The Disappearing Middle Class

Check out the numbers in this article by Robert Reich. They show the middle class' erosion of purchasing power over the years.

"In the late 1970s, the richest 1 percent of American families took in about 9 percent of the nation’s total income; by 2007, the top 1 percent took in 23.5 percent of total income. " OUCH!

The article also discusses how the middle class has dealt with this over the years. It's hard to see what the disappearing middle class can do next to boost family income. The implication is a long term drop in consumer buying. Very consistent with PIMCO's new normal.

bought AKO.A

Sorry, I'm a bit late on this one. I bought AKO.A on June 23 at $19.88 CDN. This includes $20 in commissions, which should have been 10$ but I did not specify all or none, so they split my order in two and charged me twice. Thanks a lot. Lesson learned.

Embotelladora Andina S.A. is a Latin America Coke bottler based in Chile, but with sales in Argentina and Brazil as well as Chile. It bottles other stuff besides Coke, and gets about half its revenue from Brazil.
There are two share classes: AKO.A and AKO.B. The B shares get a 10% higher dividend than the A shares, but have no voting rights. Also, the B shares are a lot more liquid. However, at the time I bought these, the A shares had a higher yield. Of course, there are also corresponding ADS issues which trade in new york in USD.

I'm not sure why but the shares have just shot up to $23 USD. AKO.B is up too, and on slightly higher volume at that.
So why buy this company? I think it's a good consumer staples stock for Latin America. It's a good brand (Coke) and what it sells is cheap enough that a lot of people can afford it. For those with less money, it makes a nice treat. For those with more, they can get addicted to the caffeine and drink lots.

Here is what I like about this company:

• inexpensive consumer staples
• great brand (Coke)
• Good market (Brazil)
• Compared to similar companies (Diageo, PMI, Yum), AKO has very low debt.
• I started out looking at the Greek Coke bottler, but found AKO more compelling.
  

Here is what I don't like about this company::

• EPS growth has been lacking the last few years. I think this is what has been holding back the share price.
• You can see it graphically at morningstar by mousing over the little bar chart icons on the left & seethe graph below for a longer time frame.
  
• You can see revenues are down, but taxes are up, leading to a drop in EPS.
  
• Overall, it's a good company. The decision to buy comes down to your growth estimate.
  

That's the story. Here are the numbers.

growth and efficiency:

• net margin > 7%*, last 5 years (actually >10 for each year) good trend. small drop in last few years.
• roe > 15%, last 5 years (actually >20 for each year)
• eps growth over 3 years, average for the last 5 years = 27.9%
• increase/decrease in outstanding shares last 5 years -> none
• improvement in efficiency ratios over 10 years, but stable for last few years.
• free cash flow> 0 last 5 years: all 5 years. a bit choppy but growing trend.
• avg eps growth (in chilean currency) since 2001 = 20%
• expected growth rate: 10% (analyst estimate)**

* I read somewhere that the long-term S&P500 average net margin was 7%.
** From reading a lot of expected growth ratings, it seems to me that when analyst don't know what to guess, they often guess 10%.

Valuation:

• p/e ratio vs historical is v low, but not vs the S&P. (I.e. (S&P P/E)/(AKO P/E ) is a bit lower than in the last 5 years.
  
• yield is hard to figure because AKO gives out a big dividend at end of fiscal (May) and the dividend amount really bounced around, like many companies outside North America. The dividend was lower in 2009.
• fwd p/e (morn.) 13.3
• peg :1.3
  
• fwd yld (morn) 1.68%
• morningstar:
• p/e, p/s, p/b all slightly lower than industry.
• rev growth 3yr avg higher than industry
• eps growth 3 yr avg much less than industry
  
• net margin much much higher than industry
• roe much much higher than industry.
• debt/eq much much less than industry
  

Financial health

• payout ratio TTM is 48%.
  
• leverage: 1.74 (always less than 2)
• current ratio: 2.13

DCF valuation

• Had a lot of trouble figuring cash flow TTM due to the currency difference and the multiple originals per ADR. SO I used TTM eps instead, including the eps from the quarter ending in june 2010.
• avg YoY eps growth (in Chilean currency) since 2001 = 20%
• discount rate: 2.83% (ten year tsy yield)
  
• eps ttm (Q2 report + s&p) = 0.85 USD, per ADS.
  
