Is Tax Selling Causing Apple's Decline?

In recent weeks, there has been talk that part of Apple's 23% decline may be due to the fact that capital gains taxes are likely to go up in 2013.  The logic goes that since many Apple shareholders are sitting on large capital gains, they are selling to lock in a lower tax rate.  If that logic were true one would expect to see similar selling in other top performing stocks, but on average other top long term holds have not seen the same decline that Apple has.

In October I posted a list of the top performing stocks since October 2007--stocks which should have large embedded capital gains liabilities.  The chart below compares their performance since the election.  It turns out that on average these stocks have continued to do better than the S&P 500 since November 6.  This basket has outperformed the S&P by 2.8% since then.

What Happens To Japanese Government Interest Expense if Rates Rise?

Recently there has been more talk that the Bank of Japan would increase its asset purchases again in order to create inflation there.  Given the high level of government debt in Japan, increasing inflation and rising interest rates could cause some unique problems.  In particular, rising rates would mean rising interest expense for the Japanese central government.

Currently the government spends about ¥9.8T on interest expense, which works out to about 1.23% on ~¥800T in aggregate debt.  At that level of debt, every 1% increase in the government's interest rate means another ¥8T in expense.  This implies that at a 5.2% average rate, interest expense would exceed current receipts of ¥42T.

It's important to note that this analysis doesn't take into account the tenor of the current debt load.  Since ¥440T has a maturity of 10+ years it would take some time for interest expense to match any increase in market rates.  I also haven't modeled in any changes in the aggregate debt load.

December 2012 Investor Letter

Below is a letter that is written monthly for the benefit of Avondale Asset Management's clients. It is reproduced here for informational purposes for the readers of this blog.

Dear Investors,

November was the wildest month for equity markets since…last November. The S&P 500 was down as much as 5% mid-month, but managed to finish slightly positive thanks to a late month rally. One might recall that this is nearly identical to the trading pattern of November 2011, when the S&P 500 was down by 7.5% mid month, but finished down only slightly. That reversal was the beginning of a five-month-20%-rally for stocks. Let’s hope that the pattern continues to hold.

Certainly there are plenty of reasons why we shouldn't have a repeat of last year though: the fiscal cliff hangs over the market, earnings growth has been slowing, Europe is still unresolved and China has lost some of its shine. But there was lots of gloom this time last year too, and that didn't impede a big rally. As I've written before, one of the only things I can guarantee investors is that the market will swing between times of extreme optimism and extreme pessimism. Counterintuitively, pessimism is actually what tends to propel the market higher, because when people become so focused on what’s wrong with the world it creates an opportunity for known problems to be solved rather than new problems created.

Right now the problem that everyone is focused on is the fiscal cliff. For most of the year I have focused on this problem as well, but after further analysis I’m glad to write that I think the cliff could be more manageable than the market currently expects. Ultimately the cliff itself is a bit of a red herring because the alternative to the cliff is a compromise, which means higher taxes and lower spending (just like the cliff). Either way there is going to be deficit reduction in 2013. This is “bad” to the extent that it means a removal of short term stimulus, but in the “worst” case circumstance the deficit would be reduced by about $45B per month, which is almost exactly the same amount of money that the Fed will be providing to the economy via QE3. The Fed is doing everything it can to create a monetary cushion to land on in the event that we hurl ourselves over the cliff. In the short term, I think there is a good chance that it could work.

Two caveats: 1) there is a strong possibility that going over the cliff could be so damaging to market psychology that it won’t matter that the alternative wouldn't have been much different. 2) What’s good for the short term is not necessarily good for the long term. Deficits boost the economy today, but both fiscal and monetary stimulus must be reduced at some point. The US economy cannot exist in a state of perpetual economic stimulus, and the true cliff will come when congress addresses entitlements and the Fed stops printing money. Those ideas aren't even currently part of the national dialogue, which is far from positive. The “good” news is that for now market participants will likely continue to ignore the elephant in the room and bid securities prices higher. The bad news is that the more we ignore it, the bigger the elephant will be when we are finally forced to deal with it. Alas, all this is for another day.

In terms of our portfolios, I’m happy with how we are navigating this period. In the middle of last month, we reinvested a sizable portion of our cash position and were able to benefit from the pullback by buying some really good companies at favorable prices. As long as we continue to do this, I feel confident that we can continue to do well in a variety of investment environments.

Scott Krisiloff, CFA

Opinions voiced in the letter should not be viewed as a recommendation of any specific investment. Past performance is not a guarantee or reliable indicator of future results. Investing is subject to risk including loss of principal. Investors should consider the suitability of any investment strategy within the context of their personal portfolio.

Non Performing Loans at US Banks

Despite concerns about the fiscal cliff, it should be encouraging to investors that bank stocks have held up quite well over the last couple of months.  It seems that sentiment may have finally turned for the group, especially for Bank of America, which regained the $10 level yesterday yet still trades for a little over 50% of book value.

