There’s No Small-Cap Market
Posted by Eddy Elfenbein on April 13th, 2017 at 11:39 am

One of the misunderstood points of financial markets is that Affect A is very often the outgrowth of Effect B.

A good example is volatility. Commentators often discuss volatility as if it’s an entity above and apart from the market, but that’s not really the case. In reality, movements in the VIX are strongly correlated to what the market recently did. I once found a 70% correlation between the VIX and the distance the S&P 500 is from its six-month high. Markets don’t rise because volatility is low. Instead, volatility falls because the market is up.

Another example is gold. It’s not some mystery risk quotient. Rather, movements in gold are strongly tied to movements in real interest rates. Sure, there’s some noise mixed in, but once you clear things off, that’s what’s really going on.

Today I want to turn my sights to the small-cap market. There’s a great deal of literature about the “small cap premium.” Frankly, I’m pretty skeptical that it truly exists. Even if it does, it appears to be quite small and highly volatile. The data shows that small-caps have underperformed for several years at a time.

Likewise, movements in the Russell 2000 aren’t anything magical. The Russell 2000 is largely the S&P 500 just without utility stocks. Check out this chart. It’s the Russell 2000 divided by the S&P 500 (blue line) compared with the Utility ETF divided by the S&P 500 (black line).

Over five years, and they’re like mirror images.

My point is that for me to be convinced that there’s truly a small-cap premium, I would need to see a comparison of similar companies in similar industries with similar balance sheets and similar risk profiles. Obviously that can’t literally be done, but in a theoretical exercise, once everything is corrected for, I doubt there’s much of a small-cap premium.

Morning News: April 13, 2017
Posted by Eddy Elfenbein on April 13th, 2017 at 7:05 am

Oil Retreats as U.S. Production Gain Offsets Stockpile Decline

Venezuela Staves Off Default, But Low Oil Prices Pose a Threat

China Exports Jump the Most in Two Years as Imports Moderate

Trump Isn’t Wrong on China Currency Manipulation, Just Late

Trump Liking Yellen Ignites Prospects for Fed Policy Continuity

Wounded by ‘Fearless Girl,’ Creator of ‘Charging Bull’ Wants Her To Move

This Is The Jeff Bezos Playbook For Preventing Amazon’s Demise

Tesla Seeks Independent Directors as Board’s Musk Ties Eyed

Lessons From the United Airlines Debacle

Fox News’s $200 Million Golden Goose Gives CEO His Biggest Test

Investors Are Cherry-Picking the Assets of a Fallen Renewable Energy Giant

JP Morgan Profit Rises 16.8%

KPMG Fires 6 Over Ethics Breach on Audit Warnings

Jeff Miller: Are You Fooled By This Chart?

Cullen Roche: (Another View on) The Slowdown in Lending: A Rorschach Test

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The S&P 500 Loses Its 50-DMA
Posted by Eddy Elfenbein on April 12th, 2017 at 5:04 pm

For the first time since November 8th (Election Day), the S&P 500 has closed below its 50-day moving average. We traded above the 50-DMA for more than five straight months. This is one of the longest such streaks in recent years.

Today’s close of 2,344.93 is the lowest since the closing low from March 27 of 2,341.59. Interestingly, today’s intra-day low dipped to 2,341.18, a hair below that key mark.

Amazon’s Letter to Shareholders
Posted by Eddy Elfenbein on April 12th, 2017 at 12:42 pm

Here’s a sample:

“Jeff, what does Day 2 look like?”

That’s a question I just got at our most recent all-hands meeting. I’ve been reminding people that it’s Day 1 for a couple of decades. I work in an Amazon building named Day 1, and when I moved buildings, I took the name with me. I spend time thinking about this topic.

“Day 2 is stasis. Followed by irrelevance. Followed by excruciating, painful decline. Followed by death. And that is why it is always Day 1.”

To be sure, this kind of decline would happen in extreme slow motion. An established company might harvest Day 2 for decades, but the final result would still come.

I’m interested in the question, how do you fend off Day 2? What are the techniques and tactics? How do you keep the vitality of Day 1, even inside a large organization?

Such a question can’t have a simple answer. There will be many elements, multiple paths, and many traps. I don’t know the whole answer, but I may know bits of it. Here’s a starter pack of essentials for Day 1 defense: customer obsession, a skeptical view of proxies, the eager adoption of external trends, and high-velocity decision making.

Read the whole thing.

Morning News: April 12, 2017
Posted by Eddy Elfenbein on April 12th, 2017 at 7:07 am

Global Economic Recovery Is Gaining Momentum, IMF’s Lagarde Says

World Trade Seen Growing 2.4% in 2017, Uncertainty Weighs

Trump’s Message to Bankers: Wall Street Reform Rules May Be Eliminated

Trump’s Trademark Continues Its March Across the Globe, Raising Eyebrows

The Correct Question To Ask About The Google, DoL, Spat Over Gender Inequality In Pay

United CEO Apologizes Again After First Mea Culpa Falls Flat

Toshiba Casts Doubt on Its Ability to Stay in Business

Uber Has Lost Its Most Important Political Asset In The UK

Wal-Mart to Discount 1 Million Online Items Picked Up in Stores

Elliott Management Seeks to Remove Akzo Nobel Chairman

Subaru Makes an Even Sleeker Outback

Yahoo Is Sued Over $17 Million Fund for Chinese Dissidents

DALIO: ‘I don’t think we’re going to have a radical change in the economy’

Howard Lindzon: Reading Venture Capitalists

Jeff Carter: The Answer is “Delaware C Corp”

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Stocks, Bonds and the Election Cycle
Posted by Eddy Elfenbein on April 11th, 2017 at 2:26 pm

This is one of those instances where I did some research and it showed absolutely nothing. Oh well, that’s how a lot of research goes. Still, I’ll post the results anyway.

