Alchanati Campbell & Associates
What's Up Market Instability? From Our Real Estate Market To Our Borrowing Practices
Why Our System is Broken According to Ray Dalio. Lenders are lending out tons of money because interest rates (the cost of borrowing) are very low, Central Banks continue to buy financial assets adding money to investor pockets, investors are choosing to invest the money instead of spending it and they are choosing to take losses on their investments (accepting very low or negative interest rates when lending their money), and money is being thrown at start-ups at alarming rates (even when these not profitable tech start-ups already have too much investor money). Money is “free” for those who have money and creditworthiness, but it is becoming expensive to borrow for those who do not have the required creditworthiness (consumers being charged 50-200% interest on their borrowed money). The government deficit will continue to grow which will require the government to increase their debt, interest rates will remain low even though raising rates would help the government control their debt levels, and the world has been overly leveraged for a long time. Pension and healthcare liability payments are at risk. Pension fund managers are finding it increasingly difficult to find substantial returns that can meet their pension fund obligations. The US healthcare system is unstable and becoming more expensive for consumers. The three options to be able to fund pension and healthcare obligations would be to cut their promised benefits, increase the money supply or by raising taxes.
Signaling Theory. Signaling Theory is the idea that the actions of high-level executives and the companies they manage give signs as to how the company is performing and expecting to perform beyond the simple earnings report. It is most prevalent in dividends. When a company increases their dividend yield (the relative percentage of the stock price paid out to investors), it displays to the marketplace that the company is ok with retaining less of their earnings (the more dividends they pay, the less they keep). If a company is ok with retaining less of their earnings, it is likely because they know, or expect based on private information, that the company is performing well. That could mean more sales in a crucial area, a potential acquisition, a new product set to debut, and so much more. As a result, investors will buy more of the stock, because based on all the signs, the company is going to perform well in the earnings season. On the flip side, if a company decreases its dividend, it tells investors that the company can no longer afford to pay that much dividend, as it will eat into their decreased profits too much. In this case, investors will sell off the stock because, in their minds, not even the executives of the company have faith in their upcoming performance. In fact, signaling theory is so important that companies will actually take on new debt in order to keep paying out the same or higher dividend even if their revenue (and bottom line cash flow) is decreasing.
The Economy and Equity Market. The economy, which has exhibited 1.9% GDP growth over the last 4 quarters, leads investors to believe the equity market, which has displayed over 22% growth since January 1st, will start a decline to follow suit. Although the economy and equity market usually follow each other, with the former acting as a quasi-leading indicator for the market, this is not always true. A professor from Chapman, Mark Skousen, put this best in one of his classes, and paraphrased from his book, “A Viennese Waltz Down Wall Street”, the market and economy can grow apart, like in the Viennese waltz, but will always come together at the end. In the current global atmosphere, we see a slowing global economy, with political fears present in China and the UK, leading capital to flow from these troubled countries to a relatively stable safe domain, the US. Although the US economy is showing just OK economic data, we are relatively doing better than most other countries. This relative point is what is leading the US markets to display what seems like irrational exuberance, in what looks like a faltering economy. As fears of a global slowdown grow, and sovereign debt continues to lead further into negative interest rates, we will continue this Viennese waltz, with the equity market making new heights, and the economy falling behind.
Why it's Better to Put Bonds in Retirement Accounts. When it comes to investing, it’s not how much you make that matters- it’s how much you keep after taxes. As a general rule, investments that tend to lose less of their return to taxes are good candidates for taxable accounts. The best investments to hold in IRAs and 401ks are taxable bonds and taxable bond funds. Outside of a retirement account, they’d be taxed much higher than your stock funds. There are many different types of bonds: US Treasuries, corporate bonds, high-yield bonds, and municipal bonds. Investors may be able to realize significant tax benefits by including bonds in their portfolios. There are also many different types of retirement accounts, but the most well known are the IRAs and 401ks. The Roth IRA is funded with after-tax dollars and grows tax-exempt. Bonds are generally taxed at a higher rate than stocks. If bonds are not held in an IRA, income from them is taxed as ordinary income (the federal tax rate for ordinary income can be as high as 37%). IRAs are especially attractive for holding Treasury Inflation-Protected Securities. Since the income produced by bond funds is taxable, it is better to put them in a tax-exempt account. But it is important to avoid holding municipal bonds in an IRA.
$2 Trillion. In the early 1930s, a relatively small oil company known as Standard Oil of California was seeking new sources of oil from abroad when it stuck oil on the Arabian mainland and received drilling rights from the government. Several years later, Texaco bought a 50% state in the arrangement and helped find vast amounts of oil. In 1944 the company name was changed to the Arabian American Oil Company or Aramco. Aramco would go on to become the world’s largest oil supplier and support U.S oil needs as U.S policies and wars limited oil sources. In the 1970s the Saudi Arabian government began to increase its interests in Aramco and eventually took over full control of Aramco through the Saudi Arabian Oil Company. Today, Aramco is believed to be the world’s most valuable company, worth somewhere between $1.2 and $2 trillion dollars and most likely holds the title of most profitable company with a reported $111.1 billion in net income for 2018. Aramco also has the second-largest proven oil reserves and second-largest daily oil production. With stats like this, their December IPO should be a breeze as investors fight over shares, but that does not seem to be the case. Aramco’s IPO comes at a time when many investors are beginning to turn away from oil. American investors remain skeptical towards the IPO largely due to its valuation. The Saudi government originally estimated Aramco to be worth $2 trillion dollars but then dropped their valuation to $1.7, but many analysts think that geopolitical factors need to be accounted for an estimate a valuation closer to $1.2 trillion. Aramco remains at the center of several multinational disputes and is often the target of attacks aimed towards the Saudi government or western influence. The recent September attack, for example, cut Aramco’s oil production in half, such an attack on a large public company would be devastating for shareholders. Investors have also made the point that the Saudi government may only sell 2% of Aramco which would give virtually no say to minority shareholders. As if these issues weren’t enough there are reports that Aramco’s finances are heavily entwined with the government’s, stating that its profits have been used to boost government budgets and even pay for government officials' luxurious accommodations, which is something many shareholders will not stand for. These issues have to lead the Saudi government to pressure rich Arabian families to commit to investing millions in order to ensure a successful IPO. The Saudi government has also turned to China, the world’s largest oil importer to commit to the IPO. China is expected to commit around $10 billion in an effort to hedge against rising oil prices and support its Belt and Road program. There are likely going to be many more updates on this as the company prepares for their IPO and the December OPEC meeting so we will be sure to keep our readers updated.
The Alchanati Campbell and Associates Team
WHAT'S UP FRIDAY? is a weekly newsletter that will give you a summary of "What's up?" on Wall Street, in the US and around the World written by The Alchanati Campbell and Associates Team. What makes us unique is we focus on long-term knowledge; knowledge that will still be useful to you 10 years from now.