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Still Having Troubling Understanding Why Cash Is "On The Sidelines"? The Answer Hails... From Nearly A Century Ago
BNY's Nicholas Colas is once again delightfully insightful with an explanation for the "cash on the sidelines" phenomenon so simple, and so elegant, no wonder it has eluded all the neosophists on CNBC for so long. "One of the lingering questions about U.S. equities remains the conundrum of “cheap” price earnings valuations on so many high quality stocks. Perhaps estimates are too high, but after several quarters of generally in-line-or-better earnings reports, that doesn’t seem to be the worry (at least for now). We think the DuPont model, an old (ancient, really) financial analysis model highlights why multiples are as low as they are. Problem #1 – cost cutting only takes you part of the way to maximizing shareholder returns in a cyclical downturn. Problem #2 – investors need to see a resumption of corporate investment growth to allow valuations to return to more normal, long term levels." Perhaps, in a wholesale revulsion to the Frankenstein monsters of modernity, starting with a thoroughly roboticized market, and quadrillions in capital flows each year in the form of electrons, investors have subconsciously reverted to the simple days of yore, in investing analysis as well as in everything else...
From BNY ConvergEx' Nicholas Colas: "Old School Business Math Gives Insight on Lackluster Market Valuations" (pdf)
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yeah i held TIE for a bit this year.. jumped out of everything in May and socked it all into gold/silver
“The end of the decline of the Stock Market will probably not be long, only a few more days at most.”
- Irving Fisher, Professor of Economics at Yale University, November 14, 1929
“…there are indications that the severest phase of the recession is over…”
- Harvard Economic Society (HES) Jan 18, 1930
Been following your quotes, sensing a pattern here.
It's amazing how we as humans, forget the truly detailed small things of the past. We just remember snapshots of it. Then we repeat it.
And the boom and busts continue.
BIG FIRM SUSPENDED; Prince & Whitely, 51-Year-Old House, Is Unable to Meet Its Obligations
In the midst of the severest market reaction in two months, the New York Stock Exchange announced yesterday that the 51-year-old firm of Prince Whitely, one of the largest and best known houses in Wall Street, had been suspended on its own admission that it was unable to meet its obligations.
-October 10, 1930
NEW YORK JOINING IN BRITISH CREDIT; Federal Reserve Bank Agrees, if Requested, to Buy Prime Commercial Bills.
-August 2, 1931
REDISCOUNT RATE CUT TO 1 % RECORD LOW; Federal Reserve Bank Here Takes Drastic Action
-May 8, 1931
You may find this interesting as well.
http://newsfrom1930.blogspot.com/
cool site! thanks.
This is a daily summary from a corresponding period during the 1929 collapse. Interesting to compare where the thinking was on a day-by-day basis back then as compared to now. Good stuff.
Thank you, the lessons you can learn from history ...
Stocks went through an irregular session; early trading was on the downside, but several periods of short-covering caused good rallies, particularly after unexpected Westinghouse dividend announcement; however, as soon as this demand was supplied the rallies petered out.
http://www.youtube.com/watch?v=sTUIHK7gHRE
I think they were lying and were just short...
". . . no wonder it has alluded all the neosophists on CNBC for so long."
I expect you mean "eluded", Tyler. Confused me for a minute there.
I can only assume TD is being sarcastic about this guy's "analysis." Calling the current state of the economy a "cyclical downturn"? Alluding to the "conundrum of cheap price earnings valuations on so many high quality stocks"? No point in looking at the rest.
"The other point that merits attentions with respect to the DuPont model is that it is very much a tool meant to point the way for future expansion and growth.
The key challenge Alfred Sloan mastered with its use was not cost cutting or manufacturing rationalization. It was expansion. The best businesses with the strongest
returns got cash to grow."
beautiful words......
cost cutting is not a strategy - it is a short term tactic. unfortunately fucktarded managers use it as a strategy....growth requires investment....when the investment dries up the economy is terminal - just as it is today...the permanent and severe backwardation of gold is a symptom of this dirge....
why doesn't anyone want to invest in an over regulated, debt riddled, gdi shrinking, centrally planned, debauched currency, bankster-centric economy? i am so stumped....
