02/20/13   What To Do With Cash

Editor’s Corner

Ron Rowland

Corporate America is flush with cash.  The technology bear market a dozen years ago taught companies to control their urge to invest in new capacity and personnel.  The financial bear market, of more recent vintage, encouraged companies to fortify their balance sheets.  Corporate America took these lessons to heart and is now sitting on much of its profits from the past ten years.  Believe it or not, there is such a thing as too much cash.

For companies, there comes a point when excessive cash becomes a noticeable drag on ROE (Return On Equity) calculations.  When that point is reached, boardrooms start to discuss their options.  They can institute or increase dividend payments, enter in to stock buybacks, go on an acquisition spree, or ignore the pressure from analysts and shareholders.  In recent years, the favorable tax treatment of dividends made that option preferable to many shareholders.  Stock buybacks are typically welcomed by those seeking capital appreciation.  Additionally, there are times when acquisitions make the most sense, whether the reason is to spur top-line growth, shore up bottom-line profits, or just to take advantage of a good deal.

The merger and acquisition path seems to be garnering a large amount of attention these days.  The US Airways Group (LLC) merger with AMR Corp (AAMRQ), Warren Buffett’s Berkshire Hathaway (BRK.A) acquisition of Heinz (HNZ), and Office Depot’s (ODP) proposed takeover of OfficeMax (OMX) are all the buzz lately, and more deals are likely to follow.  Perhaps this will become 2013’s preferred method of reducing corporate cash.

The stock market has been moving steadily upward so far in 2013.  A pullback is inevitable, so it’s not a question of if, but when.  Perhaps it’s starting today.  The low-volatility climb of recent weeks makes today’s 108-point drop in the Dow seem larger and more painful than it actually is.  Granted, some groups are feeling it more than others – precious metals, miners, and homebuilders are among the biggest losers today.  However, not every group is down.  Tobacco, insurance, and soft drinks posted gains.

The Fed released minutes of the January FOMC meeting today.  Officials are beginning to worry about the potential for negative effects from the extended easy-money policy.  Some members are suggesting that policies might need to change prior to the unemployment rate reaching 6.5%, which is the current threshold for action.  Further evaluation and discussion is planned for the March FOMC meeting.

Investor Heat Map: 2/20/13

Sectors

Industrials climbed ahead of Financials this week to once again take over the leadership role in the Sector rankings.  Financials only managed a one-week stay at the top, but it didn’t fall far, landing in second place.  Energy held steady in third place with the energy services segment posting impressive gains.  Consumer Discretionary remains in fourth with volatility picking up among retailers and homebuilders.  Health Care has been quietly posting new highs as it hangs on to fifth place.  The lower portion of the Sector rankings had more shifting of positions than the upper half.  Consumer Staples climbed two positions as Berkshire Hathaway’s (BRK.A) bid for Heinz (HNZ) signifies there is value in the sector.  Real Estate’s ranking was unchanged while Materials slipped two spots to eighth.  The bottom three remain the same, although their order changed this week.  Utilities heads up the laggards, and Technology climbed out of last place, a position it held for four weeks.  Telecom is the new cellar dweller thanks to extreme weakness in second tier names such as CenturyLink (CTL), Windstream (WIN), Frontier Communications (FTR), and Level 3 Communications (LVLT).

Styles

Mid Cap Value heads up the Style rankings again this week, and Small Cap Value is close behind with the gap between them narrowing.  With Small Cap Blend in third and Mid Cap Blend in fourth, there is an obvious market preference for the lower left-hand portion of the traditional 9-square Style Box.  Micro Cap moved up a notch to sixth, pushing Large Cap Value down to seventh in the process.  A seventh place ranking is usually not considered a good one, but today it is quite respectable given the top seven positions are so tightly bunched.  The lower portion of today’s list is dominated by the Large and Growth oriented categories.  Large Cap Growth and Mega Cap are posting good absolute strength numbers but are lagging the others on a relative strength basis.

Global

Pacific ex-Japan surged to the top this week, displacing Japan, which took over the top spot a week ago following an impressive climb through the rankings.  Pacific ex-Japan’s strength comes mostly from its large allocation to Australia, which jumped about 4% this week.  The U.S. also made a strong climb in the rankings recently and keeps its second place position today.  EAFE and World Equity both moved up a notch to grab third and fourth.  Japan, last week’s top-ranked global category, fell all the way to fifth.  Its short-term pullback has now been completely recovered though, paving the way for an improved ranking next week.  The European Union and the U.K. held their positions, and while they are not exactly positions of strength, they are ahead of the three developing market categories of Emerging Markets, Latin America, and China.  Canada is stuck on the bottom for now.  Strength from its energy producers is being overwhelmed by weakness in the Canadian dollar.

 

Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

 


“We have found that, though their stars are generally old, the galaxies that result from these mergers are relatively young.”

Pieter Van Dokkum, Professor of Astronomy


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