11 Mar 11th March 2024
Weekly Index Movement
| S&P500 | -0.3% |
| Nasdaq | -1.6% |
| Aussie All Ords | +1.2% |
For the first time in 8 weeks, markets produced a negative performance. But it wasn’t like that on Thursday when the US was at a another new high.
This week it was Fed Chair Powell that lit the fire with his testimony to Congress. He said he is waiting to see inflation moving sustainably at 2% and that we aren’t too far from that. He basically signalled that cuts are coming. It will probably take a few more inflation prints so I’m looking at the June meeting as the first potential cut. That isn’t far away.
But, Powell has the luxury of time because the US economy is still doing reasonably well. So maybe we won’t see cuts until September?
Corporate earnings remain strong and a growing economy offers the possibility of further improvement to bottom lines in 2025 and beyond.
The issue isn’t “when will the Fed cut?” but rather “take a good economy with companies growing earnings and add rate cuts, and what do you get?” Higher stock prices is the answer.
Stay long.
Deglobalisation
I don’t know if that is even a word. But it is happening.
In the US a congressional committee has passed a bill that would remove TikTok from app stores unless its Chinese owner divests the video-sharing platform. The House Energy and Commerce Committee approved the bipartisan bill 50-0 on Thursday after a classified briefing from officials about the risks the app posed to Americans because of its ownership by the Chinese group ByteDance.
At the same time, a Chinese government directive expands a drive that is muscling U.S. technology out of the country—an effort some refer to as “Delete A,” for “Delete America”. Document 79 was so sensitive that high-ranking officials and executives were only shown the order and weren’t allowed to make copies. It requires state-owned companies in finance, energy and other sectors to replace foreign software in their IT systems by 2027.
This could have monumental impacts. For example, META says that 10 percent of its revenue is accounted for by Chinese based advertisers. That is almost double over two years ago.
Imagine taking it away?
I doubt it will happen. Profits will always come first and causing too much pain to your profit making companies will not benefit anyone.
Politicians might try and put bans in here and there, but when it comes to real money, they won’t upset the apple cart.
New York Community Bank (NYCB)
It was roughly this time last year that Silicon Valley Bank collapsed. This year New York Community Bank is in a bit of strife.
NYCB is delaying its 10-K because it says it found material weaknesses in its internal controls related to loan review “resulting from ineffective oversight, risk assessment and monitoring activities.” The long-standing CEO also just resigned. This is not good.
Then Moody’s and Fitch both downgraded the regional bank to three levels below investment grade.
NYCB is down around 33% and means the market thinks the market value of assets less liabilities is less than 20% of what it was on paper at the end of Q4. NYCB’s 2028 floating rate debt, which offers a coupon of SOFR + 305 bps, traded below 70 cents on the dollar today. They ended January around par.
If you are brave this could be an interesting play. The stock is now very cheap. On Wednesday it raised $1bn in new capital from a syndicate led by former Treasury Secretary Steven Mnuchin; he will join the company’s board while former Comptroller of the Currency Joseph Otting will become CEO. The combination of new capital equal to about 10% of existing equity book value and the institutional heft of the investor syndicate is a welcome change in tone for the beleaguered lender. Between this new vote of confidence and the existing capital base of the bank, a repeat of the Silicon Valley Bank mess feels unlikely at this stage.
Talking of underlying problems……..you might recall a while ago I mentioned a company called B Rily Financial (RILY) and stated it was under a short attack because of a news story that stretched a long bow to Rily. I suggested it was a buy around $20.
Well, it turns out where there is smoke there is fire. They failed to file their 10-K (basically financials)
When asked directly in the earnings call whether its auditor refuses to sign off on the 10-K, RILY declined to respond. It said earlier in the call it had to delay the 10-K because of the time it took to participate in a law firm review of its connection to fraud. The company says the report exonerates management. But the law firm used is one RILY has done business with, so the potential conflict of interest taints the conclusion.
RILY also just cut its dividend in half. It says it sees opportunities to invest in the company, and buy back stock and debt. Though the stated use of the funds is commendable, dividend cuts are never welcome. The only thing positive here is that the company did not cut the entire dividend.
We will learn more when the company files its 10-K. While management maintains a positive posture, as this plays out it might not be pretty. The other challenge here is that shorts, even if they are not completely right on their thesis, can damage a business with their constant barrage of allegations. Companies in businesses that require a high degree of trust, like finance, are especially vulnerable.
The stock is still around $23 but risk is increasing so you might want to cut and run with a small profit.
BuyBacks
Uber’s recent announcement of its inaugural $7billion stock buyback has been one of the more surprising events of the year to date, and it got me thinking I should explain about buybacks and why they are good.
In Australia, the favoured way companies return money to shareholders is via a dividend. That is because dividends in Australia have a favourable tax treatment due to franking credits. But, depending on your situation, even with franking credits, it is possible buybacks could be better for you.
Personally, I prefer a buyback. I don’t need the income of a dividend and even with franking credits I still end up paying excess tax on the dividend. Then the question becomes, what do I do with this cash I’ve now got?
Buybacks are better for me. That might not be the case for you, as we are all in a different position.
With a buyback, instead of paying money out as a dividend, a company takes that same total amount of cash and uses it to buy back it’s own stock on the market. This reduces the number of shares outstanding which, in theory, increases the value of each share.
It works like this. Imagine a company with 100 shares outstanding. Each share is trading at $10 each so the market cap is $1,000
The company announces a buyback for $100 and so buys 10 of its own shares. These shares get cancelled so there are now only 90 shares outstanding.
The value of the company should not change during this event so the market cap should remain at $1,000. With only 90 shares outstanding each share should now be worth $11.11. An increase of 11%.
If I don’t sell my shares I have no tax consequences. But the buyback has increased the price. This can go on for years. Maybe I even get to presevation age and then I sell my shares and pay no tax at all!
That’s why I personally prefer buybacks over dividends.
Companies prefer them as a buyback gives the company a bit more flexibility. They don’t have to pay all the cash out on a certain date and can choose when to buy shares.
Some companies do both. Pay dividends and buyback shares. New Hope Coal (NHC) is one. Apart from roughly a 10% dividend they have a $300million share buyback happening right now. From watching their buy-back reports, they seems to buy on dips in the share price. That provides a floor and we saw it happen in the last couple of weeks when the stock dropped from $5 to $4.50 then promptly recovered to $4.75. I bet the company reports it was them buying shortly.
Warning
Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account and might not be suitable for you.