Trends in Stocks

Investing in stocks is always hard.  You are looking at data about the past but you are betting on an individual stock in the future.  In addition, there has been huge correlation among stocks and markets and the impact of currencies and central bankers (often inter-twined) has given various world markets boom and bust qualities.

In the US, there are two markets, the NASDAQ and NYSE.  NASDAQ has traditionally been more technology focused, meaning that when these stocks go up, the NASDAQ soars.   Here is a quote on “the only six stocks that matter” about the NASDAQ from the Wall Street Journal:

Six firms— Amazon.com Inc.,Google Inc.,Apple Inc.,FacebookInc.,Netflix Inc. and Gilead Sciences Inc.—now account for more than half of the $664 billion in value added this year to the NasdaqComposite Index, according to data compiled by brokerage firm JonesTrading.

Thus the bottom line is that if you don’t have these stocks in your portfolio, the overall index may be rising (and our benchmark for performance), but your own returns will be worse.  We do have some of Amazon and Facebook in portfolio 2, but not much of it overall.

Outside the USA, foreign markets have been hurt by the rising US dollar, which makes their market values lower for us here in the USA (where the dollar is our currency).  This hurts stock investments in Europe (the Euro), Canada (the Loonie), and Australia (the Australian dollar) if you are denominated in US dollars (which we are).   The dollar is up significantly vs. almost every other currency in the world with the exception of the Chinese Yuan.

The Chinese market went crazy this year, in what appears to be a major bubble, that recently started crashing and was accompanied by strong intervention from the central authorities, who went after short sellers and even stopped stocks from trading for various reasons.   At one point almost the entire Chinese stock market by valuation (over 80%) was not trading.  The rationale is that if stocks are heading down, and you can stop trading, then this gives the market participants time to stop panicking.  This type of intervention stops the market from functioning efficiently, however, and will have many other unforeseen impacts down the road.

Mergers and acquisitions (M&A) activity also soared in 2015, which is a sign of bullishness and also likely a sign of a market peak.  A Wall Street Journal article recently summed it up:

Companies are merging at a pace unseen in nearly a decade. Halfway through the year, about $2.15 trillion in M&A deals or offers have been announced globally, according to Dealogic. That puts 2015 on pace to challenge the biggest year on record, 2007, when companies inked deals worth $4.3 trillion… In industries ranging from health care to technology to media, chief executives are rushing to make acquisitions, often either in anticipation of takeover moves by rivals or in response to them.

When acquisitions occur, you as a stock market investor typically want to be the “acquired” company, not the “acquirer”.  The “acquired” company receives a premium price to their current market value but the burden of “earning” that higher price falls on to the acquired company, and typically M&A does not pay off long term for most companies (as opposed to internal or “organic” growth).  While there have been many acquisitions, most notably in the health care / insurance / pharma industry which is consolidating under Obamacare, our portfolios had few of these acquired companies in the mix.

Finally, you had a decimation of the commodity indexes.  Commodities such as oil, some foodstuffs, natural gas, iron ore, copper, gold, etc… have seen their prices collapse, which in turn damages the stocks of mining companies, oil companies, and many other participants in the commodity value chain.  Per Bloomberg:

Almost all commodity markets have taken a severe beating lately. The aggregate Bloomberg Commodities Index is down 61 percent from its 2008 peak and 46 percent from the 2011 post-crisis high

These are severe reductions.  They impact entire economies particularly the Arab countries (which make all their export income in oil), Russia (many commodities), Australia and Canada.  There are large “secondary” impacts as well – reduced commodity prices hurt service demand in Canada and Australia and put their housing boom at risk.

So what does this mean for us and our portfolios?  We’ve been hurt by the commodity bust, the rise of the US dollar (on our foreign stocks), and we’ve missed some of the booming stocks because they were narrowly concentrated in a few names and some of the largest M&A was in sectors where we had few investments.

We are now going to look at some of the stocks and cull some prior to our next round of purchases which will occur in August – September as the beneficiaries of the various portfolios head off to school for the year, and will tie new purchases (of the cash) with additional investments that will be made soon.

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Recent Stock Moves

Rise of the China Stock Market

When you are judging the success of your portfolio against benchmarks, which conceptually is a simple exercise, the question soon arises:

1) who are you comparing yourself against?

2) what currency is your benchmark denominated in?

