May 7, 2010
A Wild Day in the Market; What’s Going On?
The stock market is officially in a correction. Volatility has spiked higher and fear is gripping markets around the globe. Many large US companies are down 10% or more as the fundamentals improve. Wow! Yesterday was remarkable on many levels!
This dramatic one day market decline is not about individual stocks or fundamentals. The day began yesterday as a fairly typical down day. Then, about 2:30 Eastern time the markets collapsed into free fall. The Dow Jones industrial average lost 700 points in a matter of minutes. The initial fall was blamed on a trader who entered an order with too many zeros. This triggered program sales and then, so the story goes, computer errors caused stocks like Procter and Gamble to drop over $20.00 per share. It was a perfect storm and frightening to watch.
What does all this mean? The market opened down yesterday on fears Greece’s problems would spread and cause the European banks to freeze. Comparisons to the Lehman failure and the devastating impact this had on the US economy were alarming. What this tells us is that there is a still fear and uncertainty, even as investors as recently as two weeks ago piled into small, high beta, high risk stocks. Years ago we bought and sold stocks through a specialist who matched buyers and sellers. Today, trading is instantaneous even from mobile phones. Things can unravel very fast with a very decisive break in the market uptrend. Yesterday was an institutional day – retail investors were on the sidelines and didn’t create the volatility. The risk trade became a fear trade in a matter of minutes. Investors watching felt powerless!
What do you do on days like yesterday? The market bounced back yesterday to where the trading session started – down but not in crash territory. Fundamentals are improving and this kind of panic selling is painful but in hindsight it is almost always best to stand back and stay on the sidelines.
Is this market turmoil the sign of things to come – another 2008 market crash? There are many problems in the US economy and Europe is in crisis. Fear is that the Euro will collapse as a reserve currency and the European economy will stagnate. This leads to speculation US exports to Europe will decline.
The market is not likely to retreat to March 2009 levels. There are definite signs of recovery and US corporate balance sheets are strong. The key to success isn’t market timing or panic selling. A discipline approach to asset allocation is the only way to manage in markets driven by emotion and macro events. If investors trim stocks to their equity target when the market rallies like it has then there should be cash on hand to buy.
We have plenty to worry about. It would be a mistake to back up the truck now and buy indiscriminately and it would be equally wrong to sell all stocks and leave funds in cash yielding less than 1%. This decline could go on for awhile but this will lead to some very attractive opportunities. Stocks will swing between gains and losses as headlines drive emotions. Extreme uncertainty will cause fluctuations in price and high frequency trading is now 50% or more of trading volume. The only way to thrive in this environment is to take a longer term view and buy those stocks that offer dividends, good growth and stable earnings. Prices for stocks like Johnson & Johnson, Microsoft and Hewlett Packard are at very low levels compared to their growth, dividends and sound financials. The crazy market behavior and rumor driven trading will pass and over time these quality companies will reward investors. Profits today are good and improving with the economy.
The answer to “what to do” depends on investor attitudes toward risk. Unfortunately, when the market advances it is common to think only about returns and ignore what might happen when risk rears its ugly head. Yesterday was a reminder that things can unravel quickly. It is common for investors to raise stock targets at high levels and want to own less when the market is down. This emotional approach is costly and days like yesterday are painful. On the other hand, disciplined investors recently trimmed stocks as the market rose, are below their target stock weight and can take advantage of opportunities on crazy days like yesterday. The reaction to yesterday’s market says a lot about risk attitudes. Some reacted with “Wow! What great buying opportunities” while others panicked and wanted out. There isn’t a right answer. The emotional reaction becomes a good indicator for risk attitudes and can be used to determine a long term asset mix target.
The debt worries in Europe and in the US are real and should not be taken lightly and wild reactions to headlines will continue. Stocks are down over 10% in the past few weeks and 2-4% daily moves are common. The world today is confusing and issues are complicated and interrelated. Risk control and discipline are critical.
MARCH 16, 2010
Something Else to Worry About? Watch High Yield Bond Maturities
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The New York Times says high yield bonds will be maturing in record amounts over the next four years. Refinancing these bonds will cause problems for lower quality companies that took advantage of low interest rates. Will this cause another round of defaults and corporate bankruptcies? In 2012 $155 billion of higher risk bonds will come due and then in 2013 and 2014 another $ 558 billion will mature. This will happen at the same time the Government borrows record sums and interest rates are higher.
Bond investors are complacent. It is the consensus view that interest rates are going higher and yet there is a reluctance to raise cash and shorten portfolio maturities until the increases are immediate. Waiting for confirmation of higher interest rates in the face of this known risk may be one of the most regrettable decisions when looking back over 2010 and this period of economic recovery.
Junk bonds recovered as investors felt more comfortable with the economy and bid up risky investments. This may be an excellent time to look at the yields from these bonds, which are now on par with quality bond returns before the recession, and take some profits. This is an even more compelling decision if the massive maturities on the horizon cause concern – as expected.
