Awash in cash

People who like dividend stocks might find that technology stocks are the type of stocks that they like.

For one thing, they have enough cash to buy several small European countries. “Companies have enough money to do whatever they want, and that’s before potential reparations” from the tax bill, noted Howard Silverblatt, senior index analyst for S&P Dow Jones Indexes. And how. All told, about $1.8 trillion is cooling its heels on corporate balance sheets, and much of that is on tech balance sheets. Here are the 10 companies with the biggest cash stashes:

Apple has another $195 billion in “long term investments” on its balance sheet, which skeptics might label as “pretty darn close to cash.”  And overall, IT is the second-largest dividend payer, behind financials.

Why does IT have so much cash, aside from being immensely profitable? One reason might be that IT went through a near-death experience in 2000-2002, and they have learned the lesson that cash is your best friend in hard times. (Banks, which have gone through several near-death in the past 50 years, never seem to learn that).

Another is that IT companies rely on innovation to survive, and innovation doesn’t come cheap. Either you have to hire top people (and pay them well to keep them) or you have to pay up to buy innovative companies. That requires cash, too, although having an extravagantly valued stock price is good, too.

What’s interesting is that many of these stocks aren’t insanely priced. Apple sells for 14.4 times its estimated 12 months’ earnings, and pays a 1.45% dividend, too. Cisco sells for 14.4 times earnings and pays a 3.0% dividend. Oracle pays a 1.48% dividend and sells for 15.3 times earnings. Only Facebook, which sells at 26.8 times its expected earnings (and doesn’t pay no stinking dividend) fits the profile of the gunslinging tech company of yore.

(The two biotech companies in the chart, Amgen and Gilead, also rely on heaps of cash to continue innovation, are cheap, and pay good dividends. Coca-Cola is, well, Coca-Cola).

During the 2007-2009 bear market, and for some time thereafter, technology was the sector with the highest dividends, precisely because it had the cash on hand to do so. Banks were too busy staving off bankruptcy. For investors who like dividends and dislike bankruptcy, large-cap IT seems to be a reasonable bet.

Naturally, there’s an ETF for that: The First Trust NASDAQ Technology Dividend Index Fund (TDIV), which currently yields 2.14% on a trailing basis. The fund doesn’t have the sizzling returns that an all-tech fund has — it’s up a mere 21% this year, vs. 36% for the technology sector — but that’s not why you buy a dividend fund. Assuming these companies don’t waste their money on something foolish, like buying several European countries, they could be a good long-term investment for dividend investors.

Taxes and the urge to merge

Tax reform, in whatever final shape it takes, is likely to put lots of money into corporate hands. While these companies already have lots of cash — a record $1.8 trillion in nonfinancial companies in the Standard & Poor’s 500 index — giving them more cash may give them an incentive to actually, you know, spend it. I talk about one likely option in my latest column, here. 

On another topic, the Baby Boom Generation spans the years 1946 to 1964. There’s a big difference between the early Boomers and their younger siblings: If you were born in 1946, you came of age with the Beatles, the Vietnam War, Lyndon Johnson and Richard Nixon. If you were born in 1964, you grew up with The Clash, gas lines, Jimmy Carter and Ronald Reagan. More importantly, older Boomers are more likely to have pensions and more likely to have taken a beating from the past two bear markets. Younger Boomers? They probably don’t have pensions, they face soaring college tuition costs for their children — and some will retire just as the Medicare Trust Fund runs out of money. You can read about it here.

By the sweat of your brow

“By the sweat of your brow
    you will eat your food
until you return to the ground,
    since from it you were taken.”

One of the enduring mysteries of the U.S. tax code is why the system is harder on those who earn their income by the sweat of their brow as opposed to those who get money from their investments.

The tax code’s main purpose, of course, is to fund the activities of the government, and Americans have been having a lively discussion about the proper scope of government activities and how to pay for them for more than 200 years.

Over the years, however, the tax code has been used to encourage certain behaviors and discourage others. In its current incarnation, for example, we give deductions for contributions to some retirement savings accounts, because that’s a good thing. We levy tax penalties on early withdrawals from retirement plans, because that’s often a bad thing.

There are plenty of things to argue about with these types of tax incentives. What is curious, however, is the favorable treatment of investment returns over ordinary income. Currently, for example, employment income is taxed at a maximum 39.6%, while long-term capital gains are taxed at a maximum 20%.

Ostensibly, the lower tax rate for capital gains – the difference between your purchase price and sales price on a winning investment – is to encourage investment. As such, it has some merit: Congress cut the capital gains rate from 28% to 20% in 1982, and the stock market took off. (On the other hand, Congress returned the capital gains rate to 28% in 1987, and the stock market generally rallied until 2000).

