Category Archives: Stocks

An Inverted Yield Curve Did Not Always Precede Recessions

I made a post before how an inversion of the yield curve has preceded the last 8 recessions in the US. Recently, I came across this interesting chart on Twitter which shows the yield curve spread for US treasuries with a maturity of 3 month and 10 year from the last 100 years.

This chart shows that yield curve inversions didn’t happen between the 1930’s and 1960’s before a recession happend.

Long Term Yield Curve Inversion Chart
Long Term Yield Curve Inversion Chart

Currently the US 3 month – 10 year yield curve is inverted.

Yield Curve Inversion 3 month - 10 year spread
Yield Curve Inversion 3 month – 10 year spread

Global PMI’s Are Rising Again After A Long Negative Streak

Purchasing Managers’ Indexes (PMI) are economic indicators derived from monthly surveys of private sector companies. Today the latest PMI Manufacturing Index for the US (The ISM Manufacturing Index) came out which was the most negative reading in the last decade.

Global manufacturing PMI’s are rising again though after a record streak of 15 negative months of declines. The last time this index went positive after a long streak of negative PMI’s it was 2009 and that turned out to to be the bottom and a great moment to buy stocks.

Global Manufacturing PMI
Number of months in a row of rising or falling Global Manufacturing PMI’s

The above index has coincided quite nicely with the Bloomberg World Stock Market Cap index which hit a high in January 2018. The index still hasn’t recovered since then.

Bloomberg World Stock Market Cap Index
Bloomberg World Stock Market Cap Index

Does The Inversion Of The Yield Curve Signal a Recession?

An inverted yield curve is one of the few indicators that before have always correctly signalled an upcoming recession. An inverted yield curve happens when the yield on 10 year treasuries is below the yield on 2 year treasuries (sometimes called the “2s10s”). The 2-10 year yield curve is the most common people view. Currently the 2-10 year yield curve is positive after it turned negative for the first time since 2007 at the end of August.

Yield Curve Inversion
Yield Curve Inversion

In the past a negative yield curve has always signalled that a recession could happen in the next 1 to 2 years. Note from the chart below that the curve can be at or below zero for a long period before a recession happens. Furthermore from the chart it looks like a rapidly steeping yield curve signals a recession is close.

Yield curve inversion long term chart
Long term chart of the yield curve

The question arises will an inverted yield curve signal a recession this time? A big difference in my opinion with other times is that this time the yield curve is watched by a lot of participants in the market and so a lot of stories are published about it.

Stories mentioning "yield curve"
Stories mentioning “yield curve”

From the mainstream media such as Drudge Report.

Drudge report yield curve inversion recession
Screenshot of the frontpage of Drudge Report on August 14, 2019

To the president of The United States who even talks about a “crazy” inverted yield curve.

Donald Trump President of The United States Tweets on the Yield Curve Inversion
Tweets from the president of the United States Donald Trump mentioning the yield curve inversion

And even members of the Federal Reserve such as Atlanta Federal Reserve President Bostic (picture below) and Neel Kashkari (in a post on Medium here) the President of the Minneapolis Federal Reserve are openly talking about the inversion of the yield curve and what it means for the economy.

Federal Reserve Bostic Yield Curve Inversion
Headlines from Fed’s Bostic on May 16, 2018

It remains to be seen whether the signal works this time.

Forward P/E And 10 Year Returns

Since 1988 stocks have always produced a negative 10 year return when the Forward Price to Earnings ratio was 22 or higher. This chart says nothing about 1 year returns. Then returns are all over the place whether the Forward P/E is 12 or 22. Although you can see from the chart that positive returns are lower 1 year out compared to when the Forward P/E is lower.

This data is for the US and I have no idea what these charts would look like if you would take an index like the Nikkei 225 or a European index such as the Euro Stoxx 50 or the AEX Index.

Forward PE and 10 year returns
Forward PE and 10 year returns

If you invest on a long term basis the lower the Forward P/E for the market the better your return could be.

Forward PE and 1 year returns
Forward PE and 1 year returns

As of the end of June 2019, the Forward P/E for the S&P 500 is 16.9. This was above the average of the last 30 years. This average is skewed to the upside though because of the extreme valuations during the 2000’s Dot-com bubble in stocks.

S&P 500 Forward PE ratio
S&P 500 Forward PE ratio

The 1980’s Japanese Stock Market Bubble

The Japanese stock market was booming at the end of the 1980’s. The Nikkei reached a high of 40,000.

Long term chart of the Nikkei 225
Long term chart of the Nikkei 225

Because of this boom, Japanese companies were among the most expensive companies in the world. This led to a lot of Japanese companies buying up foreign companies. Newsweek came out with this cover in 1987 capturing the zeitgeist of that time. This zeitgeist was later also captured in the movie Die Hard (the company at the center of the movie being Japanese).