"Fear Mr Bonn, takes gold out of circulation & hoards it against the evil day."
Kidding aside, Mr Bonn, I'm very curious as to your claim of permanent and severe backwardation of gold.
I'm not seeing it in COMEX spreads, care to give us a clue as to your metrics?
cost cutting is not a strategy - it is a short term tactic.
Yes; I've asked many managers "Do you think you can shrink your way to greatness?". For some reason, they get all huffy and upset.
.
No mention of the third component of the DuPont Model which is financial leverage (Assets / Equity). With continued deleveraging, this will also negatively impact ROE going forward. People must recognize that P/E ratios are driven by earnings growth AND increasingly larger capital investment (as a % of book value) in excess above the cost of equity as the firm grows. A firm cannot maintain a premium P/E with one and not the other. If so, P/E ratios eventually revert to a no-growth type level (e.g.; roughly 10x).
+1
Scary, but if you do the math, *real* returns in stocks adjusted for leverage over the last 150 years is only about 4%. The difference is changes in leverage. I know everybody likes to pretend that stocks return 10% "over the long run", but that's not true. It's 4%.
You can get to the 10% number by removing stocks that went to zero (hiding your loss), which is how they compute the 10%, and when you don't account for changes in leverage (e.g., all profits for the last few decades merely reflect changes in leverage).
It's the same thing with the bond market: You want to be in bonds in a period of *decreasing* interest rates. The reason bonds have been such a stellar performer over the last few decades is because we've had a few decades of 18% interest rates slowly walking down to 0%. Demand for bonds has exploded for decades due to increasing leverage. No way in the world I'd be in bonds now (e.g., we're headed to a bond market dislocation where the bond prices will be lower than the theoretical cash value of the bond, because of the threat/reality of default by the counter-party). Pretty soon people will figure out that at every bond auction, they have negative returns in the *very next week* (we're already seeing that with Greece sovereign bonds, and some company bonds). Bond buyers in a decade of *rising* rates get slaughtered.
For the "very long term", stocks give you a nice small appreciation (e.g., 4%), and help you buffer against currency changes (e.g., you own a piece of something that theoretically produces something). Unprecedented leverage is what we've seen for the last few decades, allowing us to manipulate that number to 10%, and it is unfortunate that our current levels of leverage (our current levels of debt) will now take out nations and currencies.
Now, that previous leverage is leaving (i.e., we are de-leveraging), and it won't be back for decades.
Hear hear!
Agreed, except on one point: corporates are not de-leveraging. Look at the FOF, nonfarm nonfinancial corporate business (table F102), net increase in liabilities (line 37). It has remained positive throughout this crisis, and it's been on an uptrend lately.
Gotta respect someone who points references like that, but isn't leverage about assets vs, liabilities? In other words, if corporations hold more cash, isn't leverage going down, even if liabilities are up?
In theory, if you owe nothing, but have nothing, you have no leverage.
If you borrow $10M, and leave $10M in the bank, ASSUMING no friction (e.g., no debt service and no risk), then you similarly have no leverage (i.e., the transaction can be instantaneously reversed at zero cost and zero risk).
However, if you spend that $10M on a "sure thing", you've now "levered" yourself because you don't have the $10M to pay back the loan. Your "sure thing" might not be so "sure", and even if it is, you no longer have the ability to reverse the transaction (e.g., even with a "sure thing" you open yourself up to cash-flow or time-value-of-money liabilities).
So, if we pretend the corporate cash-advance (e.g., corporate bond) is parked in a bank that *cannot* default, and there are no other costs to borrowing/holding that money (e.g., the bond pays 2%, and the bank returns 2% on the deposit, there are no taxes, and everybody works for free, and there's no chance anything can go wrong), then there's no additional leverage to keeping that cash.
