The Sentiment Cycle of Equity Investors

Posted by David Hunkar on 22 December 2015, 9:42 am

One of the important factors that investors should have for success in stock investing is keeping control of one’s emotions. Though things like fundamental data, macro economic indicators, charts, etc. are also important to review and analyze before making an investment decision, not falling for emotional volatility is also important. This means having a strong stomach when markets experience extreme volatility.

I came across the following The Sentiment Cycle chart published by Schroders Investment Management of UK:

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Source: Schroders

This cool chart is self-explanatory. In the New paradigm phase, investors pile on an asset and prices continue to accelerate. The asset becomes THE asset town. In the current environment FANG stocks come to mind. Facebook(FB), Amazon(AMZN), Neflix(NFLX) and Google(GOOG) have become the darlings of investors this year due to substantial gains and the belief that the future belongs to these firms. However all these companies are in the tech field and it is not impossible for some company to dislodge their leadership positions. During the dot con boom, Yahoo(YHOO) seemed to be the must-hold stock due to its strong position in the search/directory field. Then venture capitalists started favoring Google over Yahoo because Google was better and ever since Yahoo has become useless for most internet users.

Apple(AAPL) is one stock that is in the Blind Faith and Acknowledgement Phase. A few years ago Apple become the must own stock and is now a core holding of many funds and individual investors alike. However nobody knows for sure if the company can continue to bring interesting products to the market and more importantly will consumers will be willing to pay their over-priced products. The failure of Apple watch is one example where consumers did not want pay a few hundred dollars for a glorified digital watch despite all the media hype. So 10 year or even 25 years from now what will happen to Apple the company and Apple stock is anybody’s guess. However the current assumption of investors is that the fundamentals of the company has not changed and it is better to keep holding the stock despite slight declines this year.

Disclosure: No Positions

Rolls Royce: A Poor Performer in the Aerospace and Defense Industry

Posted by David Hunkar on 22 December 2015, 2:21 am

UK-based Aerospace & Defense giant Rolls Royce Holdings plc (RYCEY) has been a poor performer in terms of share price returns. In the past 2 years, the total return (TR) which includes dividends was a loss 50%. relative to the FTSE 100’s flat TR (based on the London-listed domestic stock in British Pounds). But Paul Mumford, manager of Cavendish Opportunities fund thinks the stock is a value play now for investors with a five-year view.

The company has announced five profit warnings in less than two years and the new management structure may help turn around the firm.

The following chart shows the 5-year price return of the OTC traded ADR :

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RYCEY – Ten year returns:

In 5 years the stock is down 12%. In 10 years the stock is up by just over 8% in terms of price appreciation alone.

The 5-year and 10-year return may seem average but actually they are worse because other defense stocks have been great performers in the past decade due to higher defense spending especially after 9/11.

The following chart shows the 5-year return of Boeing(BA) and Rolls Royce:

While Boeing share price has more than doubled Rolls is down by over 12%.

After a 5:1 split in August, RYCEY currently trades at around $8.50 a share. Currently the dividend yield is 4.19% and the company has a market cap of over $15 billion.

One of the takeaways to remember is that not all defense & aerospace stocks are bullet-proof. Or to put it another way – a rising tide will not lift all the boats. Poor management and other issues will adversely impact the stock returns.

Competitors of Rolls include: BAE Systems(BAESY), EADS (EADSY), Cobham plc(CBHMY), Meggitt plc(MEGGY), QinetiQ(QNTQY), United Technologies Corp(UTX)

Disclosure; No Positions

Petrobras and Ecopetrol: Latin America’s Fallen Oil Giants

Posted by David Hunkar on 21 December 2015, 3:11 am

Brazilian oil giant Petrobas(PBR) and Ecopetrol (EC) of Colombia were some of the largest oil companies in the world based on market capitalization until a few years ago. However both have declined dramatically in recent years with billions in market value wiped out.