Newsweek 1987 Cover Your next boss maybe Japanese
Newsweek 1987 Cover: Your next boss maybe Japanese

Ultimately the bubble burst and Japanese stocks entered a bear market. Stocks crashed almost 90% from the top and the Nikkei reached a bear market low in 2009 during the credit crisis. Japanese stocks are up 350% since then but still almost 50% below the all time high set almost 30 years ago. Japanese stocks to this day have not yet recovered.

One other way that shows how big this bubble was is how large the market capitalisation of Japanese stocks was as a percentage of global stock market capitalisation.

Japan market capitalisation as a percentage of global market capitalisation
Japan market capitalisation as a percentage of global market capitalisation

Berkshire Hathaway’s Apple Stake

Berkshire Hathaway and Apple are currently the second and fifth company in the S&P 500 by weighting in the index. The market capitalisation for these companies are currently $ 980 billion for Apple and $525 for Berkshire Hathaway.

At this moment Warren Buffet’s Berkshire Hathaway holds a $ 50 billion stake in Apple. This position is 5% of the market capitalisation of Apple and more interestingly 10% of the market capitalisation of Berkshire Hathaway. The stake in Apple is 25% of Berkshire’s equity portfolio. Meanwhile Berkshire’s has hit the enormous amount of $ 122 billion in cash.

S&P 500 top 10 holdings
S&P 500 top 10 holdings as of September 12, 2019

Berkshire’s performance over the years has been stunning, as I’ve posted before. In euro’s though, the performance is even more stunning the last decade since the effect of the dollar gaining in value has added to performance.

Berkshire Hathaway B in Euro
Berkshire Hathaway B in Euro

Are Buybacks The Main Driver For The Rally In Stocks?

A fascinating chart I came across on Twitter. Since the financial crisis around $ 3 trillion has been flowing in to passive index funds which typically have a lower fee than active funds. But what is interesting about this is that there have been no net inflows in US stocks since the financial crisis.

All the money that has flowed into passive index funds have been offset by an outflow of actively managed funds. In fact, there is actually $350 billion less in US equity funds (both active and passive) than before the financial crisis.

Cumulative US Equity Fund Flows
Cumulative US Equity Fund Flows

At the same time the S&P 500 is up 300%. Even more when dividends are factored in.

S&P 500 from 2003 till September 2019
S&P 500 from 2003 till September 2019

So why then are stocks higher if demand from investors in funds actually down $ 350 billion over the last decade?

Buybacks

The answer could be because of demand for stocks from buybacks. Buybacks have become more popular since the financial crisis. With buybacks a company uses its own money to buy back its own shares in the market. Buybacks are popular because they are a very tax efficient way to generate shareholder value.

When a company performs a stocks buyback program the company buys back their shares on the stock market. This way the amount of outstanding shares is reduced. Remaining shareholders will share their profits with less shareholders. This should lead to an increase in the price of the remaining shares.

If a dividend is paid out a tax must be paid in this received dividend. A capital gains tax only has to be paid when the shares are sold. So during the period which an investor holds his shares no taxes have to be paid (which is different from when a dividend is paid).

S&P 500 Quarterly Buybacks
S&P 500 Quarterly Buybacks

US Investors Have Been Net Buyers Of European Equities For Over A Year Now

Confidence in the European economy is slowly coming back. The eurozone’s economy (countries that have adopted the euro as their currency) grew by 0.3% in the last quarter of 2013 compared to only 0.1% in the quarter before. The Dutch economy grew by as much as 0.7% in the fourth quarter relative to the third quarter. Growth for the whole 28-member EU was 0.4% in the last quarter of 2013. For the whole of 2013 the economy of the eurozone contracted with 0.4% while growth for the whole EU grew with 0.1%.

This growth in the European economy has gradually attracted investors from outside the EU to buy European Equities since last year. US investors have been net buyers of European equities for over a year now as the chart below, courtesy of Gavyn Davies, depicts. The Eurostoxx 50 ETF (FEZ) has showed a very nice return lately and is up 20% from a year ago.

NET US Buying of European Equities (12mma)

NET US Buying of European Equities (12mma)

But as Shaun Port of Nutmeg pointed out, most of this money has actually been going in UK stocks. Historically US investors seem to favor UK stocks above stocks from other countries in the eurozone. Which is pretty interesting because the FTSE 100 has been in the same tight range for over a year now (chart).

US Net Purcheses Of European Equities, Rolling 12-month total

US Net Purchases Of European Equities, Rolling 12-month total

As a bonus: here is the same chart from Shaun Port as a percentage of total market capitalization.

US Net Purcheses Of European Equities, Rolling 12-month total As A Percentage Of Market Capitalization

US Net Purchases Of European Equities, Rolling 12-month total As A Percentage Of Market Capitalization

 

Where Is That Stock And Dollar Crash I’ve Been Waiting For All These Years?

Fear sells. For years a big fear-mongering industry has been putting out books and articles about how the economy is going down the drain soon and the U.S. dollar will be worth less than the paper it is printed on. The bears have been saying this for years. Here are a few (hilarious) examples of “Doom & Gloom” books over the years that I found.

