Two relatively quick items that I want to address today; they have been in my ‘to do’ box for a while.
One of the most interesting features of the fixed-income landscape today, and one that will likely serve in the future as an exam question on finance quizzes, is the increasingly widespread proliferation of negative nominal interest rates among government bond markets…and occasionally even for high-quality corporate paper.
In finance theory, this can’t happen. Because currency earns a 0% nominal interest rate, theory says that no rational person would ever accept a negative nominal interest rate. If I have $50 today, and put it in the bank, I will have $49 tomorrow. So why not just keep the $50 in my wallet? (Obviously this leads to high cash balances, which means low monetary velocity, by the way). And this is true in the absence of “other costs.”
So why are so many interest rates negative? Are individuals irrational? No: at least not so irrational that they prefer less money to more money. However, what is true at an individual level does not necessarily scale to the institutional level. An institution, such as a money fund or corporation, does not have the freedom to hold its assets in physical currency. Microsoft has $90 billion in cash and equivalents. If this were in $100 bills, it would weigh about one thousand tons. That’s a pretty big vault. And vaults cost money. Guards cost money. And, if Microsoft had this money in the vault, it would be harder to spend. It is much easier to wire $5 million than it is to send an armored car.
In the presence of those costs, Microsoft and other institutions will accept a negative interest rate. It will invest its money at a negative rate rather than build a vault.
Now, an important (if obvious) point is that cash balances are so high, and interest rates so low, because global central banks are making sure we have plenty of cash. Too much cash chasing too few investment opportunities causes rates to be low.
Walmart and Minimum Wage Increases
It has been a few weeks now, but when Walmart in February announced it was going to increase the minimum wages it plans to pay its employees (preceded by Starbucks, Aetna, and the Gap and followed by TJX and Target), I received a number of queries about what the hike was going to do to inflation. Is this the beginning of the much-feared “cost-push inflation”?
The answer is no. Wages, as I have said many times, follow inflation rather than lead it. Think about it: wouldn’t it be really weird for companies to raise wages and then raise prices, to the extent that they have control – at least with respect to timing – over both? No, whatever price increase is going to be caused by the increase in the wages Walmart expects to pay is already in the price. Walmart is not surprised by their own move to raise wages. Nor is anyone surprised by the general increase in the minimum wage, which happened in 2009.
So, while I continue to believe that inflation is rising, and will continue to rise…I don’t believe that the increase in prices is going to be any faster due to these wage increases. It does, however, increase my confidence that inflation is rising, since obviously these retailers are confident enough in the pricing environment to be able to increase wages (which are sticky – it is harder to lower them than to raise them).
It is hard to be the top dog.
Today, despite another low-volume session (incredibly, NYSE Composite volume is already 1.5 billion shares behind 2012’s volume-to-date), investors were looking forward to a slew of earnings announcements. By and large, companies hit or exceeded the hurdles set for them, as they typically do.
Apple (AAPL), which released fiscal Q1 earnings after the close, was among those that exceeded expectations. Sales rose 18%, although falling marginally short of expectations, and the company posted a $13.81/share profit compared with expectations for $13.53/share. Apple guided Q2 revenue estimates downward, and the stock was pummeled more than 6% after the close.
What’s amazing to me is that investors were not satisfied. Bloomberg gaped that “Apple Inc. posted no profit growth and the slowest increase in sales in 14 quarters…” This is a very large company. How long did people think that the firm could grow at “only” 18%? The same story also suggested the reason for the disappointing reaction: “The results reinforce concern that Apple’s growth is being hurt by higher production costs…”
No, its growth is being hurt because it’s a very large company. (Review the beginning of my January 15th post, where I link the research on the performance of the stock market’s “top dog”.)
Now, Apple is a wonderful, wonderful company. I want to be like Apple. I want my daughter to marry someone like Apple. It only has an 11.7 trailing P/E, and a yield of 2.06%. There’s much to like. But it’s huge. Like Microsoft before it, it is going to transition to a period of large-industrial-concern growth (MSFT has a 10.7 multiple and a 3.33% yield). The difference between MSFT and AAPL is that the former has an almost unassailable position in some of its markets. The latter, while a very cool company, has unassailable positions in … perhaps the iPod, to the extent that market isn’t cannibalized by the smartphone market. On the other hand, MSFT is a ruthless, uncreative company that has historically put out buggy products (although version 275 of Excel seems to crash less). AAPL is an ultra-cool, creative company that is in ‘what have you done for me lately’ product markets. I am not saying that I would do a long-short on MSFT-AAPL, and I’m not even saying that AAPL needs to trade lower from these levels. I’m merely pointing out that the dividend growth model contemplates a transition to lower long-run growth, and AAPL is going to have lower long-term growth eventually. That shouldn’t be surprising. Its main problem as an investment was that it was far too expensive for a company in transition, and moreover that transition was almost assured once it became such a huge company. Gravity isn’t just a good idea, Icarus: it’s the law.
The good news is that if AAPL is on its way to becoming IBM (without the gray-costumed drones of the 1984 advertisements, of course), it may have fallen far enough. IBM trades at a 13.4 P/E and a 1.66% dividend yield. Even Icarus bounced once he’d fallen for a while.
Thursday’s main economic data will be Initial Claims (Consensus: 355k from 335k). It is getting late enough in January that it is starting to make sense to pay attention to Claims again; however, as always with a weekly figure it will take a few weeks to let the average settle out.
More important, to me, is the auction of the new 10-year TIPS. This is not a re-opening, but rather a January-2023 maturity. The Treasury will be auctioning $15bln of the security, and I believe the auction will go well. The WI is pricing at roughly a 10-11bp pick-up from the current 10-year. That looks like too much, and I would expect that investors who own the current 10-year TIPS would be eager to add 11bps for six months of maturity (and pick up a slightly closer-to-the-money deflation floor in the process). Add to this the fact that the 10-year sector is fairly cheap on the curve generally, and you have the ingredients for a pretty good auction even if the absolute levels of yield are heinous and the breakevens are relatively wide by recent standards.