The following chart shows the 5-year price returns of Petrobras and Ecopetrol:

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Source: Yahoo Finance

In 5 years, PBR has plunged by over 87% while Ecopetrol has declined by about 84%. Unlike PBR, Ecopetrol’s fall is due to company specific issues and declining oil prices. Petrobras was the crown jewel of the Brazilian growth story. Its disastrous collapse was triggered by a variety of factors in recent years including corruption in the management of the firm. The fall in crude oil prices simply added more misery to the company.

In 10 years, PBR declined by over 81%.

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Source: Yahoo Finance

In late May of 2008, PBR traded at over $72 after a 2:1 split earlier that month. Since then it has been mostly a downward slope down year after year. PBR’s $28 .0 billion market cap today is a fraction of what it was once at the peak of the stock price.

Similarly Ecopetrol’s market cap also was cut over $100 billion from the peak. In 2012, it was the fifth most valuable with a market cap over $136.0 billion. At that it was more valuable than BP plc(BP) according to a recent Bloomberg article. Now the market cap is about $14,0 billion.Recently Ecopetrol announced lower production volume for 2016.

Petrobras is mired in corruption probes and it may take a few years before the oil major gains its mojo back.

From an investment perspective, both these Latin American firms can be avoided at this time. For those wiling to make a bet, Ecopetrol has brighter prospects than PBR. Ecopetrol also has a higher dividend yield.

Disclosure: Long PBR and EC

Why USA Stands For Unequal States of America

Posted by David Hunkar on 20 December 2015, 10:26 am

Inequality in the United States of America(USA), as measured by the Gini Coefficient, is the highest among developed countries. Inequality has always been high in the US. However in the years since 2000, it has increased sharply to much higher levels. Since the US follows the capitalist system of government, inequality will always be high when compared to other developed countries which follow socialism. However what is concerning is that the sharp increase in the rate of inequality in recent years.

The Gini Coefficient is measure of inequality of income or wealth of a country’s residents. In simple terms, the higher the measure the worse the inequality is. From Wikipedia:

The Gini coefficient (also known as the Gini index or Gini ratio) (/dʒini/ jee-nee) is a measure of statistical dispersion intended to represent the income distribution of a nation’s residents, and is the most commonly used measure of inequality. It was developed by the Italian statistician and sociologist Corrado Gini and published in his 1912 paper “Variability and Mutability” (Italian: Variabilità e mutabilità).^[1]^[2]

The Gini coefficient measures the inequality among values of a frequency distribution (for example, levels of income). A Gini coefficient of zero expresses perfect equality, where all values are the same (for example, where everyone has the same income). A Gini coefficient of one (or 100%) expresses maximal inequality among values (for example, where only one person has all the income or consumption, and all others have none).^[3]^[4] However, a value greater than one may occur if some persons represent negative contribution to the total (for example, having negative income or wealth). For larger groups, values close to or above 1 are very unlikely in practice.

Source: Gini coefficient, Wikipedia

The following chart shows the Gini coefficient of wealth distribution (in %), 2014 and change since 2000 (in percentage points) among select developed countries:

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Only Sweden, Belgium and Norway do not fit the pattern in the above chart. In all the other countries, the Gini remains high and the change since 200 also increased. Inequality in Sweden is the highest among rich countries next only to the US. However since 2000, the rate has not increased greatly. Comparing the US to other developed countries, the authors of the report note the following:

Unequal States of America

The same cannot be said for the US, where the crisis and the sluggish economic recovery that followed have caused a dramatic deterioration in wealth distribution. The increase in inequality, i.e. the rise in the Gini coefficient, is more pronounced here than in any other country during the period analyzed. The result: the USA (which, the way things are going, could well be taken to stand for the ”Unequal States of America”) has the highest Gini coefficient in our analysis. It is, unfortunately, impossible to tell at this stage whether this is largely the result of asset accumulation setbacks brought on by the crisis, which hit smaller and medium-sized assets particularly hard, or whether the developments are already the result of the digital revolution which, at least for the main protagonists, is increasingly turning out to be a ”wealth catalyst”.

Source: Allianz Global Wealth Report 2015, Allianz