As a sort of rule when it comes to investing in risk assets, you want to have owned stuff whose charts start at the bottom left and end up at the top right. In the easy money bull market of the last 5 years, there are no shortage of examples that fit this description, and I think it is safe to say the charts of assets that have gone from the top left to the bottom right over the same time period should likely be avoided at all costs at this stage of the game.
One example of an A+ performer would be Disney (DIS). The shares are up 81% since Jan 1st 2013, nearly doubling the performance S&P 500 (SPX) in that same time period and doing so with very little volatility:
Since the end of 2012, DIS has grown earnings by about 42% and sales by 15%. The stock trades at 20x current years earnings, which is around 7 year highs:
So what about that earnings growth, expected to be 27% in the first three quarters of their fiscal 2014? In the nine months ended on June 28th, the company reportedly bought about $5.1 billion worth of their stock. Back in Sept 2013, when DIS was in the mid $60s, the company announced an expanded buyback program where they would buy between $6 and $8 billion in 2014. They are getting there quickly and will probably reach the high end target. Sales growth has been between 3% and 7% for the last 4 years, so managing earnings has been a core strategy to help the stock massively outperform the broad market.
A major byproduct of the Fed’s QE policies of the last 5 years has been to make capital readily available to corporations so that they could put it to work and stimulate the economy. DIS is a great example of a U.S. multinational that has used that capital for financial transactions rather than business investment. The company sports a paltry 1% dividend yield, has operated well in a difficult environment by using its balance sheet to manage earnings ($155 billion market cap, $4 billion in cash and $16 billion in debt). While the debt to cap ratio is not egregious by any means, the company has been one of the biggest buyers of its shares at all time highs for two years:
One could have made the same case at any point since the breakout to new all time highs since 2012. But here is the major difference – the U.S. Fed is one month away from ending their policy of QE, which could result in a different rate and risk appetite environment in the coming year. Another byproduct of QE has been depressed volatility in public markets that, much like low rates, makes buybacks attractive for companies. As a result implied volatility in many low vol names that have had massive moves could also be very attractive. Low rates have made buybacks attractive, buybacks have depressed volatility, but all good (think manipulated) things come to an end.
The four year chart below of DIS’s 30 day at the money implied vol (IV) looks much the way you would expect it too, nearing all time lows:
It is my sense that there is a storm brewing here. Every-time there has been talk of a stock market bubble, the SPX has thumbed its nose at the notion and gone on to make higher highs as equity volatility has grounded down to a halt. But there have been pockets of equities where the mini bubbles burst and have not been reflated (specifically in tech like 3D, some cloud and internet security and Macau casinos). The current consolidation in large cap equities at a time where rates seem to be inching up seems like it is setting the stage for the final FU, if you know what I mean. But let’s see how this market reacts to today’s Alibaba IPO, the largest of its kind, ever, and then Apple’s release of iPhone 6 sales on Monday. Both could be seminal sentiment events for this bull market.
While I have no interest in trying to pick a top, I would say that there seem to be some unique opportunities in the offing as it relates to crowded, overpriced, over stimulated earnings, historically high valuations with record low levels of implied volatility. Disney just made the list.
Stay tuned, we are considering trades in Disney and a few others that fit the bill.