• for a deps valuation of $21.87 USD per ADS.

A couple of notes about this. First I calculate the value of the earnings that will accumulate over the next ten year; not over an infinite period. This is to make it more comparable to the 10 year bond, whose yield I use as the discount rate.

Second, I think its silly to expect a growth of only 10%. First, the historical growth rate is much higher. Second, Brazil has great demographics, with more young people than old people, low debt and the poor are becoming less so. (There is an article on this in the current issue of the economist. It shows the payoff from what many people derisively refer to as "social engineering"). Anyway, with 10% growth, you get deps valuation of $12.54.

The recent news is that EPS have dropped. That's because of higher Brazilian taxes due to a loss of tax credits and a higher rate of taxation resulting from the increased revenues from Brazil. While EBITDA was up 9% yoy, net earnings were down 14%. It looks like these taxes are not a one-time expense; they should continue to be this high in the future. If the shares drop, they could get close to fair price.

Another Gem from Bill Gross

Gotta read this one.

Preferred Shares - Update

Since I sold out my preferred share positions, the Euro blew up and people are fearing a double dip recession. Consequently, fears of inflation abated and 3 of the preferred share issues are up between 2% (cl.pr.b) and 6% (bns.pr.m, pow.pr.b). BCE.PR.A is down 4%.

Preferred Shares - Performance

As I explained in earlier posts, I had bought some preferred shares because they had gone down in price and was hoping to see a normalization of share prices before fear of inflation kicked in. It didn't really happen. Here's my investment performance on those preferred shares:

	bns	bce	cl	pow
buy price	20.25	22.00	23.39	21.70
sell price	18.71	21.67	24.85	21.00
buy date	11-Aug-09	4-Nov-08	11-May-09	10-Aug-09
sell date	8-Apr-10	23-Apr-10	8-Apr-10	8-Apr-10
net gain/loss	-54.81	155.50	131.13	-4.84
return	-5.41	4.71	11.21	-0.45
annualized	-8.23	3.21	12.33	-0.68

net gain/loss includes dividends and 20$ in trading fees for each security.

The total return weighted by shares per security was 3.46%. Annualized that comes out to 2.36%. Over that period, XBB, a Canadian bond ETF gained about 4% and the TSE gained about 16% without counting dividends or interest, compared to my 3.46% including dividends. So, all in all, not very good for me.

Forget NBG

Forget NBG. The spread of the downturn has created bargains elsewhere, such as Google. NBG's a good bank, but at the end of 2009, it had about 20% of assets exposed to greek gvt debt. That's over 20B euros, about 20x 2009 earnings before taxes. That's a looooong time for write downs.

National Bank of Greece

I took a look at NBG's Dec 2009 annual report to try to determine its exposure to Greek gvt. debt. Including loans to government and agencies, it appears to have 18% of assets in the Greek government. It is also apparently hedging its exposure to Greek government fixed rate bonds by buying German bond futures. Couldn't find any specifics. I hope it was hedging for rising interest rates!

If Greece defaults, then a fair-ish book value for NBG would be 2.89 USD/ADS share (based on a little algebra from the data at reuters.com). According to Reuters, NBG is trading at 2.71, for a P/B of 0.75. I would buy at 2.50, or a P/B of 0.7, and sell at a P/B of 0.8 (2.89 USD). Keep in mind that as the Euro falls, so does the book value. A P/B of 0.7 at today's exchange rate is not necessarily the same share price as a 0.7 P/B at next week's exchange rates.

US Bond Outlook - Update: Stay Away from Junk

In a recent post, I recommended investing in high-yield bonds since they still seemed to have some capital appreciation left. The performance of high-yield bonds is similar to the performance of the stock market as a whole. You can see below that in the last few days, the S&P500 is tanking, and along with it, a high-yield ETF.

So, I changed my mind. Stay out of the high-yield stuff until Mr. Market has calmed down. You might miss a bit of the run-up, but you'll still get a nice yield.

