Drama. There is more money in the World than there is enterprise to use it and, as a result, the “money-people” are scrambling to turn it over for a better return and higher yield (Bloomberg, September 11, 2014, Pimco’s Gross Says Good Time to Lever Up on Credit Investments).
But it won’t help much – it’s a defensive (place-holding) strategy because the reasonable expectation is that short-term rates will decline, or fade, because there is no reason that they should increase, and we (or they) are hoping for capital gains measured in basis-points (100 basis-points=1%), and the demand for long-term money is weak, or “risky” and measured in percents, because we might not get it back; please see our recent Posts “(P&I) The World According To Money” and “(B)(N) Jurisprudence, Interest & Capital Gains” for more on that situation.
And the times are changing – it’s not the same old, same old, anymore, and the markets in the developed countries have been unusually – even other-worldly – disruptive since the 70’s.
The chart in Figure 1, above, shows the slow demise of the 10-year bond yields on government debt in a dozen of the G20-countries over the course of the last fifty to one hundred or more years, to which is coupled the lowest, relative, government debt levels in a generation and the likelihood that inflation will either be defused where it is still high in the high single digits, or remain low in the range of 2% or 3%, and even that seems high in the context of realized and projected GDP growth; please see Figure 2 on the right.
There are, of course, lots of governments who will “take” the money from us, and offer “premium rates” for it, but it’s uncertain and (really) unlikely that they’re going to be able to give it back, or even service the coupon for very long – default is the order of the day and the centuries-old policies of “gun-boat diplomacy” and “resource exploitation” aren’t of much use anymore and not a substitute for enterprise.
Moreover, productive companies that could use it, don’t need it, and are quite able to borrow at low short-term rates and fund their projects and growth through their own resources, acting as their own “banks” by borrowing short term and, effectively, lending to themselves, long-term.
Stocking-Up For The New Normal
Many of the industrials are in that position now, with modalities well in excess of α>1 (please see The Theory of the Firm for more information), and others, such as WalMart, Home Depot, Caterpillar, and Boeing, have made other adaptations that are integrated with their business model to reduce their dependence on long-term debt.
The chart on the left shows that these companies have developed a “stable production modality” with respect to their “Enterprise Risk” (1 + log(N/N*)) and the pricing of the same, for which only the “pricing” is the one degree of freedom that can’t be predicted, but which we can reasonably expect will not decline, but if it does, it’s a buying opportunity for the long-term money; please see our recent Post “(B)(N) Through The Looking-Glass” for more details.
The transports (please see Figure 4 on the left, and click on the link for more details) are not quite as well situated, and the utilities (which we’ll look at below) are not able to churn their debt that easily, and they continue to carry a large overburden of long term debt and a high dividend rate with a high payout rate – something for everybody, and it might last; please see Exhibit 1 below for the Fundamentals.
Nevertheless, the entire market value of the Dow Industrials, Transports, and Utilities, is less than $8 trillion at the present time, but there’s about $40 trillion of government bond-money and a world debt market of another $50 trillion, according to The Economist, and another $800 trillion in derivative and “securitized” assets, all of which are looking for a new home, and even all the North American markets don’t amount to much more than $30 trillion, even after the double-digit increases of the last two years; please see our Post “(B)(N) The Easy (EC) Theory of the S&P 500” for more information.
As a result, it doesn’t seem possible that the “old games” of volatility-based investing, promoted gratuitously for the last forty years by the Capital Assets Pricing Model (CAPM) and Modern Portfolio Theory (MPT), can work, or that they are even meaningful or have ever “worked” – volatility is not risk (and it never has been) – the risk is in 100% capital safety, 100% liquidity, and a hopeful but not necessarily guaranteed return above the rate of inflation – which takes us back to 400 years ago circa 1600 and what an investment really is, and everybody knew it: an investment is the purchase of risk, and we ought to know the price of it, because there is a lot of money that wants to buy it from us.
The Dow Utilities – Fundamentals of the New Normal
Exhibit 1: The Dow Jones Utility Companies – Fundamentals
The utilities are surely the draught-horses of America, for pension plans, endowment funds, and income-seeking investors; nearly 80% of their debt, $640 billion, is long-term, and they paid-out 82% of their earnings, for a dividend payout of $16.4 billion, and an aggregate dividend yield of 3.7% at the current prices; please see Exhibit 1 above for further details (and click on it to make it larger if required).
Yet their current “market value” is $440 billion, which is $200 billion less than an iPhone (Apple Incorporated) and comparable to a world-map ($400 billion, Google Incorporated).