However, tom is correct that corporations as a whole are not (yet) de-levering, and some things contribute to the conclusion that leverage is actually *increasing*:
In contrast, you'll notice the corporations are not *spending* their cash on new efforts. While leverage might be mathematically increasing, that's because of adjusted-accounting regarding *past* transactions. Companies are *not* ready to go on a buying spree, hire lots of people, open new facilities, and pursue ambitious new efforts.
The current "pain" relates to the fact that we are no longer increasing leverage at the same rate. At best, we've stopped growing (when summed among corporates, government, and private household). In this case, the consumer is "leading" the de-leveraging. That's only because we've just gotten started (much more pain on the way, with *actual* de-leveraging by everybody).
For many of these corporates, including a lot of Fortune 100 corporates, de-leveraging means end-to-the-ponzi. Think GM, but without a government rescue.
Unfotunately, this is an artifact of M&A heating up, not cap equipment expenditures or business growth (generally quite the opposite).
While it looks like they're taking on debt, they're still de-leveraging in the aggregate (as those acquisitions are liquidated) and contributing to a slowing of the velocity of money (dropping employees who stop consuming, ending leases with REITs, etc).
Some one really needs to explain this to Yale Professor Roger Ibbottson, who's like the Grand Poohbah of head-up-your-ass statistics.
http://mba.yale.edu/faculty/profiles/ibbotson.shtml
I wouldn't care, except for 20 of the last 22 years, we've had Presidents who studied at Yale. Spoiler alert: Havard's no better.
Mikla,
Do your numbers reflect inflation? just wondering...
Yes, that's 4% return, adjusted for inflation.
It's a little "messy" in that you can't account/normalize dividends very well over time, because of changes in tax law. For example, today (and the last couple decades) dividends mostly are not "in style", so they mostly don't matter these days.
However, IMHO, it's reasonable to assume a sustained 4% (adjusted for inflation) over time, which includes both stock appreciation and dividends.
The end of the ponzi means a collapse in real returns. This suggests risk-free savings vehicles should see an increase in interest by savers. Note I did not say "investors," which is a synonym for a ponzi player.
The ponzi will no longer make you rich. You will have to live on in your old age whatever you have truly saved. For 3rd worlders over the last century, this sure as HELL has not meant paper notes or bank accounts.
The political class and the elites are the only players in debt who get their claim tickets honored.
+1
I actually agree with this assertion (continued ongoing collapse in real returns), although it's not stupid at some level to "diversify" into some level of equities. But, that's only as a "hedge", and not as an investment.
This is an important point also, too often missed. Definition of terms:
I agree with trav7777 in that market players today (and the past few decades) are mere speculators, not investors. The speculation is based on the future expected price appreciation of "Pets.com", not because of any logical return-on-investment sense. Yes, like the "Tech Bubble", it was all ponzi speculation. Most of the market right now is all ponzi speculation. When the retail investors figure that out (and they are starting to), they are going to freak out.
I agree with this statement too. It will be terrifying when people figure this out. You'd be MUCH better off loaning whatever cash you have to your neighbor so he can start his pizza business (and be a direct investor in a local business) then you would be to gift any of your money to the de-leveraging ponzi.
So this model explains 300 dollar a gallon paint?
Paint is $20 per gallon, disposal of the empty can costs $180. ?
The du Pont model might not be very popular, but you don't need it to understand that cost-cutting is an unsustainable way to boost profits. That point is widely taken on board and is one reason for lower P/E multiples.
There's also: the unsustainably of the deficit spending that's indirectly boosting corporate profits, the impact of the crisis on equity optimism, widespread awareness of various kinds of manipulation, and awareness of the affects of aging demographics on equity values.
Absolutely! The defecit is running $500 per person, per month these last few years. What do you think would happen if you asked families of four to actually cough up $2,000 a month to keep their house and 401(k) values up?
Really, what do you think would happen?
It depends. Will they name a predator drone after me? Can I still watch American Idol?
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