Y H & C Investments Monthly Review: September 2019- Edition 134

U.S. Economic & Financial Markets Outlook- Is the Bond Market Mispriced Or Is the Economy Headed Into Recession?

(Y H & C Investments may have positions in companies mentioned in this newsletter. It is the responsibility of each investor to research possible investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives)

In August, the Dow Jones Industrial Average fell .31% the S&P 500 lost .19%, and the NASDAQ retreated .51%.  The investment world is enamored with the much publicized negative yield curve, primarily because history has proven it’s usefulness in predicting oncoming recessions.  On the opposite end of the spectrum, consumer confidence is high and recent jobs reports support the idea of a U.S. economy growing at a nominal rate of two to three percent.  FOr investors, the ten year treasury note currently resides at 1.50%, ticking close to an all time low.  As bond prices are the inverse of bond yields, a buyer of treasuries is paying sky high prices for the privilege of earning all time low interest income.  Investment theory dictates when an economy is performing adequately, interest rates for bonds typically range in the neighborhood of three to six or seven percent, depending on how quick the nominal GDP growth rate is as well as inflation.  It seems obvious there is a disconnect between the state of the economy and the current status of the bond market.  Either the economy is performing better that what bonds are pricing in, which means bond yields have to head higher, or as many are predicting, the economy is headed for a tougher stretch.

If you look at other economic statistics to try and get a more complete picture of the current environment, there are all kinds of data to support either side of the argument.  Much of the global data shows weakness in Europe and Asia.  Domestically, manufacturing and capital investment has seen sharp drop offs over the last year.   The strength of the economy lies in consumer spending, which makes up 70% of all economic activity.  Much depends on what your circumstances are in terms of how you view things.  My own thinking is the bond market should not be the only measure one uses to make evaluate or consider investment decisions.  Without question, the stock market endured a volatile August because of much trepidation over the historical relevance of the downward sloping yield curve.  Usually, fall and winter bring increased economic activity and it wouldn’t be surprising to see that same pattern repeated again this year.  As for stocks, low bond yields and willingness to help by the Federal Reserve lend support, offset by unpredictable political rhetoric and trade tensions which could drag on for a long time. As a result, expecting the unexpected probably is a wise approach, and certainly focusing on specific situations where one sees value that fits nicely in a diversified portfolio.

Global Economic & Financial Markets Outlook- As Global Bond Yields Head Lower, Stocks Hold Strong

(All country index data provided by countryeconomy.com, August 31, 2019.)

Global equity markets continue to hold up well during a unique period in financial market history.  With unprecedented circumstances in global bond markets, specifically trillions of dollars of negative yielding fixed income instruments, fears of an economic slowdown gain popularity by the day.  The heightened tension across the globe regarding trade and taxation keeps investors from taking more risk.  Still, stocks are holding their ground, at least at this point in the year.  Let’s take a look at specific country index performance, shall we?

The Euro-zone (Stoxx 50) is ahead by 14.74%, while UK’s FTSE is in the green by 7.12%.  Frances CAC 40 is up 15.85%, and Japan’s Nikke is nearly flat at 3.45%.  The Shanghai Exchange has been solid (+15.73%), as has New Zealand’s NZX 50 (+22.08%), while India (+1.48%) stays muddled.  Russia is solidly ahead (+14.56%), as is Switzerland (+17.42%).  Down south, Brazil shows strength (+15.07%), as does China (+15.73%) to the east.  Up north, Canada’s TSX (+14.33%) has been a solid performer as well.  Looking ahead, bond yields, inflation, and currencies all seem destined as critical factors to whether the strong equity performance continues, along with the whether or not the world sees better individual country and global growth.

The Art of Contrarian Thinking- Merger Arbitrage Offers A Strategy For Higher Returns and An Efficient Use of Idle Cash!

(Y H & C Investments may have positions in companies mentioned in this newsletter. It is the responsibility of each investor to research possible investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives)

In a nicely diversified portfolio, some holdings are dividend paying stocks which generate income either quarterly, semi annually, and sometimes monthly.  If the dividends are not reinvested,  cash builds up over time.  If you have one or two nice capital gains on prior investments, even more cash is built.  In the current interest rate environment, holding cash is a primary option if your perspective is the market will suffer a large downturn and you are better off waiting to be able to take advantage of the selloff.  If the market does not experience major selloff, the idle cash winds up being unproductive.    You can split the pile of cash into separate buckets, with one pile going to other uses and the other remaining there, just in case the doomsday scenario plays out.

One strategy you might consider with your pile is called merger arbitrage.  You scour the news for a situation where a company you are familiar with and a business you analyze as high quality.   The company announces it is going to be purchased or merged with another public company.  Sometimes the deal will be all cash, other times it is consummated with all stock, and on other occasions, there will be a mix of cash and stock.  Mergers and acquisitions take time to play out, and an announced deal takes several months to close.  During that time, the stock price of the company being sold will fluctuate below the announced deal price.  For example, company A is being bought by company B for $20.00 per share in stock and cash.  The current price of A is $18.50 per share.  The deal will close in six months.  If you buy A, and the deal goes through, you will make $1.50 per share on the $18.50 purchase price.  The six month return on this purchase is $1.50/18.50, or 8.11%, with an annualized return of double that, or 16.22%.  The caveat is the announced deal has to close at the stated purchase price.  Sometimes, the deal can be delayed or altered, especially if the two companies are in highly regulated industries like health care, financial services, utilities, or gaming.  In these cases, the spread between the announced deal price and the current price of A would widen, indicating more risk of the deal actually closing.  There are many investment firms that specialize in merger arbitrage because there are so many deals that take place and the ability to generate higher returns can be inviting.  Merger arbitrage is an area to consider using in your portfolio in a variety of ways, but certainly with idle cash that you might want to put to more efficient use.

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Yale Bock, Y H & C Investments, its clients, and the family of Yale Bock have positions in the securities mentioned in the blog,  Investing in securities involves risk and the potential loss of ones principal.  Past performance is no guarantee of future results.  All investment decisions should be considered with respect to ones risk tolerance, return objectives, liquidity needs, tax considerations, and one’s overall financial situation.  The fact that Yale Bock has earned the right to use the Chartered Financial Analyst in no way means or guarantee performance better than market indexes.

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