The banking system has healed a lot since 2008 and profitability has almost returned to old highs.  However, non-performing loans remain piled on US banks' books and probably will stay there for years to come.  According to recent FDIC data, non performing loans (NPL) as a percentage of all loans at FDIC insured banks are still higher than they were at the peak of the S&L crisis.  

While it's an interesting data-point, this isn't necessarily cause for alarm because NPLs are supposed to be written down to fair value when they go to non-accrual status.  This means that as long as housing prices remain stable, these loans probably wont have to be written down any more.  Also, just because a loan is marked as NPL doesn't mean that it's not still paying.  In fact, many of these loans are probably still generating cash flow for the banks that hold them.

After an Iconic CEO Leaves

Since Apple is having a particularly rough day today, I thought it would be worth reposting something I initially posted in August 2011 when Steve Jobs officially stepped down as CEO.  It's a comparison of DIS, WMT and MSFT after their iconic CEOs departed.  Looking at DIS and WMT, each of those companies continued to be top stocks for 5-6 more years.  MSFT underperformed the S&P but greatly outperformed the Nasdaq after Gates left.  Can AAPL's outperformance last as long?  It's gone about a year and a quarter without Jobs and until recently has remained a strong stock, but perhaps tech is such a rapidly changing space that the benefit of Jobs' vision has less longevity.

--

Originally posted 8/25/11:

With Steve Jobs stepping down at Apple, there are plenty of questions about what comes next.  Jobs is undisputedly the most influential CEO of the last decade and one of the most influential people of the last 35 years.  Jobs' contributions to society have been extraordinary and today he is deservedly drawing comparisons to other great industrialists like Ford, Edison, Carnegie and Rockefeller.  When the history books are written, it's likely that these comparisons will hold up.

While I wanted to run a stock chart comparison to these early 19th century industrialists, individual stock data from the early 20th century isn't easy to come by.  Still, there are at least three iconic CEOs of the latter 20th century who can arguably be compared to Jobs: Disney, Walton and Gates.  Here's a look at how each company's stock performed in the decade following its CEO's departure.

Each chart begins on the date that the CEO stepped down.

DIS

Click to Enlarge

WMT

MSFT

What's striking is that in the case of DIS and WMT, each stock continued to massively outperform the S&P 500 for 6 and 5 years respectively after the departure Disney and Walton.  Perhaps this is a testament to the bench of talent that a great CEO cultivates.  However, after the 5-6 year mark, both stocks had prolonged periods of underperformance (for DIS at least partially due to the 1974 bear market).  This may be an indication that a visionary CEO can continue to carry a company for years after leaving, but after a while, the company loses the benefit of that vision.

Of the three companies, only MSFT has underperformed the S&P 500 from the day that Gates stepped down.  Of course at least part of this has been because of the collapse of the tech bubble (MSFT was trading at about 60x earnings at the time).  Still, looking at the underlying earnings of MSFT and the gross mismanagement since Gates left, it is a testament to Gates' leadership that the company continues to enjoy top market share in the PC business.  

Another primary reason for MSFT's poor performance has been because of the efforts of Jobs himself who arguably engineered an organic monopoly in high end consumer electronics.   He will be missed for his vision, but we may not really know how much we miss him for another 5 years.

Corporate Bond Issuance Since 1996

With interest rates at record lows and possible tax changes on the horizon, a number of companies have been accessing corporate debt markets and using the proceeds to alter their cap structure.  Today, Intel was the latest company to announce a debt offering to repurchase shares after that stock has fallen more than 30% since May.

One of the goals of maintaining a zero interest rate environment is to encourage consumers and companies to take actions like this.  The Fed is trying to push the economy to re-lever.  So far, it has had mixed success in this pursuit, although borrowing has begun to pick back up in 2012.

As far as corporate debt securities go, 2012 could be a strong year.  US companies are on pace to issue $1.3T in new debt into securities markets (through October).  This would be a new all time high and is already more than was sold in all of 2011.  As a percentage of corporate bonds outstanding though, that number is still lower than in the late 90s--only 16% vs over 25% back then.  It's almost double what was issued in 2008 when credit markets froze though.

Source: SIFMA

US Auto Sales

US auto sales continue to rise in recent months, which is causing a fair amount of excitement about the possibility of a hot auto market.  High ticket items like cars can be big contributors to GDP, so from an economic standpoint the data is very encouraging.

Still, from a historical standpoint, auto sales remain relatively weak.  If 15m vehicles were sold (annualized) in November, the rate is still below the average rate during the mid 2000's when there were closer to 17m cars sold per year.  

On a per capita basis, the number looks even more depressed.  As of October we were selling 0.047 cars per person per year in the US (~1 car for every 21 people).  Outside of this recession, you'd have to go back to the lowest point of the 1991 recession to find a similar per capita rate.