dr. Tom:  Not so; see below.

What the FT Fails to Mention

The alleged “disconnect” between profits and stock prices is not anomalous but normal.  Historically when profits are “better than expected” because companies have pricing power (aka “inflation”) the Fed tightens and stock prices fall despite strong earnings.  The best example is the 1987 stock market crash.  Conversely, stocks frequently perform well in periods of weak profits but ample central bank liquidity such as 1985-1986 (when profits fell but stock prices soared) or the end of recessions (1982-83, 1991, 2003).  Currently we are in the “sweet spot” – plenty of liquidity and underwhelming but not terrible profits.  (As an aside, the tendency of stocks to rise in a weak economy is one of the many reasons why it is futile to time the stock market.)

After “going nowhere” since 2000, stocks are still reasonably valued (though no longer dirt cheap) with a trailing PE of 15.2x versus a Q1 2005-Q2 2007 average of 16.2X.  With negative “tail risks” becoming less likely, investors are willing to pay up for equities offering better returns than bonds.  With the dividend payout ratio at only 32%, dividends may rise faster than profits, causing yield hungry investors to pay up for stocks. (I am hearing that bond funds are starting to buy stocks for their yields, which is a bit scary.  High yield stocks such as utilities, staples, telcos, etc. are expensive.)

Profits may reaccelerate modestly before the next recession.  The Federal budget deficit is smaller than expected, so yet more fiscal austerity in the U.S. is not likely.  Pro-growth reforms — tax reform, immigration reform, and possibly ObamaCare  repeal — may boost confidence and growth.  With his administration swimming in scandal, Obama won’t be launching new attacks on capitalism.  And Europe may start to grow again.  Meanwhile, corporate America is “rolling its own growth” via share buy-backs, judicious M&A, and restrained capital spending that avoids margin-killing over-expansion.  (Here is another why it is so hard to time the stock market: full-blown “prosperity” a la the late 1990s leads to overinvestment and margin collapse, as well as Fed tightening.)

 When QE Ends . . .

. . . stocks may well decline or flatten out for a while.  But a true bear market is unlikely because A) the Fed will not tighten until the economy is stronger, B) stocks are seldom clobbered by widely anticipated developments. The way to think about it is that this year stocks may run up ahead of fundamentals, and then digest their gains and “rest” for a few quarters once liquidity is withdrawn.  Today on CNBC David Tepper makes the smart argument that, with Treasury bond issuance declining as the deficit shrinks, the Fed actually “needs” to taper bond purchases to avoid putting the financial markets in overdrive.

Copyright 2013 Thomas Doerflinger.  All Rights Reserved.

Posted in Uncategorized | Tagged , , , | Leave a comment

The Furies, Then and Now

Posted on May 13, 2013 by tomdoerflinger

In April 1590 Henry IV of Navarre, the Protestant heir presumptive to the French crown, led his army of 20,000 to the outskirts of Paris and laid siege to the Catholic city of 220,000.  Grain inventories amounted to only a one month supply, so food prices immediately soared.  Poor citizens were wracked by acute hunger in less than two weeks, and city officials forced the Jesuit College to share its stock of food.  But before long the Parisian poor had to move on from eating grain to consuming their own cats and dogs, which were “killed and cooked with herbs and roots in large pots,” producing a runny stew  that was consumed with an ounce of bread. By mid-summer the city’s elite was exchanging their jewels, tapestries, and other treasures for porridge of “cooked grass and weeds without salt, and pots of horse-meat, ass, and mule.”

The Case for Cannibalism

The starving poor rioted in August, but the unrest was viciously put down by the city government, determined to avoid surrender to the hated Protestants.  The body count proceeded to mount; “some mornings there were 100, 150, and at times as many as 200 dead of hunger in the streets,” a contemporary reported.  Extreme measures were in order.  Bones in a cemetery were disinterred, ground into powder and mixed with water to form wafers.  Cannibalism inevitably followed, which raised delicate theological issues.  A prominent Catholic argued “there was less danger [in the hereafter] by eating a child in such circumstances, than by recognizing . . . a heretic [Henry IV].”  Historian Lauro Martines, in his fine book Furies, estimates that at least 13,000, but possibly as many as 30,000, perished in the siege.

