Richard Thaler has a lot to say about human economic behavior, but not so much about today’s stock market environment.
* Theories abound for the eerie calm in the U.S. stock market, including a wild one that contends panicky investors are willing to pay almost anything for the stocks that threaten their job prospects.
* Our team is staying disciplined amid the calm, while taking actions across both the stock and bond sides of our managed portfolios.
* We also continue to emphasize triple-bottom-line thinking in our portfolio decisions and share several related updates from our holdings.
Recent Nobel Prize winner Richard Thaler knows a thing or two about the behavior challenges that constantly constrain us. The University of Chicago professor has published a body of work over the years that bridges psychology and economics. A theme among this work is the rejection of the mainstream economics myth that the consumer is hyperrational. Among other things, Thaler’s studies reveal how we often lack self-control, misconstrue causality, mistake luck for skill, succumb to herding behavior, and feel compelled to intervene or take rash action when things go south. Many of his insights, especially those around “nudges” (basically, how choices are presented to those choosing), have been applied to address a wide range of social challenges. Auto-enrollment policies for reduced school lunches and retirement plans are just two such nudges that continue to make a significant mark on society. So, when he was asked by Bloomberg TV for a comment on today’s eerie calm in the stock markets, I figured the guru of behavioral economics might have a “real-life” explanation. Instead, Thaler had this to say:
We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping. I admit to not understanding it.
Well, that makes two of us, Richard. But what a nap it has been! As of September 30, the U.S. stock market (S&P 500) has generated positive quarterly returns in 19 of the last 20 calendar quarters. The last time we had a down-double-digit quarter? Six years ago, in 2011. On a day-to-day basis, stock market moves have been miniscule, as well. Look at this chart showing the S&P’s daily volatility over the years:
Another expression of this market calm can be seen via the Chicago Board Options Exchange volatility index. Known as the VIX, this index uses the market prices of stock index options to measure expected future volatility.
The chart above shows that the VIX is now plumbing lows not seen … well, ever. Investors seem to be cucumber cool and unfazed by a bull market now in its ninth year, very lofty valuations, central banks poised to take away their monetary Kool-Aid, and even threats of nuclear war. Instead, they’re simply keeping calm and carrying on.
Many theories can be adduced for the chilled-out stock market of the last few years. The most reasonable I’ve seen point to some combination of (1) relatively steady (if slow) global economic growth along with benign inflation trends (supporting similarly smooth trends in corporate earnings), (2) expectations that global central bankers will only gradually move away from the highly accommodative (i.e., market-supporting) policies deployed since the global financial crisis, (3) an abundance of financial capital globally driving super-low interest rates (allowing corporations to financially engineer earnings higher and forcing investors into higher stock allocations to hit their return bogeys), and (4) investor shifts, postcrisis, away from actively managed investments and into passively managed ones (thus diminishing the sometimes violent market discipline that comes from investors sensitive to price and quality while boosting the influence of those agnostic to such considerations).
A more extreme view from financial advisor and commentator Josh Brown provides a different take on the stock market’s low-vol mystery. Brown contends that rather than napping, investors are panicking over their go-forward job prospects in a world of machines. As such, they are investing with an if-you-can’t-beat-’em-join-’em mentality and bidding up the stock prices of anything in the brave new world of connectivity, robots, automation, and artificial intelligence. For those who are interested in the full post, see “Just Own the Damn Robots,” at thereformedbroker.com.
I’ll admit that Brown’s take on the world seems a bit of a stretch and might only be a ploy to attract some page views (he got mine). But markets are complex beasts, and as Siri tells me stories daily of developments like robots doing fully automated dental implants in China (who signed up for that?!) or the Hands Free Hectare farm in England yielding four tons of barley without a single human ever setting foot in the field, I start to think maybe we should keep this “fear factor” in mind when thinking about the anti-fear in markets today.
Of course, our job as investment managers is to stay forward-focused and work with the hand we’re dealt with, mysteries solved or not. And what is our team doing as of late? In a nutshell, here are some of the general investment actions we’ve been taking more recently amid the calm.
1. For stock and bond holdings that are approaching our internal fair value estimates, we are peeling back. This is merely disciplined portfolio management, one position at a time, when we find our margin of safety insufficient. Examples of recent trims/sells include Technopolis (Scandinavian office buildings), Sparx Group (Japan asset management), and Hain Celestial (U.S. natural and organic foods).
2. We are being very mindful of our U.S. stock exposure, the area where the market calm is most pronounced and valuations are most expensive. Our portfolios still hold a basket of U.S. stocks, although these tend to be in situations that don’t “screen” all that well in today’s hot areas. For example, we own stocks like alternative lifestyle media company Gaia that aren’t held by the most popular index funds. We also own stocks of companies where near-term uncertainty is obscuring underlying value. An example in this category is Uniti Group, an owner of mission-critical telecommunications infrastructure whose largest tenant (Windstream) is contending with an aggressive bondholder.