Whether you want to invest there or not, China has had a major rally, and the Chinese Yuan is stable against the US dollar (in the range of 6 Yuan / dollar and 6.4 Yuan / Dollar over the last 3 years) as opposed to other currencies like the Euro and the Japanese Yen which have cratered in dollar terms.

The incredible rise in stocks in Chinese stock prices has mostly gone “under the radar” of US media.  Recently they connected the stocks in Hong Kong with stocks on mainland China and not only have prices risen substantially, the same stock trades for different prices in each location.  Per this WSJ article

Shares of Chinese companies listed in Hong Kong look like a steal compared with shares of the same companies that are listed in Shanghai. Such stocks on average trade at a 32.89% discount in the former British colony, according to the Hang Seng China AH Premium Index.

Typically, under a concept called “arbitrage”, the price of equivalent items in different markets are narrowed when investors take steps to capture the “easy money” of buying that same good cheaper in a different place.  A very simple example is that you can’t have gasoline selling for $4 in one state and $3 in an adjacent state; everyone just crosses the border to buy the cheaper gas until the price differential narrows.  Gaps of a couple of percentage even across exchanges is enough for investors to jump in and take advantage; a 32% differential is extreme.

This rally isn’t due to a perception that the economy in China is getting better; in fact it seems to be getting worse.  The rally has been enhanced by structural moves that allow more investors into the market (largely retail mainland investors) and lets them buy stock on margin, as well.  Per this WSJ article:

Margin lending has more than tripled in the past year to a record 1.7 trillion yuan ($274.6 billion)…The practice isn’t unique to China, where margin debt equals 3.2% of total market capitalization, compared with 2.3% in the U.S. But when compared with the value of stock that is freely traded, making it accessible to ordinary investors, the percentage for China rises because state entities own more than half of the market.  Research by Macquarie Securities Group shows China’s margin-debt ratio at 8.2% of the free float. That easily exceeds the peak of 6% reached in the late 1990s in Taiwan, the second-highest level globally in recent years.

Thus if you didn’t have a proportionate share of your portfolio invested in Chinese stocks, you were a “relative” loser, although there are many reasons to believe that this rally isn’t sustainable.  This goes back to the original question of how benchmarks are defined.

Individual Stock Moves

In one of the portfolios I follow there have been significant and immediate moves in several of our stocks.  These stocks were related to China or the the technology industry.

Linked In (LKND) recently had an earnings call and their stock price plunged by over 20% in one day.  The cause of the drop wasn’t the earnings themselves (they beat expectations), it was their “forward guidance”.  For stocks with a high price / earnings multiple like Linked In, the market needs to have continued rapid growth to justify the high stock price today.  In fact, Linked In currently doesn’t book profits, primarily due to their high amounts of stock based compensation (stock given to executives in lieu of cash).  Linked In’s guidance talked about currency headwinds (meaning that if they brought in the same revenues overseas it would “count less” towards net income because of the rise in the US dollar) and also some one time acquisition costs from recent companies they’ve purchased.

Amazon (AMZN) had their last earnings call where they continued to show no profits on a GAAP basis and yet their stock rose 6.8% due to other factors that analysts apparently found compelling.  Note that a 6.8% gain for a company the size of Amazon is a large increase in market capitalization (over $10 billion) in a single day.

China Life Insurance ADR (LFC) has almost doubled from around $40 / share to $80 / share as part of the overall China rally discussed above.  While a seemingly sound stock this performance gain is not tied to any fundamentals in how the company operates; this growth is tied to the giant overall rally.

Wynn Resorts (WYNN) dropped more than 10% in a single day after earnings were released.  Wynn has a property in Macau (China’s only location with legal gambling) and it has been hit hard with a recent crackdown on high-roller gamblers by China’s communist leaders.  Note that the scale of gambling in China dwarfs Las Vegas by any measure (total market, amount bet per player, etc…) and thus properties in China have been proportionally more lucrative than their US equivalent.  It is not known whether this will be a long term reduction of high rolling gamblers or a short term hit; that depends on inscrutable Chinese government polices.  Left to their own devices, it is highly likely that Chinese would continue to gamble at record rates.  Wynn also has long running board issues and governance issues as well.  At risk is their dividend, which “income investors” price highly in an era of virtually zero yield on debt (without taking on significant risk).

Westpac (ADR) – the Australian bank slightly missed earnings and their stock went down almost 5%, but then recovered a bit and was down 3%.  The CEO said that flat earnings won’t be tolerated in a later interview.  Unlike those companies with little or no GAAP profits (Amazon, LinkedIn), a company like Westpac won’t usually fall as much with a minor earnings miss because it has a lower P/E ratio and incredible future profit growth isn’t already “baked in” to the stock price.

