foxex: Compound Magic

The Market Sum | Insight after the bell

By Caleb Silver, Editor in Chief

Wednesday's Headlines

1. Markets stall and stock buybacks get the spotlight

Markets Close

Dow
25,390.30 -0.08%

S&P
2,731.61 -0.22%

Nasdaq
7,375.28 -0.36%

VIX
15.38 -1.22%

INV Anxiety Index
101.38 Neutral

US 10-Yr Yield
2.702 +/-0.00

The Magic of Compounding

My 12 year-old daughter asked me the following question this morning: Would I rather receive an $100 per day allowance for a month, or 1 penny on the first day of the month that doubles every day for next 30 days? In other words, $0.01 on day one, $0.02 on day two, $0.04 on day 3, and on and on...It's a trick question for anyone who doesn't know the magic of compounding, but it's also a great lesson in investing for people of all ages. Finding an investment that will compound 100% every day (or every year, for that matter) is a little trickier. Still... I thanked my lucky stars that my pride and joy learned that lesson at 12 and I promptly deposited more money into her custodial brokerage account.This is a good read on practical compounding. Read it and share it with the kids in your life or the adults who still haven't discovered the magic.

Investing $100 in stocks for 30 Years

Markets Today

Stocks couldn't make it five days in a row today, but the losses were limited. There was no 'State of the Union', bump. Nor did it cause the sell-off. While President Trump cited the fortitude of the U.S. economy and gains in the workforce, there was no promise of an infrastructure spending bill or a new military build-up to rally those sectors. He did take aim at the high cost of prescription medication, as expected, but drugmakers like Pfizer and Glaxo actually trader higher today. It was the video game makers that got tilted today. Both Electronic Arts (EA) and Take Two Interactive (TTWO), two of the biggest companies in the space, were blasted by investors after reporting weak earnings for the last quarter. They blamed the weakness on "intense competition". I thought that was the point of video games??!! I'm old, I guess. Despite their popularity, video game stocks have not been fun, lately. Check out GAMR, the ETF for video games over the past year.

Big Deal about Stock Buybacks

There has been a lot of news and noise about stock buybacks lately. Former U.S. presidential candidate Bernie Sanders and current U.S. Congressman Chuck Schumer have been taking corporate executives to task for using their extra cash to buy back shares of stock, which inflate the stock price, thereby enriching the executives, themselves.

(Read more about why companies buy back their shares here.)

Schumer and Sanders want to introduce a bill in Congress to prevent companies from buying back their stock unless they pay their workers at least $15 an hour, in addition to other provisions.

In their own words:

"Our bill will prohibit a corporation from buying back its own stock unless it invests in workers and communities first, including things like paying all workers at least $15 an hour, providing seven days of paid sick leave, and offering decent pensions and more reliable health benefits. In other words, our legislation would set minimum requirements for corporate investment in workers and the long-term strength of the company as a precondition for a corporation entering into a share buyback plan..."

The backlash against buybacks intensified in 2018 as companies bought back shares at a record pace, topping $1.1 trillion for the year. Buoyed by extra cash from the Trump tax cuts, critics argued that companies pumped up their share prices with the buybacks instead of investing more in their employees, R&D efforts and boosting their dividends.

They are not wrong. The reality is that it is much easier for a company to buy back its own shares or raise its dividends than it is grant pay raises to their workforce. Axios charted the buyback and dividend boom for companies in the S&P500 over the past 20 years. As earnings exploded (purple line) buybacks and dividends did, as well. That helped shareholders by adding value to their shares in the form of higher prices (buybacks) or payouts to shareholders (dividends).

When earnings plunged as they did in the financial crisis, those 'artificial' boosts to shareholders went with them. Those are easy decisions for an executive team and a board of directors to make. Rescinding a wage increase is not.

The Sanders/Schumer op-ed got the ire of corporate executives around the world. It even prompted Lloyd Blankfein, the former Chairman and CEO of Goldman Sachs, to take to twitter to blast the politicians for their proposed bill.

I smell a big issue on the rise as the 2020 election draws nearer.

Chart of the Day: VIX at New Lows as Fears Dissolve

Prior to President Trump's State of the Union address on Tuesday night, the VIX (or CBOE Volatility Index, also known as the 'Fear Gauge') dropped to touch its lowest level - around 15 - since early October. Of course, early October was also when stocks began their most recent fall from all-time highs.

So investors' fear levels are now back down near where they were before the prolonged market shake-up of the past four months. In the process of this most recent VIX drop, the index has fallen below its 200-day moving average, a significant indication that fear and volatility are indeed on the decline. On Wednesday, volatility was also down, even though markets had dropped slightly.

Aside from ongoing speculation over U.S.-China trade negotiations, which Trump did not address in much detail on Tuesday night, bullish market drivers continue to prevail. This includes a dovish Federal Reserve that seems to be increasingly cooperative with the markets, and a continued march of solid company earnings releases as earnings season begins to wind down. As a result, investor complacency is prevailing once again, and the overall market bias has clearly shifted bullish.