Investors bid the utilities up by 8.6% last year, and a further 14% so far this year but, obviously, our stop/loss (the green line in Figure 1.1) put us into cash for long periods of time, although we’re always fully prepared to buy them back at lower prices if they’re still trading above the price of risk and are, therefore, (B)-class; please click on the links “(B)(N) The Dow Utility Companies – Prices & Portfolio and Cash Flow Summary” for further details.
The return on the shareholders equity is a slight 8.5% (to which we might add the debt interest) and the return on the total assets is only 2.3% and, undoubtedly, these companies could use some creative work on their debt-regime, and even equity-funding for new projects; the aggregate [P/E] is 22×, but it varies between 13× for Consolidated Edison and 110× for Williams Companies; please see Exhibit 1 for further details.
What are they worth?
In general, as investors, we don’t “price” stocks; for example, we don’t care about the earnings, or the projected earnings, or the [P/E]s, or the conflict in the Ukraine (and elsewhere); we don’t calculate volatility (except as demonstrated, using Popoviciu’s Theorem) or co-volatility; and we know that there is no “reversion to the mean” (because there isn’t one); nor do we look for “heads and shoulders” or “dead-cat bounces”; and we don’t want any “inside information” or the Wall Street Spin; and the list goes on – there are as many reasons for a stock price as there are investors and their money, and the only bedrock is at the takeover price, if it is low enough, and somebody wants it.
As a practical matter, all that we care about is what we want – we want 100% capital safety, 100% liquidity, and a hopeful but not necessarily guaranteed return above the rate of inflation – and we get it by simply observing whether the stock, at the current prices, is (B)-class or (N)-class, and we only buy and hold the (B)-class companies; please see, for example, our Post “(B)(N) Demand and Supply” for more information on “undervalued” and “overvalued” companies and what that means to us.
But, bereft as we are of all anxiety, we can “price” stocks as if they were an IPO, and there have been some recent examples of how that works; please see our Posts “(B)(N) Fannie Mae & Freddie Mac” and “(B)(N) BABA Alibaba Group Holdings Limited“.
If we do, then amidst all of the drama of investor stock pricing, we’re basically assessing the “revealed prices” for arbitrage opportunities for all the stocks in a similar industry; that is, one in which all the companies have similar operating and product or marketing challenges and, therefore, similar, and probably over-lapping, trading connections in substance or kind; please see Exhibit 2 below.
Exhibit 2: Enterprise Risk and Dividend Risk
For more information on the chart elements and the “Five Equations of State”, please see our recent Post, “(B)(N) Through The Looking-Glass“.
And for more information on real “risk management” in modern times and additional references to the theory and how to read the charts and tables, please see our Post, The RiskWerk Company Glossary and “(P&I) Dividend Risk and Dividend Yield“, and our recent Posts “(P&I) The Profit Box” and “(P&I) The Process – In The Beginning“; and we’ve also profiled hundreds of companies in these Posts and the Search Box (upper right) might help you to find what you’re looking for, such as “(B)(N) TLM Talisman Energy Incorporated” or “(B)(N) ATHN AthenaHealth Incorporated” or “(B)(N) PETM PetSmart Incorporated“, to name just a few.
And for more applications of these concepts please see our Posts which rely on the Theory of the Firm developed by the author (Goetze 2006) which calibrates The Process to the units of the balance sheet and demonstrates the price of risk as the solution to a Nash Equilibrium between “risk-seeking” and “risk-averse” investors within the demonstrated societal norms of risk aversion and bargaining practice. And for more on The Process, please see our Posts The Food Chain and The Process End-Of-Process.
And for more on what risk averse investing has done for us this year, please see our recent Posts on “(P&I) The Easy (EC) Theory of the Capital Markets” or “(B)(N) The Easy (EC) Theory of the S&P 500“, and the past, The S&P TSX “Hangdog” Market or The Wall Street Put or specialty markets such as The Dow Transports & Utilities or (B)(N) The Woods Are Burning, or for the real class action, La Dolce Vita – Let’s Do Prada! and It’s For You, Dear on the smartphone business.
And for more stocks at high prices, The World’s Most Talked About Stocks or Earnings Don’t Matter – NASDAQ 100. And for more on what’s Working in America, Big Oil, Shopping in America or Banking in America, to name just a few.
We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product
The Perpetual Bond™
Alpha-smart with 100% Capital Safety and 100% Liquidity
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For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to RiskWerk@gmail.com.
Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.