Preferred Shares - Sold

Several days ago (sorry for the late post, as if anyone actually reads this thing!) I sold my preferred share positions (BCE.PR.A, BNS.PR.M, CL.PR.B, POW.PR.B). The reason is pretty simple: Mr. Market is anticipating more interest rates increases. Since these preferred shares pay a fixed rate of interest, when interest rates go up, the shares prices of fixed-rate preferreds go down.

My idea was that the share prices would recover to historically more normal levels as the economy improved. In the meantime, I would be getting a 5 to 6% yield. That happened for (see figure below) CL.PR.B and for BCE.PR.A, but not for the others. But even CL.PR.B and BCE.PR.A eventually succumbed to the effects of the expectation of increased interest rates.

from bigcharts

In a future post, I'll show my returns on each preferred.

US Bond Outlook

Is the corporate bond runup over?

LQD is a corporate bond index ETF. IEF is a treasury bond index ETF. I'm using these as a proxy for corporate bond and Treasury bond prices.

At the beginning of the market meltdown, there was a divergence of corporate bond prices and Treasuries, then in March 2009, prices began to converge, with Treasuries dropping and corporates rising. (Figure 1). On March 31, 2010, the 1 year return for Vanguard's intermediate-term Treasury fund (VFITX) was -0.41%, and for its intermediate term investment grade corporate bond fund (VFICX) was 21.96%.

Figure 1

from bigcharts

Historical prices suggest the runup in corporate bond prices is just about over (Figure 2). Yields would serve as a better measure, but the prices are good enough stand-ins for my purposes.

Figure 2

from bigcharts

The rise in interests rates should also adversely affect both Treasuries and corporate bonds, but an article by Vanguard argues that this would probably occur mainly with shorter-term maturities because any action by the Fed will calm fears of long-term inflation. Ok. So I'll stay out of short-term bonds.

TIPS (aka TIIS)

Vanguard also argues that TIPS might be vulnerable. One can assess the relative pricing of TIPS and Treasuries by comparing their yield spreads to the anticipated rate of inflation because the Treasuries carry inflation risk, and the TIPS do not. An expectation of high inflation should show up as a high spread, and vice versa. The current (April 22, 2010) TIPS/Treasury spread seems to be reasonable right now (2.13 for 5 years, and 2.33 for 10 years). It's true there has been a run up in TIPS, similar to the runup in corporate bonds (see Figure 3), so the TIPS party might be over, but it doesn't seem to me that they are overpriced. Moreover, since they offer inflation protection, I think they're a safer refuge in the current environment than Treasuries or corporates (but keep in mind that Vanguard disagrees).

Figure 3
(Note: TIP is a TIPS ETF)

from bigcharts

High-Yield (Junk) Bonds

Junk bonds are another, interesting, option. An asset rotation study performed by PIMCO shows historical returns of different asset classes across the business cycle. Early in the expansion cycle and in mid expansion, high-yield bonds, convertible bonds, and especially emerging market debt have done well, even beating equities! However, figure 4 below suggests the party's almost over for both convertible bonds (Vanguard's VCVSX) and high yield bonds (Vanguard's VWEHX) (Recall that IEF is an intermediate term Treasury ETF, and that LQD is an intermediate term corporate ETF).

Figure 4

from bigcharts

Another way to value high-yield bonds is through the yield spread. The typical spread has been about 300 to 400 bps over comparable maturity Treasuries (pimco). Right now, the spread is about 500 bps (see bloomberg). So it seems there's still a bit of price appreciation (about 13%) left in high yields (or price depreciation left in Treasuries!) Note how the estimate computed from yield differentials is close to the difference between the return in Treasury prices and the return in high-yield bond prices from Figure 4. The yield on Vanguard's convertible bond fund in contrast is only 3.69%, about the same as a 10-year Treasury. It's not clear, but there may not be any price appreciation left in convertibles.

High-yield default rates have also been falling, and Moody's predicts that trend will continue into 2010. Hey, it's Moody's, gotta trust Moody's, right? Of course, default rates will only continue to drop if the recovery continues.