Seeing large moves in single stocks can be viewed as a sign of a bull market in its last stages.  Since we invest for the long term we don’t pull in and out of the market based on short term moves but it is definitely something to consider; stocks with limited earnings and high P/E ratios or tied to giant rallies like is occurring in China today should be on some sort of watch.

Cross posted at Chicago Boyz

Buy And Hold Works… Sometimes

For these trust funds we work to link stock selections with long-term thinking. These portfolios start when the beneficiary is 11 or so years old so they have a long time horizon.

With that, there are times that it is wise to sell. If you believe that a stock has been part of a huge run-up and gains are not sustainable, you should sell. We sold a number of stocks in 2007 when valuations were insanely high (such as China Mobile (CHL), which peaked near $100 in 2007-8 and now is settled back in around $50 / share) and many of them have not recovered back to those levels. Unfortunately, we re-invested the proceeds into new stocks which promptly went down with the rest of the market but it still was the right thing to do.

On the other hand, some stocks seem to get permanently impaired or on a downward spiral from which they never recovered. We bought Nokia (NOK) and then sold at a loss – and the stock has kept dropping since, damaged by their dismal position in the smart phone market. We also did the same with Cemex (CX) which also had a high near $40 in the 2007-8 time frame but has settled to around $10 / share.

It is hard to know when to capitulate, and when to hold on to wait for the rebound. Urban Outfitters (URBN) was selected because it had low debt and seemed well run – until they had a bad earnings report and the stock tanked. We held onto it for over a year after it had lost about a third of its value, and then a lot of their top management resigned. Yet recently it came back and is now above its original purchase price. Other stocks that we waited on until they came back include Comcast (CMSCA) and Ebay (EBAY). On the other hand, we are still waiting for recovery on Canon (CAJ), Riverbed (RVBD), WYNN, Exelon (EXC), and Alcoa (AA). I am bullish EXC in the long term as well as RVBD; I think there is hope for CAJ because they are well run; and watching WYNN and AA.

Portfolio One Updated February 2012

Portfolio One, our longest term portfolio, did well in the early part of 2012 and is worth $23,270 on an investment of $16,500, for a gain of 41%, or about 6.1% / year over the life of the fund (this is approximate since the cash flows have been coming in across the life of the fund).

Earlier in 2011 we sold Ralcorp (RAH) for a gain on takeover rumors (it’s stock price has stayed at that level or risen even thought the takeover did not occur) and sold TEVA the Israeli drugmaker that started on acquisitions (which usually destroys value for the acquirer) and also could offset some of the gain with a loss. We left the proceeds from TEVA in cash just to reduce risk a bit although we may put this money back to work when the 2012 investment money is added again.

It is still early but all the new picks seem to be doing well (Statoil, Wal-Mart, and Philip Morris International) and the Chinese oil companies have boomed again. The only “dog” so far that we are continuing to watch is Urban Outfitters, whose CEO left a while ago and they are now planning on re-tooling their merchandise; if this happens the stock might rise else it will be time to permanently bail out.

Of the stocks sold in the past they all seem like good moves in hindsight (phew!) except for the selling of Amazon (AMZN) although the sting of this sale is partially offset by the fact that this money was reinvested into some of our best performers, such as P&G. In hindsight (always 20/20) we sold Netscout (NTCT) a bit early too but the tech plays are very volatile.

Portfolio Three Update December 2010

Portfolio Three is on its 4th round of annual investing, meaning that it is a bit older than 3 years. This portfolio started during one of the most tumultuous times in the stock market, at least during my investing lifetime.

Total investment in this portfolio is $6000, with $2000 from the beneficiary and $4000 from me. In 2007 we sold China Mobile during what looked like a peak (still is far below that price, so it was a peak to date) but then got clobbered in 2008. With only a few stocks in the portfolio, it is at risk of total performance if even one stock does badly, and Nokia (NOK) just plummeted and frankly, like with portfolio two, we didn’t pull the plug on that stock soon enough. NOK just let its lead in mobile technology slip away when it missed the iPhone and next generation of smart phones and owning a large share of commodity phones with low margins won’t cut it. Also for those that view dividends (high dividends) as a path to wealth of course as the stock plummeted the dividend went down with it; you need earnings to support that dividend in the first place.

Recently with all that we are finally about back to break even; the portfolio is worth about $5900 (out of an investment of $6000).

