I last updated this topic here: Update For Portfolio Positioning And Management As Of 9/12/15 - South Gent | Seeking Alpha
The VIX is in an UNSTABLE VIX PATTERN: A Trigger Event In The Vix Asset Allocation Model 8/31/15 - South Gent | Seeking Alpha
In numerous prior posts, I have discussed the long term secular forces that will positively impact U.S. economic growth and provide a favorable environment for stock appreciation.
Those positive and long term forces include the increases in disposable income after debt service payments due in large part to refinancing home mortgages long term at historically low rates, low inflation and interest rates, the abundance and relatively low cost natural gas supplies, technological innovations originating in the U.S. (and I anticipate an acceleration), and the long term parabolic rise in emerging market middle class consumers that will provide incremental worldwide growth.
The market will not be going up in a straight line due to those forces. There will be bumps along the road, and those downdrafts will be reflected in stock market dips, corrections and possibly a cyclical bear market due to market forces or external events. An example of a market related downdraft would be a correction due to over valuation accompanied by a reassessment of near term growth prospects. Another example would be a flash crash or some other market phenomenon unrelated to stock fundamentals and caused by HFTs and assorted scoundrels.
The EM component of the positive secular growth thesis has apparently hit a speed bump. Those consumers have not disappeared from the face of the earth, however, and their rapid growth in numbers will continue for decades to come.
In this post, I am going to focus on some of the problems. It would certainly be a rarity to have everything going right at the same time. The human species has not been manufactured to produce a positive perpetual growth motion machine and will find endless ways to muck things up.
Current Impediments to U.S. Growth:
I am going to address what I view as the main reasons for a slow U.S. recovery from the last recession. Except for real household income growth, all of these impediments are improving but are clearly sub-optimal.
Subpar New Home Construction:
In garden variety recessions, new home construction, and all related economic activity, has provided a major impetus in the recovery. That has not been the case since the Near Depression.
New privately owned home starts only recently exceeded the lowest levels hit during recessions occurring between 1960 and 2000. This is understandable given that new home construction was at the epicenter of the Near Depression. The WSJ published an article earlier this month discussing this issue. A more upbeat article about 2015 was published last March by CoreLogic.
This chart highlights the atypical character of the last recession.
The Census Bureau is the government's agency that is charged with tracking housing starts: New Residential Construction
New housing starts has started to accelerate as reflected in the last report. Privately owned housing starts were at a seasonally adjusted annual rate of 1,126,000 in August or 16.6% above the August 2014 rate. That data includes single family homes and apartments. The Census Bureau breaks the data down into 1, 2 to 4 and 5 units or more in Table 1. The 1 unit housing starts increased 8.7% Y-O-Y.
As shown in a chart published by Market Realist that uses government data, construction spending's share of GDP has been hovering in the 4% to 5% range over the past five years. It needs to move up to a more normal 7% to 10% starting this year and into 2016-2017.
Subpar Net Private Investment to GDP:
I will also include a discussion about corporate tax rates in this section, which is historically relevant when looking at corporate net private investment. Is their historical proof that statutory tax rates impact net private investment in a meaningful way?
Net private domestic investment is the amount being spent on capital assets less depreciation. Those capital assets include plant, equipment, property, technology and other expenditures that "improve productive capacity of an enterprise".
These expenditures are an important component of GDP and GDP growth.
This is a snapshot of total expenditures for net private domestic investment:
The Near Depression broke a long term positive uptrend, and the break was huge. This is another chart that depicts vividly the atypical character of the last recession.
I next modified this chart to combine GDP and net private investment into one line:
The preceding chart shows that net private investment, like new home construction, needs to improve.
For the 1942 to 1987 period, I would note that the effective corporate tax rates were higher than now as were the top tax brackets for the highest marginal tax.
The TaxPolicyCenter has the details since 1909 in a table: Historical Top Corporate Tax Bracket and Rate
So what does the corporate tax rate have to do with a willingness to increase fixed investments?
This observation was made by Buffett in a TIME magazine interview: "The idea that American business is at a big disadvantage against the rest of the world because of corporate taxes is baloney in my view. In the 50s and 60s, corporate taxes were 52%, and we were making all kinds of [job] gains."
To highlight the point, Bush Junior reduced taxes and had the worst jobs record on record, far worse than the much maligned Jimmy Carter. Bush On Jobs: The Worst Track Record On Record-WSJ
If I modify Bush's job numbers by debiting him with the job losses during his first year in office (a recession) and crediting him with Obama's first year (a recession), then there was a net job loss during his eight years: Stocks, Bonds & Politics: FED's Jihad Against the Saving Class/ /Bush Tax Cuts and Jobs (10/10/11 Post)
I am not saying, of course, that an increase in taxes creates jobs or that effective tax rates have no impact on hiring.