3. With our fixed income, we continue to emphasize quality and liquidity as available yields across much of the less-liquid and lower-quality universe remain inadequate. Our positions generally consist of a U.S. Treasury bond basket and short-term, diversified investment-grade corporate bond holdings. One area in which we historically find great value, closed-end funds, offers few opportunities for now.
In wrapping this up, I will also note that we continue to emphasize “triple-bottom-line” thinking in our portfolio decisions. As many of you ask questions about sustainability developments within our managed holdings, here are a few recent portfolio notes and quotes on that front:
“In our work as an engaged owner, sustainability is a prioritized area. Of course, we must operate in a sustainable way at Investor, but our biggest impact comes through our active work in the boards of our companies. Our view is clear: sustainability is never an obstacle for long-term profitable growth, it is a prerequisite. Companies that are at the forefront within sustainability, both when it comes to processes and its integration into the business, improve the odds of winning market share and attracting the best talents, key ingredients in achieving long-term profitable and sustainable growth.”
Johan Forssel, CEO, in Investor AB’s Q3 Report to Shareholders
Commenced operations at the Showamura Ogose ECO Power Plant, the largest solar power plant in the greater Tokyo area. The plant takes Ichigo’s solar portfolio to 128MW, including those it manages in the Ichigo Green Infrastructure Fund.
Participated in the GRESB (Global Real Estate Sustainability Benchmark) survey and was awarded the full five stars and the prestigious Green Star status. The company is accelerating efforts to reduce the energy used in its buildings, and it expects these and other sustainability efforts to drive future triple-bottom-line results.
Announced a strategic partnership with Sendai, Japan, one of the cities hit by the 2011 earthquake and tsunami. Among other things, the deal will see Sendai and the Finnish communications equipment company stage a joint disaster exercise in 2018 and collaborate on public safety innovation and development. Nokia will offer various innovation platforms and programs to universities and start-ups in Sendai and help the recovering city pursue business opportunities outside of Japan.
One of the ambitious promises made by President Trump was large-scale tax reform and simplification of the tax system. Unfortunately, we have seen more of the gridlock in Congress that we have experienced in the past, with little to no progress being made. Since it is too early to know what the new legislation will look like, the general policies that have been articulated by Trump include:
Efforts to move ahead with tax reform in the polarized political environment that we have today will be a challenge. Initial indications suggest that there’s little reason to expect bipartisan cooperation in enacting lasting tax reform. While we wait for any future tax reform, we can still focus on the prudent year-end tax-planning strategies that can help minimize your taxes.
Timing is everything when it comes to reducing taxes. Therefore, consider any opportunities you have for deferring income to 2018. For example, you may be able to defer a year-end bonus, or to delay the collection of business debts, rents, and payments for services. Doing so may allow you to postpone paying tax on the income until next year. If there’s a chance that you’ll be in a lower income tax bracket next year, deferring income could mean paying less tax on the income, as well. Similarly, consider ways to accelerate deductions into 2017. If you itemize deductions, you might accelerate some deductible expenses like medical expenses, qualifying interest, or state and local taxes by making payments before year-end. Or you might consider making next year’s charitable contributions this year instead. Sometimes, however, it may make sense to take the opposite approach – accelerating income into 2017 and postponing deductible expenses to 2018. That might be the case, for example, if you anticipate that you’ll be in a higher tax bracket in 2018.
It’s always a good idea to claim all the deductions or credits for which you qualify. Take full advantage of tax-advantaged retirement savings vehicles. Traditional IRAs and employer-sponsored retirement plans such as 401(k) plans allow you to contribute funds on a deductible (if you qualify) or pre-tax basis, reducing your 2017 taxable income. Contributions to a Roth IRA (assuming you meet the income requirements) or a Roth 401(k) aren’t deductible or made with pre-tax dollars, so there’s no tax benefit for 2017, but qualified Roth distributions are completely free from federal income tax, which can make these retirement savings vehicles appealing. For 2017, you can contribute up to $18,000 to a 401(k) plan ($24,000 if you’re age 50 or older) and up to $5,500 to a traditional IRA or Roth IRA ($6,500 if you’re age 50 or older). The window to make 2017 contributions to an employer plan typically closes at the end of the year, although you generally have until the April tax-return filing deadline to make 2017 IRA contributions.
If you are expecting to face capital gain taxes this year, loss harvesting can help reduce what you’ll pay. This involves selling any investment that has declined in value before year-end, including stocks, bonds, and mutual funds, so that the capital losses you report can offset your capital gains. As part of our overall investment process at the FIM Group, our team will review and harvest losses in our clients’ nonretirement accounts prior to year-end when we feel it is appropriate. Keep in mind, too, that you can deduct up to $3,000 of capital losses from your taxable income, so selling losing investments before year-end can be a smart move even if you don’t need to reduce capital gains taxes this year.
Year-end is a good time to evaluate whether it makes sense to convert a tax-deferred savings vehicle like a traditional IRA or a 401(k) account to a Roth account. When you convert a traditional IRA to a Roth IRA, or a traditional 401(k) account to a Roth 401(k) account, the converted funds are generally subject to federal income tax in the year that you make the conversion (except to the extent that the funds represent nondeductible, after-tax contributions). If a Roth conversion does make sense, you’ll want to give some thought to the timing of the conversion. For example, if you believe that you’ll be in a better tax situation this year than next (e.g., you would pay tax on the converted funds at a lower rate this year), you might think about acting now rather than waiting. (Whether a Roth conversion is appropriate for you depends on many factors, including your current and projected future income tax rates.)