Nevertheless, we as a nation tend to encourage hard work and look down on those who work as little as possible. And here we come to a paradox between the admiration for hard work and the tax code. Consider this comparison of two people, each with $300,000 in income, presented by Ben Steverman of Bloomberg.

Our first taxpayer is an emergency room surgeon. The other plays video games all day, thanks to his inheritance.

twogus

Now, as with all things taxable, there are some important caveats here. One is that under current law, if the heir’s parents gave him his capital in their will, the estate is liable for taxes under estate tax law. (Heirs don’t pay estate taxes.) That said, it’s unlikely that the parents paid estate tax: It doesn’t kick in until $11.2 million for a couple and $5.6 million for a single individual. About 11,300 estate tax returns were filed for people who died in 2013, of which only 4,700 were taxable, fewer than 1 in 550 of the 2.6 million people who died in that year, according to the Tax Policy Center.

This is largely an investment blog, so it’s useful to point out that lower corporate taxes in the new tax bill means that companies are more likely to increase dividends, buy back stock, or increase merger and acquisitions. All told, it’s hard not for investors to like the bill, because it will help returns from the money you earn while you sleep. But we’re a country that admires hard work. In the end, however, even with a tax break, those who earn their living by the sweat of their brow still wind up paying more.

 

The Three Percent Solution

When I was growing up, we had a lot of cats. I don’t mean three or four cats. We usually had upwards of ten, all descended from a single calico named Caroline. My parents underestimated both the gestation period of the common house cat, as well as the neighbors’ interest in adopting kittens, no matter how tri-colored and adorable. I thought little of it: I liked cats, and still do, and to me, having 10 or more cats in the house was perfectly normal. It wasn’t until I was older that I realized how peculiar that was.

One of the peculiarities of the past decade – and it’s been a singularly peculiar decade – has been the exceptionally low level of interest rates. The average yield on the three-month Treasury bill the past 10 years has been 0.38%, according to the Federal Reserve. And that figure is inflated somewhat by the first 12 months of the series, when three-month T-bill yields averaged a whopping 2.14%. After that, the three-month bill yielded an average 0.18%. (For purists, this is the market yield, not the discount yield).

For anyone who has been investing the past decade, 0.18% seems about normal. Money market mutual funds, whose yields track the short-term T-bill, have yielded next to nothing – and sometimes actually nothing – for much of the past decade. The same is true for bank CDs. But this is not normal. The average yield for the three-year T-bill since 1934 is 3.5%. If we want to get rid of the very highest and very lowest yields, we get a typical yield of 3.18% over that 83-year period.

Why is this important? For large swaths of the nation’s history, you could get a yield of 3% or more by taking virtually no risk. But for the past decade, that 3% yield has been entirely elusive. To get even a modest 3% yield, you had to take unprecedented risk, either by investing in dividend-producing stocks, or by investing in corporate bonds.

Barring some unforeseen disaster, the period of rock-bottom rates is over. From October 2009 through October 2015, the three-month T-note yielded an average 0.07%, as the Fed kept rates low to stimulate the moribund economy. Today it stands at 1.26% and, should the Fed raise rates as expected, will rise to about 1.5%. Analysts widely expect the Fed to raise rates another half percent or more next year, bringing T-bill rates to about 2% to 2.25%.

While this is still low by historical standards, it holds some interesting implications for long-suffering savers. First, a 2.25% riskless yield could be enough to dull investors’ interest in dividend-producing stocks. Currently, the Standard & Poor’s 500 yields 1.9%. While companies are flush with cash – and get more so should corporate tax rates fall – a 1.9% yield is not a terrific reward for stock market risk when T-bills are sitting at 2.25%.

Yields on bank CDs are already rising. The highest yielding nationally available one-year CD, offered by online bank Banesco, weighs in at 1.75% with a $1.500 minimum, according to BankRate.com. Goldman Sachs Bank USA offers a one-year CD at the same rate. A five-year CD from Capital One 360 yields 2.45%, but it makes little sense to lock in for five years when rates are rising.

Money fund rates are rising as well. Vanguard Money Market Prime (VMRXX) currently sports a 1.20% yield. And Bankrate.com lists three bank money market accounts with yields of 1.5%. (Bear in mind that bank money market account yields are set by the bank, while money market accounts are set by the market).

Investors who decided to seek a bit more yield by investing in short-term bond funds may want to rethink that strategy. Vanguard Short-Term Bond Index fund (VBISX), for example,  has gained 1.39% the past 12 months, including reinvested dividends. Its 12-month yield is 1.54%, indicating that investors have taken a modest loss on principal. If the Fed continues to raise rates, investors will get higher yields, but also increased principal losses.