I was curious to see if there’s a cyclical pattern to the equity risk premium. In this case, I wanted to see how stocks perform relative to long-term corporate bonds (the risk premium more often uses short-term bills).

I used the four-year Presidential Election Cycle. The average behavior of stocks during the period is well-known and I’ve written about it before. But what about bonds? I wasn’t sure if there’s a significant cycle involving corporate bonds.

As it turns out the answer is no. Here’s what the average cycle looks like:

The blue line represents the average return of the stock market over the four years of the election cycle. The data points are monthly. The first 12 are the mid-term year, followed by the pre-election year, election year and post-election year.

The red line is the same but for corporate bonds. In this case, there’s almost no variability in returns. It’s a line that rises about 0.5% each month, every month. There’s not one instance of an average four-month period when corporate bonds lost money. Any movement in the equity risk premium is almost entirely due to stocks.

Express Scripts CEO Defends PBMs
Posted by Eddy Elfenbein on April 11th, 2017 at 1:03 pm

Here’s a brief clip of the CEO of Express Scripts (ESRX) defending PBMs from the allegation that they’re responsible for high drug prices.

When Europe Leads, Here’s What Happens
Posted by Eddy Elfenbein on April 11th, 2017 at 12:55 pm

Oppenheimer Knocks Alliance Data Systems
Posted by Eddy Elfenbein on April 11th, 2017 at 11:39 am

This morning, Oppenheimer initiated coverage on Alliance Data Systems (ADS) with an underperform rating. That seems to have knocked the shares down more than 4%. (I’m not aware of any other news that would have impacted the stock.)

The company is due to report earnings on April 20. Wall Street expects earnings of $3.89 per share.

JFK Attacks the Steel Industry
Posted by Eddy Elfenbein on April 11th, 2017 at 10:25 am

Fifty-five years ago tomorrow, President Kennedy attacked the steel industry. Gary Alexander explains the fallout.

Fifty-five years ago this week, on April 12, 1962, President John Kennedy held a special press conference to demand that the executives of U.S. Steel (and many other domestic steel companies) roll back their recently-announced $6 per ton price increase. He accused steel executives of being virtually traitorous in their “pursuit of private power and profit.” He said that the Department of Defense would only order steel from the firms that rolled back prices. Steel companies quickly complied, rolling back prices the next day.

By the next day, Friday the 13th of April 1962, the nation’s eight biggest steel companies surrendered to the President’s demands in quick succession: At 3:05 pm, Kaiser Steel was the first domino, followed by Bethlehem Steel at 3:21. U.S. Steel bowed at 5:25, followed by Republic Steel (5:57), Pittsburgh Steel (6:26), Jones & Laughlin (6:37), National Steel (7:33), and finally Youngstown Sheet & Tube (at 9:09).

That did not end the war of words. When it came time to announce U.S. Steel’s disappointing first-quarter 1962 earnings on May 7, CEO Roger Blough told his shareholders: “This concept is incomprehensible to me – the belief that Government can ever serve the national interest in peacetime by seeking to control prices in competitive American business, directly or indirectly, through force of law or otherwise.”

All through May of 1962, stocks kept falling. From its December 1961 peak at 741, the Dow fell by 29% in six months, to 525 by late June, 1962. It turned out to be the worst bear market to befall America in the 32-year expansion between 1942 and 1974. May 28, 1962 was the worst day on Wall Street since the 1929 crash. On that day, steel stocks dropped to 50% of their 1960 levels, as part of a long, long decline.

Steel companies weren’t price-gouging. Profits at U.S. Steel fell 61% from 1958 to 1963, with the biggest drop coming in 1962. The industry lost over 100,000 jobs from 1958 to 1960, including 70,000 jobs lost at U.S. Steel alone. Their profit margin was cut in half. While salaries in the steel industry rose 13% from 1958 to 1961, profits fell, as 85% of U.S. Steel’s 1961 profits were paid out in shareholder dividends.

In 1958, U.S. Steel was #4 in the Fortune 500, and Bethlehem Steel was #9. By 1985, U.S. Steel was in the process of changing its mix of businesses, emerging as USX Corp. The only pure steel company in the Fortune 100 in 1985 was Bethlehem Steel, ranked #68. Clearly, the U.S. steel industry was slowly dying.

The President killed an already-dying industry. By July 1962, the steel industry was working at just 55% capacity, vs. 70% in April, when the President attacked them. Very soon, Japan began to dominate the steel market, which was already beset by competition from non-steel construction products made from plastics, aluminum, cement, or glass. While the normal challenges of business are always present, the President’s attack contributed greatly to the decline of the U.S. steel industry over the next few decades.

As history shows, Presidents possess great powers to inspire or destroy when they propose to take any particular industry to the woodshed. Chances are, market forces are already disciplining those companies.