By: Stash Graham
The market continued November’s run higher albeit slower as the market digested the latest developments from Washington, D.C. After a couple of weeks of a negotiation stalemate, Democrats, Republicans, and the White House agreed to a stimulus package that provided a short-term fix for the unemployed. Hard assets performed well in December. Our gold tracking position, IAU, was up +7.1% on the month. Our commodities basket position, PDBC, was up almost +6% on the month. The S&P 500 and Dow Jones Industrial Average were up +4% and +3.5%, respectively.
In the November letter, we highlighted the historic bullish exuberance in markets. A late December article in the Wall Street Journal detailed how the amount of margin debt investors are taking are at new historic highs. Margin Debt is the debt that one receives from their broker when using their existing stock portfolio as collateral. It is essential to clarify that the observation of high margin debt levels does not paint a complete picture. We need to compare the amount of debt being used to the value of the instruments used as collateral: financial instruments like stocks. When we observe the stock market’s value to the amount of margin debt used, the levels are within a normal range. What is worrisome is the growth rate of the margin debt in the last 12 months. We have witnessed one of the most significant increases in margin debt usage (relative to the 12-month low) during the previous 60 years. As shown below, when margin debt grows +50% within a year of the low point of margin debt usage, market returns tend to be negative over the next 12 months. This growth rate speaks to the rapid increase in aggression that is hard to sustain over extended periods. Hence the bad returns in the near-term future after this 50% level (the dotted line in chart) is reached.
Another metric to monitor is margin debt relative to disposable household income (chart on next page). This indicator is touching levels only witnessed a few times in the last 20 years. As interest rates remain low, disposable household income levels should continue to service the debt service payments. If interest rates start to rise, it will be essential to monitor income levels to ensure they keep up with the servicing requirements. If investors cannot afford the margin debt because the debt becomes expensive to service, you could see some forced selling. We are more concerned with a market pullback forcing investors to sell investment positions to cover the margin requirements. Still, this graph shows that people are willing to borrow at historically high levels compared to their disposable income. Disposable income is used to pay for this ongoing debt.
Please see the following updates on existing positions held at the firm:
Intel Corporation (Ticker: INTC)- The American chip giant has seen its fair share of adverse developments over the last 60 days. Apple and Microsoft indicated that they were planning to focus on internal options in their chip development, taking business away from Intel. The downward pressure on the stock price turned quickly as activist investor Third Point LLC announced a “significant stake” in Intel and want the company to hire an investment adviser to look at strategic alternatives. The company responded to the letter publicly, stating that they welcome all dialogue and look forward to discussing the idea with Third Point. The stock jumped as high as +6% on the day (December 29th). We will monitor the situation closely and act accordingly.
BNCC Corp (Ticker: BNCC)- In early December, the regional bank announced that they were issuing a special dividend, while at the same time, starting a share repurchase/buyback program. The company will pay out the $8.00 special dividend to shareholders of record on February 1st. The repurchase program of 175,000 shares will buy shares of the bank in either public markets or privately negotiated deals. Naturally, the markets enjoyed the news, and the stock was up over +10% on the day of the announcement.MDU Resources (Ticker: MDU)- On December 14th, the infrastructure construction/regulated utility company announced an increase in their 4th quarter dividend and increased their guidance for 2020 earnings. The press release quoted the management team, “Looking toward 2021, we expect the momentum we’ve built throughout 2020 to continue as our construction backlog remains strong.” The increased dividend payment of $0.2125 per share will be payable on January 1, 2021, to shareholders of record on December 10th. MDU increased their 2020 earnings per share (EPS) estimate range to $1.92 to $2.02 from the prior guidance of $1.80 to $1.90. The firm is maintaining its 3-year dividend growth rate of 6.05%.
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