I am just not focusing on the statutory tax rate as opposed to the effective tax rate that is actually paid while offering the following prediction. If the statutory rate is lowered, corporations will end up with the same or similar provisions now used to reduced the statutory rate within a decade after a statutory rate reduction. I view that as a pragmatic observation since money talks in American politics and large contributors interview candidates who come begging for money. The complexity of the tax code is due in large part to the exchange of money for political favors.
Large and profitable U.S. corporations pay an effective tax rate of less than 13% according to a recent GAO study. Goverment Accounting Office :Effective Tax Rates Can Differ Significantly from the Statutory Rate (May 2013). A large number of companies pay little or no taxes and yet still complain about their tax burdens. Citizens for Tax Justice
Low or zero effective tax rates does not stop corporations from outsourcing jobs and/or moving production to cheaper foreign countries.
Publicly traded corporations will use U.S. tax relief to increase executive compensation and perks (creating more of a pay gap with workers), to buy back stock that increases the value of management's options, and to fund increased dividends to shareholders. That is exactly what occurred when Congress gave multinationals relief on the repatriation tax in exchange for their promises to create more U.S. jobs. Many of those corporations ended up cutting jobs and using the tax windfall for the purposes mentioned above. TheHill ("corporations who took most advantage of the holiday enacted in 2004 shed jobs in the ensuing years and did not increase their rate of spending on research and development.")
If more corporate profits after tax leads to more real income gains by households, then the following chart, which shows an increase expressed in billions of dollars from $246.6 (1989 2nd Quarter) to $1,813.7 (2015 2nd quarter) in corporate profits after tax, is not consistent with stagnant real household incomes since that year. That is a 635.48+% increase: Calculate Percent Increase
I could not adjust the preceding chart for inflation, and I will be using real household income numbers in the next section here. I used an Inflation Calculator to adjust $246.6 (in billions of dollars) to $474 in 2015 dollars. The inflation adjusted 1989 corporate after tax profit increased about 282.63+% while real median household income increased from $52,432 in 1989 to $53,687 in 2014, as shown in the Census Bureau released last week. That is a 2.39+% increase.
I would submit that there is something more fundamentally broken than corporate tax rates.
More targeted tax cuts for small privately owned businesses would produce better results IMO.
I am not going to include a reduced tax rate for large corporations and the "job creators" as one of the impediments to growth.
There is a misplaced assumption in certain quarters, which has the same status as a fervently held religious belief that will never change irrespective of the facts, that lower effective corporate tax rates (generally in the 25% to 27% range in the aggregate) will be some kind of panacea to turn the U.S. economy into a perpetual growth machine.
It is not surprising this position is advocated with great intensely by those who would benefit the most by a lower effective tax rate and the organizations or other shills funded by them. Their PR is really good and consequently the trickle down theory is accepted by tens of millions who are currently at the wrong end of that tax cut gravy train.
The reality of a statutory tax corporate rate reduction would be far more nuanced for publicly traded corporations, given that only a part of those reduced taxes (or none at all) would be used to fund increases in plant, property, jobs, equipment, technology and other productive uses.
If HP wants to axe 30,000 jobs or move production to some third world country, it is going to do so irrespective of a reduced effective U.S. corporate tax rate.
The problem is not so much corporate profits after tax, but the entire trickle down theory. Nothing trickles down unless employees have the bargaining power to demand more.
Workers simply needs to be in a position to negotiate higher wages and to increase their share of income generated by their productivity. That has been lacking, particularly in the semi-skilled and unskilled trades, for more than two decades and it has not mattered to those workers whether a Democrat or a Republican was in office or which political tribe controlled Congress.
Lack of Real Income Growth: This has been a major problem for a long time.
The preceding chart ends with 2013 data. In 1989, the real median household income was $52,432. By 2013, that number had fallen to $51,939. It has been downhill since 1999 when the real median household income was reported at $56,895.
The Census Bureau released last week the number for 2014: $53,657
"Median household income in the United States in 2014 was $53,657, not statistically different in real terms from the 2013 median income. This is the third consecutive year that the annual change was not statistically significant, following two consecutive annual declines. A comparison of real median household income over the past seven years shows that income is 6.5 percent lower than in 2007, the year before the nation entered the most recent economic recession."
