Markets, Trade Bickering, and Corporate Governance

Of Equities, Oil, and Politics

Where do we go from here?

Up, up, and away! Just yesterday, the S&P 500 broke its previous record to become the longest bull market in history by most accepted standards (read this article, in more layman’s terms, at PBS). “$1 TRILLION dollar valuation for Apple? This is 1999 all over again!” critics were shouting just several weeks ago. Yet, again, markets are defying gravity even more than Elphaba in the final act of the hit play Wicked (great song!) Or… are they?

Valuations are the name of the game in determining if something is overvalued. What industry does the company belong to (eg, does Facebook in Tech or the Telcom sector? GICS says it soon will be Telecom!)? What is the market cap and how much money does it make? Is it growing and by how much? Once we have answers to these questions we can slap a forward - or backward - P/E ratio onto it and compare it to its peers and its historical average. Of course, if we throw in more variables (dividend yield, etc), then we get other metrics with which to compare our current market conditions.

Are we overvalued? Current metrics seem to indicate this is a yes (besides the P/E ratio, this Forbes article does a great job describing several methods for evaluating the market!). But this doesn’t necessary mean we go lower anytime soon since fundamentals appear to remain strong, ceteris paribus.

The Muddied Waters of Oil Markets

Oil prices have had a remarkable run over the last year. It seems like just yesterday that most everyone, even the esteemed commodity traders at Goldman Sachs, were predicting $50-$55 oil through the early 2020s (see some analyst projections from May 2017 at Marketwatch). WTI prices (The Ignorant Investor is partially focused on US oil markets, after all!) have since risen quite remarkably- up about 40% from a year ago.

Fundamentals have largely driven the bullish sentiment, with US crude oil inventories falling almost 12% from 463.2M barrels at this time last year to 408.2M barrels today (EIA data; follow them on Twitter!). On the supply side, commodity traders have looked to production output weakness in various OPEC nations (Venezuela, Libya), relatively low discoveries of new oil reserves, and – more recently – sanctions being reintroduced on another OPEC producer, Iran. The USA has played around with the idea of a hard deadline to reintroduce sanctions in November while also working on methods for minimizing the impact on oil prices (lobbying Saudi, the de-facto leader OPEC; releasing some supplies of sour crude from the Strategic Petroleum Reserve; among other plans).

The world of commodities is always a tricky place- one month everyone will focus on the supply side of the equation, the next month everyone shifts their attention to the demand side as world economies bicker on trade. And then of course there is the on-again, off again tweets by the leader of the free world about oil prices going too high. Yes indeed, folks, energy markets now more than ever are affected by the whims and posturing of political and trade commentary!

US-China Trade Negotiations live!

Since the last time The Ignorant Investor posted, equities have responded positively to the resumption of trade talks between the US and China with the S&P 500 consistently hitting fresh highs in recent days. Of course, this comes on the back of both countries levying new tariffs on each other (Bloomberg discusses skepticism around the talks in this article). Remain cautious! Soundbites that make their way into the news will continue to move portions of the broader market.

Corporate Governance is important

From a young age, children are often trained to think of the day they’ll sit in that corner office with a great view of the city, down a glass of whiskey, and then make the important decisions that all Chief Executives must make. When we grow older, depending on our career path, this dream may not change all that much- attaining that coveted CEO title is still considered the pinnacle of success. But is the CEO truly at the top of the food chain? Think again! They answer to the board of directors. In a public company, hopefully this board is strong and independent. Then, the board has the freedom, capability and, again hopefully, the desire to ensure everything is operating in the best interest of the company’s real owners: the shareholders.

Corporate governance in various forms has been all over the news these last several weeks. Firstly, in an unprecedented move, US President Trump barged into the SEC’s territory by suggesting it was time to do away with quarterly earnings reporting requirements for public companies (fine, in reality he asked the SEC to review the proposal). Secondly, Elon Musk and Tesla have been repeatedly dragged through the news cycles after Mr Musk announced on Twitter that he planned to take the company private – even going so far as to name a value for the deal (triggering a remarkably fast-moving SEC investigation in the process; the NY Times has a solid in-depth article on what SEC guidelines Elon Musk may have violated here). Investors partially responded with enthusiasm before later selling the company off as skepticism rose (Tweeting can get you in real trouble, people!). Now, as one major bank after another drops coverage of Tesla, optimism has built up again. Quite the roller coaster ride!

What about Complex Capital Structures?

A topic for another day! For now, we won’t even begin to delve into criticism of public companies adopting multiple share classes. One prominent target for criticism here has been Facebook. Why? Well, Mark Zuckerberg owns less than 15% of outstanding Facebook shares, according to filings, but controls about 60% of voting power, effectively giving him (by himself, let alone with other insiders) an iron grip over the company (some shareholders are complaining and want more oversight; read this article by Barrons)

For now, let’s focus in on Trump’s idea- it’s far-reaching topic and surely deserves more attention (read this in-depth article by the NY Times). One theory posited over the last several years is that the quarterly earnings reports have forced CEOs to guide their companies with the object of meeting very short-term goals, sometimes to the detriment of that same company’s long-term future (General Electric may be one victim of both this and other issues). Warren Buffet and Jamie Dimon more or less emphasized this in a statement back in June (read more at Fortune). To avoid the scrutiny of critics (e.g. analysts, activist investors) and SEC filing requirements in their entirety, a growing trend has emerged of taking somewhat-troubled-but-high-potential public companies private before working on years-long turnaround plans (Michael Dell and his eponymous company immediately comes to mind - hey, the guy was still praising the idea a year after taking the company private, quick summary at Business Insider - and, more recently, Elon Musk’s public musings on taking Tesla private). However, is eliminating quarterly reports the best solution for bringing about better corporate planning and governance for shareholders?

For retail investors, without other additional stipulations, the answer is a resounding no. Moving away from quarterly reports may be part of the solution, but to do so unilaterally hurts the retail investor (in fact, this article by the Wall Street Journal includes some contributors who think corporations should report information even more frequently). For this group, times have never been better. Equity trading fees – indeed, trading fees across all markets – have been falling (even hitting the level of “free” with the launch of Robinhood in 2013). Timely company information and solid analyst reports (although these generally tend to be more technical than fundamental in nature) are now available for free through most brokerages. And very powerful analytical tools are now available, as of about 2015, for relatively small fees (as low as $500/month. Still a nice bit of change, but less than it would have been even ten years ago). Eliminating quarterly reports moves against these recent trends by causing a rise in information asymmetry, to the detriment of the retail investor.

How does information asymmetry work in the investment world?

Hedge funds have a decent idea of how companies are performing throughout the year by connecting the dots from outside information that isn’t readily available to the public. Let’s look at the car industry. An analyst will have access to car insurance information from big data providers, allowing him or her to interpolate and approximately project what kind of a year General Motors is having (hey, the analyst can even estimate profit margins based on which vehicles are proving to be the most popular. Volume of sales? That too!). The retail investor will never gain access to this information – it’s just too expensive! Even now, with quarterly reports, the retail investor is at a disadvantage. This disadvantage is only magnified as information asymmetry increases.

Other Highlights

The Amazon Prime Effect on Equity Trading

More good news for the retail investor. Robinhood will soon have a new competitor in the game of free equity trades! And this one is a 1,000-pound gorilla. JP Morgan’s CEO Jamie Dimon has hinted for years that he plans to shake up the retail investing industry- and soon, that plan will come to fruition. Next week, the bank will unveil a new trading service that allows for up to 100 free stock and ETF trades per year. Read this article by USA Today for more information on this new service.