Friday, October 22, 2010

The World's Gone Mad

First of all, let's take a look at what happened to Wal-Mart (from this article in WSJ):

"Wal-Mart sold $750 million worth of three-year bonds paying 0.75% a year. It sold $1.25 billion of five-year bonds paying 1.5%, $1.75 billion of 10-year bonds paying 3.25% and $1.25 billion of 30-year bonds paying 5%."

"Remember that those bond coupons are subject to two hidden costs. First, bond interest is taxed as ordinary income. That means that if the bonds are held in a taxable account, they will be taxed up to 35% right now—and as high as 39.6% next year if the Bush tax cuts expire as planned."

"Second, bonds face a serious risk from inflation. Who wants a piece of paper paying 5% a year for 30 years if inflation jumps to 7%? Nobody. If that happens, the price of the bond would plummet."

Now let's take a look at Wal-Mart stock.

"At $54, it has barely moved over the past 10 years. Yet during that time the company's annual sales and net income have more than doubled. Net operating cash flow has nearly tripled. And dividends have quadrupled, from 24 cents to $1.09."

Read the article for more.

Second, Italy is a bigger sovereign risk than Indonesia, according to Business Week.

"Italy’s debt costs more to insure against default than that of the Philippines or Indonesia, as Europe’s financial woes overshadow a credit rating six levels higher than either of the emerging-market nations. Credit-default swaps on Italy, the only borrower among Europe’s so-called peripheral nations not to suffer a cut in its credit rating since last year, trade at 165.5 basis points. That’s more than the 131 basis points for Indonesia, which had to restructure some of its debt in 2000, or the 129 basis points for the Philippines."

Third, the Reserve Bank will tell you, "Since the beginning of the year, non-residents have been net buyers of equities and bonds to the value of R100 billion, of which R75 billion were bond purchases. This compares with net purchases of bonds totalling R15,5 billion in 2009 as a whole. Whereas in previous years bond flows appeared to be mainly speculative in nature, the recent developments suggest that there could have been a fundamental shift in these flows. There are indications that a significant proportion of these flows are more long term in nature as foreign pension funds and other fund managers take advantage of higher yields in emerging-market economies. The higher levels of bond market inflows are not unique to South Africa. It is estimated that emerging-market bond funds have recorded year-to-date inflows of US$32 billion, compared with the previous full-year high of US$9,7 billion in 2005."

Fourth: Pension funds, who rely on an 8% assumed return on capital over long time periods to match growing liabilities, have decided it's a good idea to flee stocks for the "safety" of bonds. A fool and his money will tell you this is a ridiculous idea:

"Alcoa's U.S. pension fund had 57% of its assets in stocks in 2006. The stock market started sliding late in 2007, and by the end of 2008 the decline had pulled stocks down to just 33% of Alcoa's pension portfolio. The fund's value tumbled by more than $2 billion, to $6.5 billion. Alcoa officials decided against restoring the stock exposure to its former level. With the blessing of the board, they looked for ways to insulate the fund from future damage. By early 2009, the board signed off on a plan to push stocks down to 30% of fund assets, selling shares and buying bonds. As the stock market surged back starting in early March that year, Alcoa continued to sell stocks to keep that weighting at 30%."

The pension boards will tell you it's to reduce volatility and protect principal, and that changing your strategy based on economics and markets is not what they are doing. That would be true except, "About two decades ago, in 1988, corporate pension funds had just 38% of their assets in stocks, according to the Center for Retirement Research. And 401(k)-type plans, in which individuals control investment decisions, also held less than 40% in stocks, according to the Center. During the stock boom of the 1990s, the percentage invested in stocks jumped for both groups, with individuals hitting 68% in stocks in 1999 and corporate pension plans hitting 67% in 2001."

And as for this gold illusion, it's pretty clear there's no correlation between the rate of change in M3 and the gold price, and there's clearly a somewhat complicated relationship to explain movements in the gold price related to the M3 money supply over long time periods.

All in, a good time to be buying companies at attractive prices.