Watching the slow and listless implementation of Dodd-Frank, the post-crisis banking legislation, is a reminder of what a grim sausage factory our national regulatory apparatus has become. And it’s also a reminder of the resourcefulness and guile of banking lobbyists.
For bank stock investors, this could be very good news. And one major element of Dodd-Frank appears to have been settled distinctly in favor of banks that are major residential mortgage lenders. These include Wells Fargo (WFC), JPMorgan Chase (JPM), Bank of America (BAC) and U.S. Bancorp (USB).
As reported by the New York Times’ dogged columnist Floyd Norris, Dodd-Frank elements that were designed to force mortgage lenders to retain some risk on loans they make and then sell – keeping “skin in the game,” as the saying goes – have been completely defanged. And the old model of making mortgage loans, packaging them as securities and being entirely done with the risk (you’ll recall that this model is what sent our economy into a prolonged and brutal recession) survives.
A research note out of Goldman Sachs (GS) makes the case for the S&P 500 to end the year about 5% higher than where it recently traded, and to hit 2150 in 2015. (hat tip ValueWalk). And a big part of the still-bullish outlook is a pickup in buybacks, especially heading into year-end.
The basic investment thesis is that buybacks have slowed the past few weeks because companies can’t make repurchases in the five weeks heading into their earnings releases. Now that we’re getting pesky third quarter earnings season of the way, let the financial engineering re-commence. And Goldman Sachs points out that since 2007 a quarter of annual buybacks occur in the last two months of the year. Perhaps something to do with goosing per-share performance for the year, which conveniently might impact the C-Suite’s compensation?
ValueWalk helpfully reprinted a few tables of Goldman’s top repurchase constituents. ADT (ADT) and FedEx (FDX) have been among the most aggressive repurchasers over the past 12 months, as measured by buyback yield.
Berkshire Hathaway’s (BRK.B) Big Four stock investments-Wells Fargo (WFC), Coca-Cola (KO), American Express (AXP) and (IBM) each account for more than 10% of the conglomerate’s $107 billion portfolio. Chicago Bridge & Iron Company (CBI), which designs and builds infrastructure across the energy industry, is another holding. But Berkshire’s stake accounts for less than 0.70% of its portfolio. So not exactly a high conviction position? Hold on. Here’s the market cap of the Big Four and Chicago Bridge & Iron:
The Chicago Bridge & Iron position is 1/15th the size of the Big Four stakes but it’s barely a midcap stock. A sub-$6 billion market cap is about 1/40th the size of Wells Fargo. You get the idea that if Berkshire’s investment portfolio was smaller or Chicago Bridge & Iron’s market cap larger, it would represent a larger piece of the Berkshire portfolio. According to Morningstar, Berkshire Hathaway owns 9.9% of Chicago Bridge and Iron outstanding stock and Berkshire subsidiary GEICO Indemnity owns another 2.7%. In fact, Berkshire Hathaway is the largest shareholder. That alone should be worth some further investment research. (A major hat tip to Cheviot Value Management, which in its third quarter letter to shareholders -- a good read for any true value investor -- noted it had established a position in Chicago Bridge & Iron and mentioned the Berkshire stake.)
Being biggest is its own problem in business because all the little outfits want a piece of what you’ve got. Identifying the weaknesses of the market leader is a sure-fire strategy for upstarts. Ask International Business Machines (IBM), which has ceased to grow as smaller tech companies all around it blossom. Or ask McDonald’s (MCD), where a something-for-everyone menu made it vulnerable to dozens of more sharply defined fast food purveyors, including its own offspring, Chipotle Mexican Grill (CMG).
The disappointing third-quarter results at Amazon (AMZN), where sales growth is slowing despite furious and scattered investments, thus got me thinking about its far-larger competitor, Wal-Mart (WMT). Both companies are struggling because there is a glut of retail capacity, both in stores and online – Amazon struggling to continue its 20%-plus growth rates and Wal-Mart struggling to avoid same-store-sales declines in the U.S. And there’s much more to capacity to come, as Alibaba (BABA) accelerates growth outside China in the wake of its IPO, and other entrants emerge.
We’ve written frequently and for years about our skepticism of Amazon’s business model: selling dollars for 99 cents, as the old saw goes, and it’s hard to make it up on volume. Yes, it’s a fabulous interface and we all love being customers, but undercutting the competition in an already low-margin business isn’t a long-term competitive advantage. Driving everyone else out of business seems beyond even Amazon’s abilities. And reverting to a higher-pricing model would, well, send many of your “loyal” customers off to find a better deal somewhere else.
That said, and sadly for Wal-Mart, Amazon isn’t going away time soon. And its investments to date suggest it has the capacity now or very soon to be a $150 billion retailer, if only people would buy more stuff, not just the $100 billion retailer expected for 2015. In case you’re keeping score at home, Amazon added 16,900 employees during the third quarter alone, almost equal to the entire staff at Men’s Wearhouse (MW). And still Amazon is hiring (in case someone in your home is between opportunities).
Starbucks (SBUX), we reported last March, was preparing a major test of mobile ordering so that customers can avoid standing in lines to order – a way to squeeze more sales out of each of its outlet, keep same store sales growth humming along, and fatten profit margins.
Last week, the company confirmed to Bloomberg it has launched just such a test at 150 stores on Portland, Oregon, and plans a national rollout in 2015.
