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.

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.

 

 

 

 

Greetings from Lacunaville

SDSC_0368tarting in January, I’ve been writing full-time for InvestmentNews, doing a monthly column for Money magazine, and studying for the Certified Financial Planner mark. (This, apparently, is also a test of your prowess with a hand-held calculator). And I went to Africa.

The blog, as you may have noticed, has, um, languished. I’m hoping to revive it on a somewhat irregular basis, which, come to think of it, is pretty much its usual schedule.

I’ll be updating my links pages in the next week or so. In the meantime, here are some things to watch for today, as well as some things I’ve found interesting or peculiar.

This week, all eyes are on the Bureau of Labor Statistics’ employment situation report, out at 8:30 a.m. Friday. But the stock market seems to be resigning itself to an interest rate hike, probably in June or July. (A later hike would give the impression of a political motivation, and the Fed generally doesn’t like to do that). The current consensus estimate for new nonfarm jobs is 158,000, according to Bloomberg, with the unemployment rate falling to 5%. (And, yes, the total unemployment rate is still high, but it’s the nonfarm payrolls number that Wall Street watches.)

Wages also seem to be firming up, and it should be interesting to see if traditional summer employers, such as ice cream vendors and lawn mowers, have a hard time finding help this year. All of these would seem to give the green light to the Fed to raise rates.

Of course, we’d be talking about a lordly fed funds rate of 0.5% to 0.75% after a Fed hike, an increase that will be promptly reflected in your credit card bill and eventually in your money market mutual fund account. For those who still watch their money fund account, the average money fund now yields 0.10%, nearly triple its rate at the start of the year.

DSC_0353The stock market typically dislikes interest-rate hikes. Higher rates mean bonds become more competitive with stocks, and increase short-term borrowing rates. On the other hand, higher short-term rates mean that companies will earn somewhat more on their cash, and that savers will earn slightly more on their cash.

The old adage about Fed rate hikes — three steps and a stumble — meant that the stock market takes the first two hikes as a sign that the economy is improving, and rallies. At the third hike, stock investors realize the Fed wants the economy to slow, and stocks sell off. Bear in mind that the adage originated when a normal fed funds rate was 4% to 5%. It would take a stairway, not a few steps, to get us back to the traditional stumble level, assuming the Fed raises rates at a quarter-point a pop.

I’m an optimist, and think that rising earnings are a good thing — in fact, the one thing that the economy desperately needs for sustained growth. Most companies, despite their complaining, have nice profit margins, good balance sheets, and plenty of cash. They might even be surprised to learn that when their employees get raises, they spend more — and even on the products their employers sell.

DSC_0488The one caveat: Stocks aren’t cheap, at least by the price-to-earnings ratio of the Standard and Poor’s 500 stock index. The current PE, based on forward earnings estimates, is 17 — a tad feverish, although nothing like the levels during the technology bubble. Nevertheless, at these levels, it’s a bit like driving a bit too fast on old tires. If the market takes a rate hike really badly, investors could find that both bond and stocks slide off the road. And in that case, having a bit of cash in a money fund might be a good safeguard.

 

The week ahead

Only two things matter in this first week of the new year: China and jobs. And China, frankly, isn’t looking too good.

The market plunged at the open Monday on news that Chinese manufacturing was far worse than Wall Street expected. The Chinese purchasing managers’ index fell to 48.2 last month, vs. 48.6 in November, it’s 10th consecutive decline. When the index is below 50, the manufacturing sector is in recession.

The Chinese stock market took one look at the numbers and promptly plunged 7% before circuit breakers kicked in. Wall Street took a sober look at the Chinese market’s reaction and promptly panicked. The Dow Jones industrial average is down 318 points, or about 1.8%, as I write this.

China takes these things seriously: So seriously that Chinese CEOs are starting to mysteriously disappear. If I were a Chinese CEO today, I’d be hastily packing my bags.

The stalling Chinese economy will weigh heavily on the U.S. market, since so many U.S. companies have been counting on China for increased sales and growth. So today, the stock market will be digesting this news, and discounting stocks across the board.

fredgraphAfter that, Wall Street will spend the rest of the week fretting about jobs. And there are all sorts of indicators to watch in the run up to Friday’s jobs report. (Which, for the record, is expected to show 200,000 new jobs in December, vs. 211,000 in November.)

  • Tuesday is motor vehicle sales, which should show fairly robust growth in what was once the nation’s largest employers. Analysts are expecting fairly robust gains in December, thanks to low gas prices and the prospects of modest raises in 2016. Another factor: The average U.S. auto is more than 11 years old. Cars age better than they used to, but there’s a lot of pent-up demand for new cars.
  • Wednesday is the ADP Employment report, which is a pretty good predictor of how the Friday jobs report will turn out. The consensus on the report, which excludes government jobs, is for 190,000 new jobs in December.
  • Thursday is the volatile weekly unemployment claims report, has ticked up to the highest levels since July, when the numbers flirted with lows unseen since the Nixon administration. Another important report is the Challenger Job Cut Report, which measures mass layoffs. Many companies choose to lay off employees just in time for the holiday season, so it should be an interesting report.

 

How the naive are faring

You could line up all the advisers from here to Albuquerque, and you still wouldn’t reach a conclusion as to the best diversified portfolio for your retirement savings.

Because of that, many investors simply use the 1/n portfolio — which is to say, they divide their money equally among all the options in their 401(k) plan. Among those who study these things, this is called the Naive Portfolio.

What would a Naive Portfolio look like? Most 401(k) plans are not exactly paragons of fund-picking: They often choose the largest funds. After all, those funds typically have decent long-term records and low expense ratios, and no one is going to get sued using those criteria.

Let’s compose a naive portfolio of the 10 largest mutual funds. It would look like this, ranked by size:

Tot. ret. Tot. ret.
Fund Ticker Category 2015 5 years
Vanguard Total Stock VTSMX Large blend 2.37% 13.98%
Vanguard 500 Index VFINX Large blend 2.89% 14.23%
Vanguard Total Intl Stock Idx VGTSX For. large blend -2.35% 3.30%
Vanguard Total Bond VBMFX Interm. bond 0.68% 2.86%
Growth Fund of Amer A AGTHX Large growth 6.98% 13.78%
Europacific Growth A AEPGX For. large growth 1.57% 5.49%
Vanguard Prime MM VMMXX Money market 0.03% 0.03%
Fidelity Cash Reserves FDRXX Money market 0.01% 0.01%
JPMorgan Prime MM VPMXX Money market 0.01% 0.01%
Fidelity Contrafund FCNTX Large growth 7.93% 13.87%
Average 2.01% 6.76%

Source: Morningstar.

So how did our naive investors do? At least this year, they have done pretty darn well. The average expense ratio in this portfolio is 0.35%, which, honestly, you can’t beat with a stick.

Furthermore, a 2% return is just a shade lower than what you would have gotten with a single investment in the Vanguard Total Stock Index fund. And you would have gotten that return with far less risk than a pure stock index fund, given that 30% was in money market funds and 10% in bonds.

 

Just how successful a naive investment would be over the long term is a more difficult calculation, which I’ll tackle in future posts. But the takeaway is that naive diversification is probably better than no diversification at all.