I haven’t written on the blog in about two weeks because we’re in the middle of quarterly earnings. There is a 2 or 3 week stretch each quarter where I’m pretty busy listening to the earning’s conference calls of the companies we own as well as other companies I’m looking into. The good news is that I’ve been pretty pleased with what I’m hearing form the majority of our companies so far.
In the News
Last week the Bank of Japan (BOJ) joined the Europeans in implementing a Negative Interest Rate Policy (“NIRP”). This happened one week after the head of the BOJ, Haruhiko Kuroda, told the Japanese parliament that he is not considering NIRP. As usual, you should expect the opposite of what a policy maker claims. This is essentially the BOJ admitting that all of the QE has done nothing for the real economy. GDP and inflation are both stagnant. Not that high inflation is a good thing but Japan has been trying to break 25 years of deflation. Kuroda then followed it up by saying that there’s “no limit” to the amount of easing the Bank of Japan could do, pointing out that European rates are even more negative than Japan right now. As if QE to the tune of 16% of your annual GDP wasn’t enough. I’m starting to sense a bit of desperation by our Central Banks… This is without a doubt the largest risk in the financial markets today – that is, if the markets start to sense that central bankers are, in fact, not in control and becoming desperate.
The actual interest rate that these central banks are making negative is the rate that banks earn when they deposit extra reserves with the Central Bank. By taking the rate negative, the central banks are hoping to discourage banks from holding extra cash (called excess reserves) and encourage them to make new loans with the money. This also indirectly affects the general public because banks then lower the rates they’re willing to pay to savers, as well as dropping the funding rates which drive down bond yields.
Attempting to encourage banks to lend money sounds good in theory but there are a slew of reasons why NIRP is a bad idea and riddled with unintended consequences. It’s a very simplistic view of economics that fails to take into account the behavioral dynamics of economics. The scariest thing is that the US Federal Reserve has been dropping hints for a while that they’ve been considering NIRP and are open to the idea if economic data worsens. In my humble opinion, this is lunacy. It’s crazy to me that these people still have the reins over the global monetary system and thus economy.
This is an issue because every central bank is run by academic economists who rely almost solely on academic theory and models. In theory, lowering interest rates should increase borrowing, spending and new investment and thus boost the economy and inflation. In reality, the lower they’ve taken interest rates and implemented QE the past 6 years, the more inflation, inflation expectations, consumer spending and corporate capital expenditures have dropped. And the academic economists swear their theories are right, they just didn’t lower interest rates enough or implement enough QE. Over 6 years running and all the evidence to the contrary but we’re still just cranking it up even more. Einstein has to be laughing in his grave right now – this is his definition of insanity.
10-year Treasury Yield – still falling…
Corporate Bonds Spreads – still widening…
5-year, 5-year Forward Inflation Expectations – still falling a lot…
The charts above are the bond market’s way of telling Janet Yellen that she’s done raising interest rates. You’re damned if you do and damned if you don’t. Because…
The core issues that the Western world faces are structural and take a long time to adjust – things like demographics, job skills/training as technology changes, etc. The things that could be improved more quickly, like tax policy and regulation, are the responsibility of governments (the fiscal side of policy). But no one in government ever wants to have the tough discussion because it would hurt their chances of being re-elected. Instead, they hope the Central Bank can make it all magically disappear with monetary policy.
Monetary policy affects monetary assets (stock and bond prices). It created a huge misallocation of capital and has done little to nothing to build a solid long-term foundation for the economy. But you know what, let’s take interest rates negative. What could possibly happen? I’m sure there won’t be any unintended consequences this time around.
Portfolio Updates
On a brighter note, as mentioned above, I remain very happy with the companies in which we own stock. I did a little buying in January as stocks got knocked down, but mainly adding to existing positions. However, last week I did buy stock in one new company, F5 Networks (FFIV), as a “Growth” investment. In short, F5 Networks works with companies to ensure that they’re applications work seamlessly for the end-user on any network, any device, anywhere at any time. They are a leader in the Application Delivery Controller (ADC) market with over 50% market share. Most of the growth is coming from security related business and helping companies transition their applications into the cloud. The best part is that they partner with the leading tech names and application developers, like Microsoft, Oracle, Cisco, Amazon Web Services, VMware, HP, IBM, Dell, FireEye and others. Rather than competing with the big dogs, F5 Networks’ technology is integrated with their services. This means that when these companies do well, so does F5 Networks.
The stock was knocked down quite a bit over the last year on concerns that growth is slowing. It’s actually lower now that it was 5 years ago, to the point that I think it’s a great value. This is an example of a stock not reflecting the intrinsic value of the underlying company. Click here to see my post from a few weeks ago for more on this topic.
F5 Networks – 1 year (daily) chart
F5 Networks – 10 years (monthly) chart
Thanks for following!
-Nick
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