That’s an aggressive schedule and there are, as we explained in the article linked in the first paragraph above, plenty of logistical issues to work out. But the potential payoff for Starbucks is huge. Its company-owned U.S. average about $1.3 million in revenue and, if you’ve been in one during morning rush hours, you might wonder how its baristas can do much more. But retail writer Laura Heller, a former YCharts contributing editor, points out in a smart post on FierceRetail that the bottleneck is the line to order, not the actual making of beverages.
As we wrote about earlier this year, the InvesTech newsletter -- around for more than 30 years -- is predicated on a clear strategy: Safety First.
So what’s editor Jim Stack doing amid the recent stock pullback and the return of long dormant volatility? Not heading for the exits. Yes, InvesTech reduced its stock allocation recently, but that was just a trim from 82% invested to 80%. Stack is watching his trove of fundamental and technical indictors ever closer given the recent gyrations, but right now he sees nothing to suggest that the recent volatility is the beginning of a classic bear market (sell-off of at least 20%).
Leading economic indicators -- job growth and jobless claims -- show a strengthening economy, not one about to tip into recession. One metric to keep an eye on: Stack has always noted that recessions don’t start unless there’s a significant uptick in initial unemployment claims. On that front, this might be the most reassuring downward trend you could ever want to see:
He also notes that consumer confidence remains on an upward trend, and gauges of manufacturing sentiment are still well above 50, which signals economic expansion.
Back on October 3rd the Leuthold Group announced it had reduced its core portfolio equity exposure from 55% to 40% as its proprietary Major Trend Index (MTI) fell into negative territory. The MTI is a mash up of 130 metrics segmented into five broad categories that cover the waterfront: from intrinsic value to economic factors. Pegged to 100, a reading between 95-105 is considered neutral. In early October the reading fell to 90 triggering the reduction in equity exposure. That said, Leuthold chief investment officer Doug Ramsey said the expectation is that we’re not headed into a recession, “just a stock market event that we expect to be painful enough to temporarily warrant a defensive stance.”
Indeed, the pullback that began in September has continued since the early October missive, as seen in the performance of the SPDR S&P 500 ETF (SPY), the Vanguard Russell 2000 ETF (VTWO) and the iShares MSCI Core EAFE (IEFA):
Ramsey points out that in the 14 “intermediate” corrections for the S&P 500 since 1990 (losses between 7% and 12%) the utility sector not surprisingly held on best, with an average loss of -3.1% and the sector’s index rose in three of the corrections. That said, the sector is dicey at this juncture. If you’re on board that one of the drivers of market volatility of late is the anticipation of rising rates, utility stocks that have been bond stand-ins will lose some of their allure for income seekers. And those income seekers have driven up valuations. All but one of the 30 utility stocks in the S&P 500 earn just a neutral rating from YCharts. The one utility stock you might want to target for further financial research if you’re determined to take a severe flight to safety is AGL Resources (GAS) a regulated natural-gas distributor operating in New Jersey and the southeast, which currently has a Y-rating of Attractive.
The most recent YCharts Research Focus Report on software giant Oracle (ORCL) shows that its business is continuing to hum along better than ever, with profits in its all-important Software Updates segment expanding faster than an already brisk revenue growth rate of roughly 6%.
Profits growing faster than revenues shows that the business has something called "operational leverage," and as we can see from the following chart, Oracle's operational leverage has taken a quantum leap upward since its acquisition of Sun Microsystems in 2010.
Despite the company's operational strength, we think that the stock could lag unless the firm's new co-CEOs pay careful attention to the company's expansion and acquisitions program. The firm has made a few bold acquisitions that have turned out to create great value for its shareholders. However, as the firm matures, there will be fewer good investment opportunities that are large enough to materially boost its growth.
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This is not meant as a silver lining, but just a statement of reality: the market pullback has pushed dividend yields to levels not seen for a few years.
Global growth concerns and the tanking of oil prices is obviously not good news for the major integrated oil companies. The slide in Chevron (CVX) and Exxon Mobil (XOM) from their 52-week highs is more than double the slide in the S&P 500:
But with the 10-year Treasury note at 2.3% and the Treasury rich iShares Core U.S. Total Bond Market ETF (AGG) in the same vicinity, the energy behemoths offer a pretty compelling story for patient income investors.
Bill Gross’ abrupt late-September exit from Pimco, where he helmed the flagship Pimco Total Return bond fund (PTTRX) and its ETF twin as well (BOND), is only a challenge if you happen to have any investments in a Gross-run portfolio. Which of course plenty of folks did: At the time of his departure, Morningstar (MORN) had Gross’ total fund AUM north of $400 billion.
But even if you hadn’t entrusted money to Gross, chances are you’re spending more time than usual pondering how you’re positioning your bond portfolio.
With the prospect that we’re readying for the first hike in the Federal Funds Rate in more than eight years, investors looking for bonds to serve as the safety net/risk dampener are hearing plenty of noise that a straight up high quality bond index fund is not the way to go. The major gripe is that the most popular index benchmark, the Barclays U.S. Aggregate Index is too heavily weighted in U.S. Treasuries, which, we’re told, are a horrible investment going forward given they will be the most rate sensitive and today’s low yields provide very little starting cushion to offset price declines. Th chart shows government bonds, including the 10-year Treasury.
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