Census Bureau Release 9/16/15: Income, Poverty and Health Insurance Coverage in the U.S
Wages and salaries as a percentage of GDP has been shrinking:
"For most workers, real wages have barely budged for decades" (10/19/14)(shows real income growth concentrated at the top)
For a long time now, workers have received a declining share of increases in income created by their productivity.
Understanding the Historic Divergence Between Productivity and a Typical Worker's Pay-Economic Policy Institute Publication Dated 9/2/15; Kansas City Federal Reserve Study (noting a 2.8% annual gain in labor productivity from 1996 to 2006 while labor's share of income fell and corporate profits surged); Doug Shorts Charts on Labor Productivity, Household Incomes and Corporate Profits: And the Winner Is? ("Growth in Labor Productivity has been a boon to corporate profits, but not to household incomes.") and Short's charts at U.S. Household Incomes: A 47-Year Perspective
When evaluating Short's charts, it needs to be emphasized that the data starts in 1967 and there was real income growth for a few years thereafter.
Real Household Income Growth Since 1967:
Bottom 20% (5th Quintile): 17.7%
4th Quintile: 13.1%
3rd Quintile: 23.2%
That is 60% of the households. The 2nd quintile is up 43.1% over 47 years.
Decline in Real Household Income From Peak Levels Through 2014:
Bottom Quintile: 1999 -17.1%
4th Quintile: 2000 -10.8%
3rd Quintile: 2000 -6.9%
I am about to state an opinion that has a lot of factual support. A major cause of the consumer debt bubble that started in the 1980s was the absence of meaningful real income growth among millions of households.
Real wage growth is essential to a more stable and sustainable economy.
In a consumer led economy, it is best for everyone, including the wealthy, to have spending sourced from more disposable income than from increasing debt which is not sustainable.
In the past, I have referred to the recent increase in disposable income after debt service payments as a bridge over troubled water. The troubled water is the lack of real income growth.
The improvement in the DSR and FOR ratios are not a long term solution. The bridge needs to connect to a road. The long term solution is sustainable real income growth throughout the income spectrum including the bottom quintile.
Possibly, given the decline in the unemployment rate, the wage negotiation leverage has shifted some in labor's favor. Contrary to commercials that I have seen, I do not believe Wal-Mart and other large enterprises that use a large pool of unskilled labor have increased wages out of their claimed Christian duties or altruism. It is a calculated decision designed to keep low wage workers in place whether than moving elsewhere for better pay in an increasingly tight labor market.
There are several other important impediments to growth. I will just briefly mention one that I view as important here. Student loan debt restrains spending, delays first home purchases and new household formations among millennials. Bloomberg Business (education related loans at $1.16T as of 12/31/14, up 71% since 2009) More young people need to forget about going 4 years to college and to learn in demand skills primarily from vocational schools. College has become ridiculously expensive and just is not worth that expense for most young people who have to borrow money to attend. I know that my parents paid $2,200 for my first year at Tulane back in 1969. If I just increased that number by CPI, the inflation adjusted number for 2015 is $14,285.97: Inflation Calculator: Bureau of Labor Statistics The tuition this year is $49,638 with a total cost excluding transportation of $65,080. Tulane Admission: Tuition & Fees That is more the norm for a private university with many colleges costing more. I suspect that the total cost is now closer to $75K to $80K (after tax) for a modestly spoiled child.
Portfolio Positioning: Over the past year, I have been positioning my portfolio more conservatively with a greater emphasis on capital preservation and income generation. The cash allocation has increased to over 30%. A number of stock funds have been sold. Part of the proceeds from stocks have been funneled into bonds and preferred stocks. My allocation to regional banks has been pared, based on the directional down move in interest rates, while I have been adding to my equity REITs positions.
Business Development Corporations have been one of the most hated "bond-like" sectors over the past year or so. The discounts to net asset values for externally managed BDCs have expanded to historically high levels. Investors have soured on those BDCs, in part due to a parade of dividend cuts and a persistent decline in net asset values per share among many of them even with the economy growing. What happens when the next recession comes back? Will the destruction in net asset values per share likely accelerate when the inevitable downturn happens? The only rational answer to that question is "YES".
It is no secret among long time readers that I view externally managed BDCs with disdain. Nonetheless, I will play occasionally in that sandbox hoping to harvest their dividend payments and to escape with a profit on the shares. That has been a most difficult task over the past year.
I did successfully trade one of the best externally managed BDCs, Ares Capital (NASDAQ:ARCC). By "best", I am referring to the best of a bad bunch or the least rotten apple.
Until recently, I had knocked down my miniscule BDC positions to 100 TCRD shares and close to 300 PSEC shares. Of that total, 242+ shares are owned in a taxable account with a total average cost per share of $8.76.