Recent investments in overseas companies with ADR’s like Siemens (SI) and more recently a Canadian Bank (CM) and a Chinese oil company (CEO) have done well in the stock market run-up. Since most every issue has gone up (but the Chinese oil stocks in particular) it doesn’t take a genius to do well with the rising tides but it does feel good to get within a hair’s breadth of break even in this portfolio (as in “mattress status”, comparing against what would happen if you put the money under your mattress, a sad benchmark but relevant in these times).

With 5 stocks, the portfolio is still subject to large swings due to performance of a single stock, and we will watch them and not let them fall like we did with NOKIA, lesson learned there.

Another good thing about this portfolio is that we are able to do no-commission stock buys and sells, and there is not an annual fee for having the portfolio. Not having these charges adds up over time (they are essentially subsidized by my other accounts at the provider, which is fine with me).

Update on Portfolio Two Performance

Portfolio Two is my second longest portfolio and has been running for 6 years.

Portfolio Two started when the stock market was in rocky times and has finally climbed above break even, with a total investment of $10,500 and a value of $11,403. The portfolio has 11 stocks and thus is reasonably well diversified. Big winners (that we kept) include Exxon Mobil, Siemens and China Petroleum (SNP). In the past we had some major gains on sales for BHP and China Mobile, and some major losses on Nokia (just recent), Cemex and ICICI Bank. I should have sold Nokia sooner I won’t wait for that big of a loss when I see future declines before selling.

This portfolio benefits from the fact that now commissions are effectively zero on buys and sells since I am using my “free trade” allotment on this portfolio; this probably saves $60-$80 / year which adds up over time. Fees are also effectively zero.

This portfolio seems to be in a good place with regards to a balance between US and foreign companies (since the swing in the dollar significantly impacts values, and most economic growth is overseas) and we will watch the stocks here and look for potential sales of losers or opportunities to sell high for winners.

Re-Update On Portfolio One Performance

It is time to update all of the portfolios on the site. Since I track it manually in excel (in order to check all the fees, etc… on the brokerage account) it takes me a while to do this by hand. I check performance day-to-day (or at least periodically) using the google portfolio tool, which works great. Since I was going to do the other portfolios I figured I’d re-update portfolio one since we had a great month and it is easy to do the update when there are no buys or sells.

Portfolio One is nearing the $20,000 mark, at $19,775.   This file has been seeded with $15,000 of contributions, so it is up about 32% over its life, which is approximately 9 years. The “effective” life is much smaller, since we have been making contributions of $1500 / year for all years except the first one, when it was $500. That is a pretty good rise since the indexes (US) have been worse over that time, although to calculate it effectively I would need to break the $1500 “tranches” into unique components and then determine their annual performance through today… which I will probably break down and automate some time.

This portfolio is nicely balanced with about 15 stocks. At anything more than about 10 stocks or so you get a reasonably diversified portfolio, assuming that they aren’t all the same types of stocks. Also comparing to US benchmarks probably isn’t quite right since I have been advocating about 50% overseas stocks for the last several years since most growth is overseas and this means that I should be tracking against worldwide developed countries, instead.

More importantly than talking about how the portfolio has DONE is talking about STRATEGY. I highlighted individual active stocks and put those with more than $200 “up” as green, and with more than $200 “down” as red. Since we sold Nokia (a disaster) and Microsoft (flat) we have a lot of green and not much red anymore. The point is to have a strategy going forward, not backwards, and the question is whether or not they will go up from here and when to sell, if something has reached a peak. Generally I should try to sell before they hit the $200 mark on the down side; this would have saved some heart-ache with Nokia. On the flip side some have gone pretty far down and come back (mostly), like eBay. But as a strategy point I should try to sell or at least consider it seriously around the $200 mark.

As far as the “up” stocks, it seems that the Chinese oil firms are in a bubble stage. We will watch those, just like we watched China Mobile and BHP. We aren’t with them forever, and their huge market cap means that a big multiple means that there has to be a lot of profits earned in the future. A lot of the gains are a bet on China itself and away from the US dollar, so that has to be figured in, too.

Of the ones we sold before, Netscout (NTCT) gave us a nice gain but we missed the jump from $14 to $24. It came back down to where we bought it so it seemed like a good move at the time but we also need to watch the long term. There likely will be a consolidation in the tech market as the big players seek to utilize a lot of their cash and look for growth so if we make some sells I might be looking for some smaller tech players to jump into.