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The Deal

One of the more newsworthy things about November was the surge in Wall Street transactions.  Approximately $70bn in deals were announced, including Charles Schwab & Co.’s purchase of TD Ameritrade, LVMH’s agreement to buy Tiffany & Co. and Novartis’ acquisition of The Medicines Company.  In the spirit of the moment, Xerox made an attempt to buy the much larger HP Inc. (the old Hewlett-Packard), but was swatted away by the board.   

This flurry of deals came on the heels of what had already been a busy year, particularly among some of Wall Street’s financial titans.  For example, JP Morgan Chase bought InstaMed Inc., BB&T purchased SunTrust Banks and both Morgan Stanley and Goldman Sachs got in on a wave of corporate deal making.  It’s not perfectly clear what is driving the move toward more deals.  We can speculate it represents the last gasps of the bull-run in stocks, or possibly more worrisome, the current administration’s lax oversight and dismissive view toward financial regulation. 

You may remember that some misaligned interests, both in Congress and in the savings and loan sector, led to aggressive deregulation of the S&Ls in 1982.  Within a few years, this led to a collapse of over 1000 banks, and a tax payer bailout in excess of $130bn.  It was a disaster second only to the thousands of banks that closed in the Great Depression.  While a lot of people bristle at the Dodd-Frank Act implemented in the shadow of the 2008 housing crisis and the Great Recession, we may be entering the next chapter of low/no regulation.

The surge in deals may also be a product of the low interest rate backdrop.  It’s inexpensive to borrow money today.  The Federal Reserve’s decision to lower the Fed Funds rate three times (for a total of 0.75%) this year, after it raised rates four times in 2018, may have sparked a borrowing spree.  After rate cuts in July, September and October, animal spirits are running high.

Also key to the current merger boom are the record high stock prices.  Companies often use their stock as currency when they look to make acquisitions.  Companies with high P/E ratios seek out companies with lower P/E ratios, as this can be accretive to earnings, an instant way for management to shine.

Amidst the flurry of corporate activity on Wall Street this November, stock prices, as measured by the S&P 500, rose a smart 3.6%, and are now up 27.6% for the year.  The last year with returns this big was 2013.  The last three years have produced 14.8% annualized returns, and during that span, stock prices fell in only 6 of 36 months.  That’s an extremely high batting average (percentage of positive months).  One of my concerns is that the down months have been dramatic, dropping by an average of 5%.  That is a jarring number.  Sharp drops in stock prices tend to freeze investors – as they hope for prices to rebound or struggle to recalibrate their expectations.  There is a touch of complacency with the market’s recent strength, and I don’t want our accumulated gains to be snatched away due to the deer in the headlights effect.

Sensational headlines day after day desensitize us to the nuance of the information being reported.  In my opinion, a trade war with China cannot be won; the global market place is interdependent and isolationism does not work.  Though fear of recession has receded, forward earnings forecasts are only modest.  The view from the c-suite is cautious as measured by recent capital spending surveys.  Fundamentals are stagnant and the change in stock prices this year has been driven by higher valuations (P/E’s).  The deal is, we are on thin ice; the economy is not nearly as robust as stock prices would like us to believe. I expect we will see consistently higher volatility (making stocks more challenging to hold) which means next year may require more effort, for less return. 

Investors have banked some nice returns this year, and in my opinion it is a good time to take some profits. We find it’s always more attractive paying capital gains taxes with realized investment gains.  In relation to historical levels, current capital gains tax rates are a gift we want to take full advantage of.  Stocks remain the best game in town, but we have to anticipate lower expected rates of return going forward.  Please don’t hesitate to call if we have not spoken recently.

 

Bruce Hotaling, CFA

Managing Partner

Disclaimer:
The views and opinions stated herein are those of Bruce Hotaling, are of this date, and are subject to change without notice.   Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed.  Investments are subject to market risk, including the possibility of loss of principal.  Past performance does not guarantee future results.  The S & P500 is an unmanaged index of 500 widely held stocks.    Investors cannot invest directly in an index.   The PE ratio (price/earnings) is a common measure of relative stock valuation.

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