That is not bad looking at a long term PSEC chart which starts in September 2004:
My last purchase was on 4/27/15: Added 100 PSEC at $8.45
I had traded PSEC successfully over the years. I have to adjust the meaning of successfully when talking about BDCs. In BDC land, a successful investment is one that earns a total return in excess of the dividend yield. My last foray into PSEC turned me into an involuntary longer term investor.
I have been moving closer to break-even on the shares due to PSEC's recent price spurt and the reinvestment of dividends at lower than my total average cost per share number which lowers my average cost a tad with every monthly dividend payment.
I hope to escape at some point with a total return in excess of my dividends. Harvesting the dividend without losing money on the shares is my objective with BDCs.
1. Bought 50 ARCC at $14.8-Roth IRA:
All of the foregoing is leading up to this discussion. I recently bought 50 shares of the BDC ARCC in a Roth IRA account.
2014 Annual Report (risk discussion starts at page 29 and ends at page 53)
Ares has several pie charts at its website showing asset class composition and industry concentrations. ARCC: Portfolio I would just highlight that "second lien senior secured loans", "senior subordinated debt" and preferred stock are shown at 27%, 6% and 2% respectively. Those instruments are generally the categories that suffer significant losses during a BK and consequently have higher yields than first lien debt. I have seen even second lien bonds become worthless in a BK.
A wind down in the GE-Ares joint senior secured loan program will impact ARCC's results, as explained here. There are too many variables IMO to predict those impacts now.
There has been recent insider buying: ARCC Insider Transactions
I took a snapshot of my Roth IRA account history:
I had eliminated my ARCC position last April by selling 100 shares at $17.2: SOLD 100 ARCC at $17.195 (4/28/15 Post)(profit snapshot=$116.36)- Bought 50 ARCC at $15.41-A Typical Small Lot Purchase Of An Externally Managed BDC Stock - South Gent | Seeking Alpha and Item # 3 Bought: 50 of the BDC ARCC at $16.17 (1/21/11 Post)
Other "successful" trades are discussed in these posts: Sold 100 ARCC at $17.54-IRAs in Two 50 Share Lots (9/13/12 Post)-Item # 4 Added 50 ARCC at $16.9-Regular IRA (5/21/11 Post) and Item # 3 Bought 50 ARCC at $16.89 (12/3/2010 Post); Item # 3 Sold 100 ARCC Roth IRA at $17.05 (2/25/15 Post)(profit snapshot=$17.05 plus $157 in dividends).
This last purchase at $14.8 is the lowest price that I have paid for ARCC shares. I am pleased that I did not ride down those other purchases to $14.8. I at least have a better chance now to escape at a profit.
The current regular quarterly dividend rate is $.38 per share: Dividends. Assuming a continuation of that rate and a total cost per share of $14.8, the dividend yield is about 10.27%. Ares has also paid 5 special dividends of $.05 per share over the past three years which is not included in that yield calculation.
My most comprehensive discussion of ARCC was probably in the SA Instablog where I discussed a 50 share purchase at $15.41. Bought 50 ARCC At $15.41-A Typical Small Lot Purchase Of An Externally Managed BDC Stock I am not going to repeat the points made in that discussion here.
As of 6/30/15, Ares reported a net asset value per share of $16.8, up from $16.52 as of 6/30/14. Unlike other BDCs that were in business prior to 2008, Ares has at least been able to return to NAV per share to levels higher than those prevailing prior to the Near Depression. Search 10-Qs
E.G. $15.34 as of 3/31/07 and $15.17 as of 12/31/2006: page 3
Core E.P.S. was reported at $.37, up from $.34, while net investment income was $.35. ARES is currently paying a $.38 per share quarterly dividend.
10-Q for Q/E 6/30/15 (summary of investments starts at page 5)
Recent SA Article on ARCC from Factoids: Ares Capital
I will discuss another 50 share BDC purchase in my next portfolio positioning update.
Review of Interactive Brokers So FAR
After using IB for a couple of weeks, I came to understand why many investors view that company unfavorably.
Sure, the commission is low at $1, but the site is bare bones.
It generally takes four to six seconds for IB's system to retrieve a quote, easily the slowest among the brokers that I use. I am referring to retrieving quotes in IB's "webtrader" before I enter a limit order.
I opened an account after looking only at the commission page. My excuse was that has been the only relevant page for every broker that I now use or have used in the past.
After I opened an account, I found another page containing fees that takes away some of the low commission advantage unless the investor is a hyper active trader.