Below is picture of an impressive 300-page book by Doug Casey called “Crisis Investing: Opportunities and Profits in the Coming Depression“. In this book Doug Casey makes the case that the market is about to crash any minute now! The dollar will be destroyed soon and the stock market is going to zero. The next great depression is just around the corner. You have to act fast before all your wealth, that you have been carefully building up for years, will vanish in front of your eyes! But wait.. Let’s check something.. When did this book hit the shelves? July 1980?! There certainly hasn’t been a “new great depression” since then.

Crisis Investing: Opportunities and Profits in the Coming Great Depression by Douglas Casey

Crisis Investing: Opportunities and Profits in the Coming Great Depression by Douglas Casey (1980)

Ok maybe Doug was just a little bit early on his call that ‘the world as we know it’ is going to end. What about this book from Jerome F. Smith: “The Coming Currency Collapse“. In this book Jerome describes how the dollar is going to be toast in the near future. Oh wait that one was penned down in September 1981. He’s only 33 years (and counting) off on his call of an imminent dollar crisis. The only thing that collapsed in all those years is the price of this book since you can now get it for $ 0.01.

Coming Currency Collapse by Jerome F. Smith (1981)

Coming Currency Collapse by Jerome F. Smith (1981)

What about Howard J. Ruff’s book “How To Prosper During The Coming Bad Years“? This book came out in 1984. Everyone who followed the advice in this book missed the greatest bull market in stocks ever. The S&P 500 was trading at 160 at the time. Some reviews for the book on the Amazon page even talk about all the “missed opportunities” investors lost because they followed the recommendations in this book.

How to Prosper During the Coming Bad Years by Howard J. Ruff (1984)

How to Prosper During the Coming Bad Years by Howard J. Ruff (1984)

But Howard J. Ruff was maybe just a few years off of his imminent call for a new period of “Doom & Gloom”. In this book I got here by Martin D. Weiss called: “How To Survive The Money Panic” the author talks about the coming destruction of the U.S. economy and the U.S. dollar (of course). This one came out in 1989.

The Money Panic by Martin D. Weiss (1989)

The Money Panic by Martin D. Weiss (1989)

And then there is this one by Ravi Bata called The Great Depression of 1990. 1990? You got to be kidding me.

The Great Depression Of 1990 by Ravi Bata (1988)

The Great Depression Of 1990 by Ravi Bata (1988)

Here are some more recent ones:

The Dollar Crisis: Causes Consequences, Cures by Richard Duncan. This book came out in 2005.

The Dollar Crisis: Causes Consequences, Cures by Richard Duncan (2005)

The Dollar Crisis: Causes Consequences, Cures by Richard Duncan (2005)

This one is more bizarre because shortly after this book was published in 2008 the dollar index set a long term bottom (chart) and is trading higher ever since. The Collapse of the Dollar and How to Profit from It by James Turk.

The Collapse of the Dollar and How to Profit from It by James Turk (2008)

The Collapse of the Dollar and How to Profit from It by James Turk (2008)

And here is one from November 2013 where the author is forecasting a stock market crash in 2016. The Crash of 2016: The Plot to Destroy America – and What We Can Do to Stop It by Thom Hartmann.

The Crash of 2016: The Plot to Destroy America - and What We Can Do to Stop It by Thom Hartmann (2013)

The Crash of 2016: The Plot to Destroy America – and What We Can Do to Stop It by Thom Hartmann (2013)

The last time I checked (5 minutes ago) the S&P 500 was still trading near all time highs. The U.S. Dollar is still the world reserve currency and certainly not reduced to toilet paper. The Euro is still around as are a lot of other economies and currencies the bears have been warning us for, for years.

All the authors of the books above are still touting their doom & gloom stories to this day.

The bottom line is this: Although the bears are sometimes right about their calls for stock market crashes (2000-2002 and 2008-2009) and housing market crashes (2006-2011) the crashes never seem to bring us to a new normal of forever lower stock/housing prices and a destroyed currency (at least for the U.S. market and the U.S. dollar).

This doesn’t mean that it’s never smart to be a bear. It can be very profitable, but you need to have your timing almost exactly right. It is no secret that the market goes up on average every year (7%).

Being a long term bear is thus bad for your financial health.

The Problem With Apple’s Offshore Cash Hoard

Apple has a lot of cash as can be seen on the bar graph below. But the problem is that most of it is outside of the U.S. They can’t use this cash to pay out as a dividend or buy back stock because then they first have a to pay a U.S. profit tax on the amount of cash. Only cash and investments held domestically in the U.S. can be used for this. It is one of the reasons why Apple decided to issue new debt to buy back stock instead of paying a tax in the U.S. to move their money from the offshore accounts to the U.S.

Apple's Cash Q4

Apple’s Cash and Investments 2013 Q4

As you can easily see on this bar graph most of the cash and investment are held in offshore accounts.

Apple cash and investment held offshore Q1 2013

Apple cash and investment held offshore Q1 2013