Interest Rates

Any action by the Fed could through a wrench into all of this, causing bonds prices across the board to drop. It's worthwhile noting though that high-yield bonds act a bit more like equities having less sensitivity to rising interest rates than other bonds, because interest rates increases co-occur with falling credit risk at the beggining of a recovery. Maybe this explains PIMCO's asset rotation findings discussed earlier.

What makes me uncomfortable about this recovery is that it was fueled by government spending. It's not clear to me (and to many others) that this government spending was able to sufficiently prime the pump for the private sector to sustain the recovery going forward.

Bond Allocation

As always, in my opinion it's better to directly hold the actual bonds so that you can hold them to maturity, thus avoiding a loss on your capital. Inflation eats away at your returns a bit more, but it makes for less of a roller coaster ride. I can't do this in my Vanguard account so I'm going to modify my bond fund allocation instead.

Given, the above discussion, here's how I'm going to allocate my funds across the bond asset class. Bottom line: beware rising interest rates!

Vanguard Inflation-Protected Securities Fund (VIPSX): 30%
Vanguard Total Bond Market Index Fund (VBMFX) (holds gvt and corporate investment grade bonds): 20% *
Vanguard High-Yield Corporate (VWEHX): 20%
Vanguard Intermediate-Term Investment-Grade (corporate) (VFICX): 10% *
Vanguard Money Market (really really short term bonds): 20%

* more sensitive to interest rates.

My Vanguard Performance - The Lost Decade

You might have heard of the lost decade. The cumulative total return for Vanguard's s&p 500 index fund for the last ten years (ending jan 31, 2010) is -8.48%, according to vanguard. (Appears to include reinvested dividends and management fees, see here). Hence the phrase the lost decade. My vanguard portfolio cumulative total return from Jan 1, 2000 to Jan 1, 2010 was 67%.

Fight the Power

Nothing to do with investing, but I hate it when those in power are incompetent. The truth needs out! And here's a way to do it:

http://www.cbc.ca/bc/features/gopublic/

Got inside information that should be exposed? Bogged down by bureaucracy? Been wronged and no ones taking responsibility?

We want to hear from you.

Go Public is an investigative news segment on CBC TV, radio and the web. We expose waste, incompetence and wrongdoing and hold the powers that be accountable.

Building on the success of Kathy Tomlinson's segments in B.C., Go Public is now a feature on The National. That means we want to hear from people across the country - with stories they want to make public.

My performance - securities

Here's my stock picking performance from march 2008 to Feb 19, 2010. I had some difficulty finding a tracking tool that takes dividends in to account. Apparently Google added dividend tracking to its portfolio tool, but, also apparently, it's pretty buggy.

These analyses are from my brokerage account tool. It takes dividends into account. I compare my performance to a global balanced benchmark. I erased the amounts of my investments, but the percentage change is there.



I beat the global balanced benchmark for all periods but 1 year. Since march 28, 2008, my performance is 8%, while the benchmark is -2.6%.

My benchmark is composed of a bunch of ETFs with dividends re-invested. Half of my initial benchmark investment was in a Canadian bond ETF (XBB), and the other half replicated the MSCI world index. These days you can invest in an MSCI world ETF, but not back in the old days of March 2008. So I looked at the composition of MSCI world, and replicated it with a Canadian ETF, a US ETF, and an EAFE ETF. (No emerging markets.)



You can see that the Canadian portion did really well. That's partly because the benchmark portfolio, as well as my portfolio, is in Canadian dollars. The Canadian dollar has appreciated against the US dollar and the Euro, so that's why Canada did well compared to the other regions. If you had a portfolio denominated in another currency, Canada would still have outperformed, but the other regions would have shown a better return than in a CDN$ portfolio.

My portfolio has 3 preferred shares (they have "PR" in the symbol). I haven't held them very long, but they are doing ok. They all trade below redemption value, so I think one could buy more. However, with interest rates going up the preferred shares might drop some more. Or, if people take higher interest rates as a sign of a recovery, the preferred share prices might go up instead. My three stock picks have done very well since I bought them. You can see my previous posts for discussions about these shares.



I also bought government real return bonds. These provide me with a global real return bond exposure. Some of these bonds were bought in mutual funds so I use equivalent ETFs in the portfolio to automate tracking. The Canadian real return ETF has done well, but the others have not, mainly because, as I mentioned above, the Canadian dollar appreciated against other currencies, reducing my returns from foreign bonds.