That kind of information was not on the commission page, but was buried in another section called "required minimums". Required Minimums | Interactive Brokers
The investor would then need to click "Monthly Activity" to see those fees. The monthly activity fee is $10 minus the commissions paid. So ten trades per month avoids that one. It is waived for accounts whose liquidation value exceeds $100K or for the first three months as a client. After using this broker for a few weeks, I doubt that I would send them $100K so I will have to grow whatever sum that I am willing to send to fall within that $100K account value fee exemption.
However, as I understand it now, the investor would still need 30 trades per month to avoid another $10 charge for non-professional quotes. I am not likely to avoid that one most of the time.
That fee was buried really good under a tab "research, news and market data" and then click "Market Data Fees":
"Clients choosing to subscribe to US non-professional real-time market data will have the USD 10 (or non-USD equivalent) monthly market data subscription fee waived if they spend USD 30 (or USD equivalent) or more in commission for the month."
So, I was originally intending to fully invest whatever sum was deposited in my IB account and to keep trading at a minimum. Instead, to get the most out of the $1 commission rate, I will need to use these account as a trading account just to narrow a $20 monthly fee to $10.
Their customer service is reputed to be the worst in the business.
My only contact with the service part of the business so far involves my account funding. So far, I give IB an F-.
I sent them a check, which was received on 9/16/15, but the funds will not be available until 9/28/15.
I requested that IB initiate an ACH bank transfer. IB received the funds on 9/16/15, but the funds are not available for trading until 9/22/15.
I checked with my bank and both items cleared my Tennessee bank on 9/17/15.
My bank had a copy of my check made payable to IB check for viewing that day. That time differential between receipt of the funds and their availability is just ridiculous and is a first for me. There is no question that IB knows that it received those funds on 9/17.
Try Low Shiller P/E Country Funds Again and/or European Equities with Relatively High Dividend Yields?
Earlier this year, I bailed quickly on several foreign country ETFs with low Shiller P/Es.
Update On Portfolio Positioning And Management - South Gent | Seeking Alpha (scroll to "3. Secular Forces and Sector Allocations")
I was using data gleaned from this website to select low Schiller P/E foreign country stock markets. Global Stock Market Valuation Ratios (e.g. the U.K. has a CAPE ratio of 12.7; Poland's market is at 10.3)
Part of the flee decision was based on a DXY chart that showed a resurgence in USD strength in mid-May. The DXY closed at 93.23 on 5/15/15 and at 97.43 on 6/1/15. A rise in the DXY indicates USD strength against a basket of foreign currencies weighted in the Euro.
As it turned out, the U-Turn was fortuitous primarily due to worldwide stock market corrections occurring thereafter rather than to the currency issue (i.e. right for the wrong reason or just the blind squirrel analogy).
1 Year DXY Chart:
The USDs strength since mid-July 2014 still looks like a parabola to me:
The question is, as it always is with parabolas, how high will it go before collapsing upon itself. The DXY did not like the rarefied air at the 100+ height and has shown a lot of chop with some downside bias since hitting that number.
Parabolic spikes up and down are nothing new for the Dollar Index, and a long term chart places the current spike in an historical perspective. United States Dollar | 1967-2015 The USD had a major spike up in the 1980s followed by equally powerful spike down. Since around 1988, the DXY has had trouble maintaining a move over 100.
See, also: Chart of Three Real Dollar Indexes: MacroTrends
At the moment, I am not inclined to buy back any of the low Shiller P/E foreign country ETFs.
I am leaning toward buying back some foreign dividend stocks that were jettisoned earlier this year, particularly those that pay annual dividends that I received before jettisoning them and can buy back at prices lower than my last entry point.
I will discuss those buys in the portfolio positioning updates.
Disclaimer: I am not a financial advisor but simply an individual investor who has been managing my own money since I was a teenager. In this post, I am acting solely as a financial journalist focusing on my own investments. The information contained in this post is not intended to be a complete description or summary of all available data relevant to making an investment decision. Instead, I am merely expressing some of the reasons underlying the purchase or sell of securities. Nothing in this post is intended to constitute investment or legal advice or a recommendation to buy or to sell. All investors need to perform their own due diligence before making any financial decision which requires at a minimum reading original source material available at the SEC and elsewhere. A failure to perform due diligence only increases what I call "error creep". Stocks, Bonds & Politics:ERROR CREEP and the INVESTING PROCESS. Each investor needs to assess a potential investment taking into account their personal risk tolerances, goals and situational risks. I can only make that kind of assessment for myself and family members.
Disclosure: I am/we are long ARCC.