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May 13, 2009
Bersot Capital Management is in the news!
Read what the Marin County paper, the Ark, has to say about the firm and Mary Bersot. (Click here for PDF)
May 11, 2009
Taxation on Foreign Earnings
US companies have a presence throughout the world and benefit from exposure to many economies, including emerging markets. This advantage has led to world prominence and been a major factor in earnings growth over the years. This diverse and ever expanding source of earnings has made many US companies profitable as we suffer through this recession.
Companies often delay repatriating their earnings from foreign sources and because of this avoid income tax on the funds. Taxes are an expense and expenses reduce profits. The Obama administration needs funds to pay for the massive stimulus programs and this week proposed to tax all foreign earnings of US companies. The hope is that this will add to tax revenues and discourage shifting jobs and factories overseas.
In the end this will result in lower earnings for the US multinational companies. Below is a breakdown of the dollar amount of earnings companies in the major economic sectors report from overseas. This tax proposal is not insignificant and could impact earnings by as much as 15%. Healthcare and technology companies would be hit particularly hard.
The timing of this tax is critical as earnings are depressed by slow global growth. An added tax of any amount would further reduce earnings and could dampen stock price performance. Uncertainty is also increasing for healthcare companies as reform initiatives take center stage. Stage tuned!
February 23, 2009
Rumors and Speculation
Barton Biggs described the stock market as a “mean and sadistic beast” and recent activity has proven him right. Rumors and speculation of bank nationalization have driven stocks of such household names as BankAmerica and Citigroup to under $10. The question of the day is “will the banks be nationalized?” In the last thirty days the Obama administration has committed $3 trillion dollars to restoring economic health. To take over the banks would bloat the US balance sheet even more.
It is hard to know what this administration will do or have to do. Timothy Geithner’s well telegraphed plan for reforming the banks and solving the crisis turned out to be no more than a concept which drove the markets down 5% the day he spoke and he hasn’t been seen nor heard from since. Ben Bernanke said “we will keep the banks private, or return them to private hands, as soon as possible. Christopher Dodd topped this by saying “we don’t want to nationalize the banks, but it may happen”. The White House did say last that we “will continue to have a private banking system going forward”. Reading between the lines is crazy making. Until we see a concrete plan we can trust we don’t know what they’re up to. Banks such as Citibank are partially nationalized now and may need more help if the economy doesn’t recover.
What will happen? What matters isn’t just what got us here but what we’ve learned and what happens going forward. The current administration is making decisions and executing plans that will have far reaching implications. The trillions of dollars thrown at the problem won’t solve the basic issues unless confidence is restored and the job market is healthy. The bail out funds given to companies will be a waste of money unless customers want loans and US manufactured cars are in demand. Talk of nationalizing our banking system further destroys our confidence in the institutions and makes their recovery even more tentative. If we limit pay for executives of banks that take government funds then we are dooming these financial institutions to mediocrity. We need talented managers going forward to get us out of this mess. Shareholders, not the government, should dictate pay.
Can our country bear the consequences of these massive government programs and resulting debt? We have not touched the ailing Social Security and Medicare programs. The stimulus plans will probably work in the short run to restore economic activity and for awhile we will feel better, employment levels will stabilize and the capital markets will recover.
Then what? Taxpayers will be burdened with layers of debt at a time when demographics suggest the largest segment of the population – the baby boomers – will be spending less and utilizing the healthcare system more. The weight of this may be more than our country’s poor shoulders can bear. Stay tuned – the best may be yet to come. We may be compounding the problem, not solving it.
February 2, 2009
Traveling Fast – Going Nowhere!
The stock market feels awful as we end January on another down note. The S&P 500 lost over 8% as economic headlines continued to worsen and governments around the globe scrambled to bail out their financial institutions.
It’s wise to look under the covers. Not all stock portfolios moved together in January. Large growth portfolios declined less than 3% while large value lost over 11%. Banks got tanked and companies with reliable earnings growth came through. End of story. Owning large banks has been a disaster no matter how you cut it. Returns were much better in January if you owned some bonds and cash.
The US stock market has traded in a range since September. Stocks have moved sideways and will until confidence is restored.
Will Obama come through with the magic bullet - a stimulus plan that restores spending? Will a “bad bank” free up our financial institutions and get things moving again? It’s hard to know. What is a better bet is that companies that show earnings strength and make smart decisions will hold up better until the $8 trillion on the sidelines moves the market out of this range. It will happen. In the next 3-6 months? If anyone knows for sure then they must have a direct line to a higher being or Obama, or both. In the meantime, stay with quality. It’s tempting to buy beaten down stocks, but as we saw in January, if they don’t recover the punishment can be severe. Stocks will break out of this range and move higher when confidence improves and jobs are secure and plentiful. It is better to stick with companies that manage their business well in tough times and avoid the beaten down cheap stocks. They may stay that way for awhile.
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