My three stock picks are hedged through a double inverse Canadian ETF (HXD). That's the big stinker in the portfolio. As an alternative to this ETF, I could have hedged with long-term index puts, or I could have used stop loss orders. The problem with stop loss orders though is that you can get whipsawed. You sell when the stock drops and lock in your loss, but you don't buy back until the stock goes back up. Classic opportunity loss. I still think that this is a cyclical bull in a secular bear market. Consequently, I'm going to hold on to my hedge at least until next January, or next market drop bigger than 10%.

I also bought a put on the SPDR KBW regional banking ETF (KRE) right before it shot up 20%. Ouch! Good thing I only bought a tiny amount.

Finally, I also bought two Australian bonds. One is a real return, with a real yield of 2.83%, maturing in 2015, and the other, also maturing in 2015, is a conventional bond yielding 5.35%. These will be hard to track because their market value is not automatically updated in the tracker. I'll also have to add interest payments by hand.

My Vanguard performance

I have a 401K at Vanguard that I don't contribute to anymore. Consequently, any changes in account value result from investment performance. Here's my performance (for periods ending Dec 31st.).


these are the averages for world allocation funds for ytd, 1 yr, 3yr, 5yr, and 10 yr:



My performance turns out to be pretty good. I used morningstar to find world allocation funds with similar performance to mine. This provides an estimate of my rank among world allocation funds:

5 yr rank: top 31%.
3 yr rank: top 13%.
1 yr rank worse than 86%.

Now, if you understand the math behind these things, you'll realize that while I outperformed the average, I also did it with less risk.

Below you see the performance of the best world allocation fund that beat my performance over 5, 3, and, 1 years. You also see the average performance for the world allocation category.



Looking at the big dip, the Waddell & Reed fund went from 40K to 22K. A drop of 20%. It still hasn't fully recovered. The average performance for the category went from 17K to 11,272; a drop of 33.7%.

In contrast , my portfolio dropped from 30,250 to 25,212; that's only 17% (see below). At the end of 2009 my portfolio had fully recovered and stood at 33K. (On the whole, not as good as Waddell and Reed, though).


Much better performance than average, with a lot less risk. Pretty good, pretty good. I certainly earned my investment management fees.

more words of wisdom from bill gross

In a morningstar video, bill gross says he estimates that the Fed buying has lowered the 10 year treasury yield by 50 basis points (1/2 a percentage point). A 50 basis point increase means about a 14% price drop. He also says he prefers German bonds because the German budget policy is less inflationary.

time to get out of treasuries ?

Bond genius bill gross is reducing his exposure to treasuries. In his post (Jan 2010), he explains that Treasury yields are too low, and that the Fed has been buying up too much of them. (Same deal for the Bank of England buying gilts). Gross is expecting a drop in treasury prices soon, especially since the Fed is plotting its exit strategy (i.e. selling its Treasury holdings). (See also Jubak's post on Gross' moves and comments)

More generally, there appears to have developed a supply and demand imbalance for government bonds. The supply has gone up due to various bailouts, but empty pockets are lowering demand. This should mean that gvt bond auctions won't attract that many buyers, meaning low prices and higher yields. To prevent that, central banks, like the Fed, have been buying up their own national bonds. It can't go on forever. When it stops gvt bonds prices will drop.

Gross suggests TIPS (real return bonds) might be an option because these mega deficits will result in inflation, but TIPS yields are really low too. According to bloomberg, the yield on a 5 year TIPS is 0.17%. Yuk.

Baby Boomer Retirement & Corp Profits

A couple of interesting stats from a survey of Canadian baby boomers. First, of those who kept track, they decreased their spending by 30% the first year of their retirement. Of course, that's the ones who kept track of their spending. They'll tend to be the more fiscally responsible ones. The others are probably out buying miatas, gold-plated golf clubs and world cruises. The other stat is just as concerning: 75% of yet to retire respondents project that will just just get by when retired.

When baby boomers retire (starting now) you can expect a big drop in consumer discretionary spending.