If you’re a long-term investor with reasonable risk tolerance, there’s nothing wrong with investing in a stock fund that aims for high or growing dividends. Members of the Standard & Poor’s 500 stock index have record amounts of cash, the economy is growing, and they may get even more cash through proposed corporate tax cuts. And several funds offer a convenient way to buy dividend stocks. T. Rowe Price Dividend Growth (PRDGX), for example, has gained 17.35% the past 12 months and offers a 1.4% yield. Fidelity Dividend Growth (FDGFX) has gained 16.13% the past 12 months with a 1.47% yield. Vanguard Dividend Growth, alas, is closed to new investors.

If you’re simply looking for income, however, and you’re worried about the stock market, you may soon be able to put some of that worry to rest by going to cash. Any reasonable portfolio needs exposure to stocks for long-term growth, so don’t sell everything. But if you want to raise a little cash, you’ll get a bit more reward than you have for most of the past 10 years. And that’s one thing about our current investment climate that actually isn’t peculiar.

 

Lots of cash and animal spirits: What could possibly go wrong?

If you’ve ever been to a particularly raucous New Year’s party, you know that there’s a logical progression from the first awkward arrivals and introductions until you’re sleeping in a car full of raccoons and empty Cheetos bags.  And, at the time, each step makes wonderful sense.

Right now, the markets are at a spot where spirits are high and cash is flowing like liquor at your broker’s annual Christmas party. Let’s take a look at the animal spirits first.

University of Michigan, University of Michigan: Consumer Sentiment© [UMCSENT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UMCSENT, January 1, 2017.

 University of Michigan, University of Michigan: Consumer Sentiment© [UMCSENT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UMCSENT, January 1, 2017.

As you can see, consumer sentiment has been rising since the dark days of 2009; it now stands at 98.2 — the chart is lagged by a month. Sentiment is now higher than it was in January 2015 (98.1), and the highest since February 2004.

Soptimism-graphmall business confidence is also up post-recession, but it jumped markedly after the election, presumably on the hopes of lower taxes and regulation by the new administration.

And that confidence — plus the 12% gain by the Standard & Poor’s 500 stock index this year — has sparked optimism among investors. The American Association of Individual Investors sentiment survey now stands at 45.6% bullish, vs. its 38.5% historical average. Similarly, just 25.7%  of those surveyed said they were bearish, vs. a historical average of 30.5%. Bullish sentiment is at a five-week high, and its third-highest level of 2016.

At the same time, there’s plenty of money on the sidelines, and some of it appears to be returning to stock funds. In the last week of 2016, investors poured an estimated $118 million into U.S. stock funds. But that’s a piker compared to the previous week, when an estimated $18.6 billion flooded — more than the previous 24 months combined, according to the Investment Company Institute, the funds’ trade group.

As of the end of November, there was $2.7 trillion in money market mutual funds, earning approximately zilch. A roaring stock market provides a great deal of temptation for at least some of that money.  Stock funds had about 3.2% of their assets in cash, which is not particularly high, and that figure’s usefulness has been eclipsed somewhat recently.

Another potential source of cash: Companies in the S&P 500 have a record $1.5 trillion in cash cooling its heels on their balance sheets. They can use this for buying back stocks, paying dividends, or — and this is crazy talk — reinvesting in plants, equipment and their own employees.

The bad news is that the stock market is already expensive. The S&P 500 sells at about 24 times earnings, as opposed to a historical norm of about 17 times earnings. S&P predicts that earnings will rise through 2017, bringing down the PE ratio to about 18. Bear in mind that forecasts are notoriously unreliable, particularly when they’re about the future.

Bear in mind, too, that the Federal Reserve is likely to continue to raise interest rates, and at a faster pace if the economy grows faster than expected.

Right now, it looks like animal spirits and plenty of cash will keep the market party going, and that can be good, clean fun. Enjoy the ride. Just remember that market rallies always last longer than a sober person would think. But remember that many things must go right for the rally to continue. It’s probably a good time to readjust your portfolio back to your original goals. No one ever went broke taking a bit of profits.

 

 

 

 

This old house: A good investment?

One of the surprising things about being a personal finance writer is volume of “dear idiot” letters you get. You get used to vitriol when you write about inflation (You idiot! Do you know what a pound of chicken costs these days?) or the Federal Reserve (You idiot! Janet Yellen destroyed this country!).

What surprised me a few years ago was the response I got from what I thought was a fairly milquetoast piece on buying a house. I wrote the story in 2012 and said, basically, prices are still low, interest rates are low, and if you can afford it, this might be a nice time to buy a house.