Two Centuries of Religious War

This tale of cannibalism on the Seine was far from unique in early modern Europe. The siege of Paris was just one of many horrific sieges, wars and sackings motivated by religious fanaticism in the 16th and 17th centuries.  There was the siege of Sancerre, a Protestant stronghold in the Loire Valley, in 1572; the sacking of Magdeburg in 1631 (part of Germany’s Thirty Years War); the sacking of Brescia (1512) when a quarter of the city’s population died; and the sacking of Antwerp in 1576.  Although real politic was also in play, all of these and many other catastrophic military clashes were inspired by religion.  To the combatants, a few weeks or months of hell on earth was preferable to eternal damnation.

Connecticut Conflagration

Nor was this fanaticism restricted to the eastern shores of the North Atlantic.  In New England in the 1630s sporadic deadly clashes between Pequot Indians and English Puritan settlers culminated in a horrific conflagration in 1637, well described by celebrated historian Bernard Bailyn in his latest book, The Barbarous Years.  The Pequots, including not only warriors but several hundred men, women and children, retreated to a fort in Mystic, Connecticut, which was immediately surrounded by 90 English troops.  They proceeded to block the exits, set fire to the fort, and kill about 40 Indians who attempted to escape the flames.  In all an estimated 600 to 700 Pequot perished in the blaze.  It was, a witness averred, “an awful sight to see them thus frying in the fire, and the streams of blood quenching the same, and horrible was the stink and scent thereof.”  But in what they termed this “divine slaughter” the English perceived the righteous hand of God, “who had wrought so wonderfully for them, thus to enclose their enemies in their hands and give them so speedy a victory over so proud and insulting an enemy.”

From Paris 1590 to Damascus 2013

Europe’s religious fanaticism throws current events in the Middle East into sharp historical perspective.  To my inexpert eye, there is not much difference between Sunni vs. Shia today and Protestant vs. Catholic in 1590–nor is Muslim hatred of Jews and Christians particularly surprising or unnatural.  As we learned in Iraq and Afghanistan, the notion that Muslim fanaticism and factionalism in the Mideast can be moderated by enlightened western intervention is simply false.  For the U.S., such incursions are all cost and no benefit—not even much gratitude from the intended beneficiaries. The West can do nothing more in the region than protect its own interests and let history play out—including civil wars such as the one now raging in Syria.  A great many individuals on both sides of that conflict hate the U.S. and Israel.  It is indeed unfortunate that the death toll is 70,000 and climbing, but there is little we can do about it; indeed, our intervention might prolong the conflict.  Nor do we have a moral obligation to intervene – any more than the British did in the 1860s, when 625,000 perished in the American Civil War.

Given the costly failure of past American interventions, which were viciously condemned by the left, it’s downright weird to read New York Times pundit Bill Keller’s fanciful tale of how things would play out if we intervened in Syria.  From his comfortable office overlooking Times Square, Keller sketches this pleasant reverie: “The United States moves to assert control of the arming and training of rebels. . . . We [bomb Syria and force the Assad regime to sue for peace].  All of this must be carefully choreographed, and accompanied by a symphony of diplomacy to keep our allies with us and our adversaries at bay.  The aim would be to eventually have a transition government….”  Which raises the obvious question, “transition” to what? Very likely to a democratically elected regime of anti-Semitic, anti-Christian, anti-American, anti-Israel Muslim fanatics, similar to the one now governing Egypt.  No thank you.  (To be fair to Keller, some Republicans such as John McCain and Bill Kristol share his naïve optimism.)

On a more positive note, Christianity’s long-term trend toward moderation is applicable to Islam as well.  All texts, including religious texts, are subject to wide interpretation.  Muslim fanaticism in the Middle East may well moderate over time.  But as the history of European Christianity shows, that can be a very protracted process.

Sources:   Lauro Martines, Furies: War in Europe, 1450-1700 (New York, 2013); Bernard Bailyn, The Barbarous Years: The Conflict of Civilizations, 1600-1675 (New York, 2013).

Copyright Thomas Doerflinger 2013.  All Rights Reserved.

 

Posted in Uncategorized | Leave a comment