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JULY 2014 INVESTMENT JOURNAL: INVITING INVERSIONS 
  • US Fed to end tapering in October
  • Corporate inversions sizzle
  • US money market funds in for big change
  • Major Portuguese bank collapses
     

July was a quiet month for equities until we entered the final week. The S&P 500 lost 2.7% in the last week of July which was the worst week for U.S. stocks in 2 years. Developed International stocks fared worse than the US during July losing 2.6%. Only Emerging Markets showed gains as the Chinese Shanghai Index led other emerging markets higher. Most bonds and hard assets sold off as the month came to a close as well:

     

 

     

Emerging Markets Stocks appear to be playing catch up this year. They have lagged US and Developed International Stocks during the last 3 years, but are leading the equity charge so far in 2014. Commodities lost all of their gains during July and gold's gain was cut significantly. Hard assets will be an important gauge to watch as investors jockey to stay ahead of inflation:  

            

   

As the month of July began, the U.S. Federal Reserve FOMC Minutes were released, and they gave a clear timetable for scaling back its "QE3" program, with a caveat: "If the economy progresses about as the Committee expects, warranting reductions in the pace of purchases at each upcoming meeting, this final reduction would occur following the October meeting."

  

The Fed has been slowing its asset purchases by $10bn every meeting this year and they currently stand at $35bn-a-month. This new information pushed down bond prices briefly, as investors began anticipating rate rises in the fall. 

  

However, many believe that the economy still has a lot of slack, and the Fed will not officially raise short term rates for some time. The Minutes from July also introduced a new method for raising rates: the Fed is leaning towards announcing a "target range", not a set number. So it looks like the next headline will read "Fed raises rates from 0%-.25% to a range of .25%-.50%". Their thinking seems to be that it would allow for a wider bid-ask "spread" in the money market, minimizing distortions and supporting dealer profitability.

  

As the month progressed, a storm of controversy emerged over U.S. companies acquiring foreign companies so they could move their "domicile" overseas in a so-called "inversion". This strategy is driven by differing national tax codes: much lower corporate tax rates can be found overseas, and most foreign countries do not tax income earned outside the country, as the USA does.

      

Health care and technology companies in particular have large pools of accumulated profits that are "stuck" outside the U.S., as that is the only way to avoid mammoth tax bills that would be presented upon re-patriating those profits to the USA (probably creating a lot of jobs in the process). Pfizer tried to acquire the UK's Astra Zeneca earlier this year, but called it off (for now). Others this month like AbbVie and Mylan Labs are proceeding. Even household names like Walgreens are considering going overseas. The graph below shows the big surge of interest in this tax-code driven strategy:

     

 

      

The race to get globally competitive with taxes has reached a fever pitch. Predictably, politicians spun it their way. Jack Lew, US Treasury secretary, wrote to Dave Camp, the Republican chairman of the House Ways & Means Committee that "Congress should enact legislation immediately...to shut down this abuse of our tax system...what we need as a nation is a new sense of economic patriotism, where we all rise and fall together." President Obama also accused American business leaders of being unpatriotic, but inversions wouldn't be so inviting if the U.S. modernized its tax system to be competitive in the global marketplace.

   

Also in July, the Securities & Exchange Commission approved new rules for money market funds that will fundamentally change how they are valued and priced. Under the SEC plan, "prime" money funds (whose shares are held by corporations and large institutional investors) will have to abandon a stable $1-a-share price, and float in value like other mutual funds. The plan also would allow all funds to temporarily stop investors from redeeming shares in times of high market volatility, or impose fees on them to exit.

     

These rules are meant to prevent a repeat of the mass exodus out of money funds during the 2008 crisis that nearly froze all corporate lending. We're proud to report that Charles Schwab Corp. built support for an approach that exempted funds that cater to retail investors from these new rules, since the bulk of "hot money" that causes disruptions is nearly always from institutional investors. We think this is a very important rule change that will cause all investors to be more selective about the funds they consider for investing. You can read more about it here:

  

http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542347679#.U9_HmPldWgY

     

In Europe, Banco Espirito Santo, Portugal's largest bank, collapsed under the weight of bad loans and poor management. After two weeks of turmoil, the European Commission stepped in with a €4.9 billion bailout that wipes out shareholders and some bondholders while splitting what's left into a "good" and "bad" bank.

    

Markets were jittery on the initial news, which was exacerbated by continuing geo-political events. The U.S. and EU imposed additional sanctions on Russia as acrimony rose following the downing of a Malaysian airliner over the Ukraine. Violence marred the Middle East, and West Africa saw the most deadly outbreak ever recorded for the Ebola virus.

  

The cumulative effect was to send stock markets reeling on the last day of July. Major averages were down from 1-3%. This type of volatility has been notably absent for quite some time, but it is all a normal part of the and parcel of investing, where greed and fear each make themselves known from time to time. Despite the late month sell-off, price momentum is still positive for stocks:

    

   

         

    We hope you have a great month in August, and thanks for reading our Journal!

  
  
  
  
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