This produced howls of outrage from people who had bought during the housing boom and were still underwater. And, as they learned, housing boom and bust cycles are pretty long. The housing market peaked in 2006 with the median home price — half higher, half lower — at $154,600, down from a high of $230,900 in July 2006. The median price rose to $177,200 in 2012, and stood at $229,400 at the end of the second quarter, according to the National Association of Realtors. In other words, after nine years, the median home price is nearly back to its 2006 peak. That’s a long time to be under water.

What has changed since 2012? Affordability, mainly. While the 30-year fixed-rate mortgage rate is just 3.86%, the NAR says affordability has declined 23% since 2012.  In other words, as housing prices have risen, the number of buyers has declined, thanks to stagnant income and higher prices.

But how good of an investment is real estate? It’s an extraordinarily difficult calculation, but generally speaking: It’s not great, unless you buy at the low and sell in the next frenzy.

Via Shorpy.com
Via Shorpy.com

Consider this fine 12-room home in Chevy Chase, Maryland, which sold for $17,000 in 1919, according to the wonderful history site, Shorpy.com. It sold in 2014 for $2.4 million.

While this may seem a dramatic price gain, it works out to a 5.35% average annual return during 95 years. It’s certainly beat inflation: $17,000 in 1919 dollars was worth $232,630 in 2014, a 2.79% rate, but lagged the Dow Jones industrial average, whose price, excluding dividends, rose 5.73% per year.

Of course, this doesn’t include the cost of owning the house, starting with mortgage interest and property taxes. But as any homeowner knows, the expenses don’t end there. Anyone who has owned an old house knows that this one was probably lovingly coated with lead paint for half a century. Most roofs have to be replaced every 20 years, so it would be due for its fifth one pretty soon. And there’s a little sensor on the furnace that senses when your savings account is too high and sends a big puff of black smoke out your chimney as the furnace dies.

And if you lose your job, owning a home can be a significant barrier to finding new work elsewhere. Even if good times, moving across country while selling a home is stressful. Moving across country and having to rent out a home you can’t sell is pure agony.

On the plus side, there’s the tax deduction for mortgage interest, which generally allows you to have enough deductions to itemize your tax return. And if you put 20% down, you’re leveraging any price gains. (As people discovered in the 2007-2009 financial crisis, you’re also leveraging your losses.)

For most people, a house is basically a forced savings plan that you can live in. And, while upkeep expenses don’t decrease when you pay off the mortgage, having no mortgage is a wonderful thing in retirement. When you rent, you can look forward to increases all your life — and you still have to ask the landlord’s permission if you want to paint the master bedroom something other than eggshell. All in all, it’s probably better to own, if you can afford it.

Cash is never trash

For nearly a year now, pundits have been describing the U.S. stock market as “the least dirty shirt in the closet,” “the least bad-looking market,” “squeakier than a bowl of mice.” Ok, they didn’t use the last one. But the general implication is stocks may be expensive, but hey — they’re not bonds and they sure aren’t cash.

cashYou may have noticed, however, that cash looks increasingly attractive this week. While you’re earning an average 0.02% a year on your money market fund, that’s generally better than losing 1% to 2% a day on your stock fund.

Think of it this way: The average large-company blend stock fund is down 4.26% the past month. If you had 30% of your portfolio in cash, and 70% in your basic large-company stock fund, you’d be down 2.98%. While no loss is good, smaller losses are always better than larger ones.

More importantly, you would have an easily accessible buying reserve for stocks that seem ridiculously cheap. Finding values is more than buying whatever’s on the new low list. But if you can find a good stock that’s selling at a 20% discount or more, then this is a good time to think about buying.

Just recently I posted a list of companies in the Standard & Poor’s 500 stock index that are selling for 20% or more below their 52-week highs. That list has only grown since then. As of yesterday, 141 stocks, or 28% of the S&P 500, were below their 52-week highs. Among the more interesting entries to the 20% discount club:

  • Asset managers. Franklin Resources is down nearly 30% from its 52-week high, and it has now been joined by Legg Mason and Genworth.
  • Luxury goods. Coach is now nearly 60% below its all-time high, and Fossil is 56.5% below its all-time high. Michael Kors is nearly half its 52-week high.
  • Railroads. Union Pacific, CSX, and Kansas City Southern are all at least 20% below their 52-week highs.

The two biggest areas that are getting clobbered are energy and technology stocks. The problems in energy are obvious: Oil is down more than 50% from its recent highs.

The problems in tech are not quite as clear, although the weakness in the Chinese market seems to be the easiest answer. But some tech stocks seem tempting at these levels: Intel sells for just 11.3 times expected earnings, and pays a 3.4% dividend, to boot. Applied Materials sells for 12.3 times expected earnings and yields 2.5%. And Sandisk sells for 12 times forward earnings and yields 2.3%. If you have the cash — and the tolerance for tech stocks — these might good places to nibble.