For those of you who have reached age 70½, or if you are the beneficiary of an Inherited IRA, you’re generally required to start taking required minimum distributions (RMDs) from traditional IRAs and employer-sponsored retirement plans (special rules apply if you’re still working and participating in your employer’s retirement plan). You must make the withdrawals by the date required – the end of the year for most individuals. The penalty for failing to do so is substantial: 50% of the amount that wasn’t distributed on time. As a reminder, individuals age 70½ or older can make qualified charitable distributions (QCDs) from their IRAs and exclude the distribution from gross income (up to $100,000 in a year); QCDs count toward satisfying any required minimum distributions (RMDs) that would otherwise have had to be made from the IRA.
If you are enrolled in what the IRS defines as a high-deductible health plan, you might be eligible to contribute to a health savings account, which can offer you a pre-tax option for cover- ing your deductible. In 2017, the contribution limits are $3,400 for individuals and $6,750 for a family, plus the contributions are potentially deductible on your tax return. And there’s no time limit on when you can use your contributions to cover unreimbursed qualified medical expenses.
Also, avoid the penalty box by ensuring that you paid your estimated taxes, both federal and state, if directed by your CPA. The IRS requires you to pay your taxes throughout the year and not all at the end. There are also two safe harbors that taxpayers can utilize to avoid the penalty box: You can either pay at least 100% of the tax shown on your prior year’s tax return (110% if your AGI is above $150,000) or pay at least 90% of your current year’s tax obligation.
When it comes to year-end tax planning, there’s always a lot to think about. You should look to one of the advisors at FIM Group to help you evaluate your situation and determine whether any year-end moves make sense for you.
Initial Enrollment – First-time enrollees will want to pay attention to the seven-month enrollment window. The seven months to enroll without late enrollment penalty include the month of your 65th birthday, plus the three months before and after your birthday month.
Late Enrollment – If you missed your Initial Enrollment period, there is an annual window in which you can enroll, from January 1 to March 31. You may, however, be subject to a late enrollment penalty.
2018 Open Enrollment – Those who are already enrolled can take advantage of the annual Open Enrollment window to review and, as necessary, change plan options for 2018. Changes may include moving between Medicare and Medicare Advantage, and changing Advantage and prescription plans. The window to make these changes is October 15 to December 7, 2017.
Disney was founded in 1923 by brothers Walt and Roy Disney. Globally, Disney employs roughly 195,000 employees, about the same as the entire labor force of Iceland. This includes the famed Imagineers (Disney’s “creative force,” cultivating the physical Disney experience), who number some 1,700.
Disney’s business ($55.6B in 2016 revenues, or approximately the GDP of Luxembourg) is broken into four segments:
Media Networks (42.5%) consists of Disney/ABC Television and ESPN.
Parks and Resorts (30.5%) includes Disneyland Resort, Walt Disney World, Shanghai Disney Resort, Disneyland Paris, Tokyo Disney Resort, Hong Kong Disney Resort, Disney Cruise Line, Disney Vacation Club, Aulani, Adventures by Disney, and Walt Disney Imagineering.
Studio Entertainment (17%), considered the “foundation” for the past 94 years, houses The Walt Disney Studios, Walt Disney Animation Studios, Pixar Animation Studios, Disney Music Group, Disney Theatrical Group, Disneytoon Studios, Marvel Studios, Disneynature, and Lucasfilm Ltd.
Disney Consumer Products and Interactive Media (10%) handles every- thing from toys and apparel to books and games (including the Disney Store).
Disney also owns 50% of A+E Networks (encompassing A&E, History Network, Lifetime Entertainment Services, and others including Viceland), 75% of BAMTech (Major League Baseball’s streaming technology and content delivery company), 30% of CTV (Canadian television networks), and 30% of Hulu, the streaming joint venture with Twenty-First Century Fox, Comcast, and Time Warner.
Disney is estimated to have welcomed more than 140 million visitors to its parks (for reference, Russia has 144 million citizens) in 2016. In the United States, ESPN’s subscriber base was roughly 90 million, with The Disney Channel’s a tick above at 93 million; internationally, ESPN’s base swells to 141 million and The Disney Channel’s 205 million.
Our investment case for Disney is multifaceted. Its moat and corporate culture have been leveraged to build an underappreciated business model. Disney is not merely a strong brand, it is able to build new top-tier brands with consistency. is made possible largely through a dedicated and formidable workforce.>span class="Apple-converted-space">
Much attention is often given to the handful of executives at the pinnacle of an enterprise, and Disney is no stranger here. A story in the media about Disney will inevitably mention Chairman and CEO Robert “Bob” Iger, perhaps getting into how he has managed the impossible to emerge from former head Michael Eisner’s shadow, as well as repairing a relationship with Apple’s Steve Jobs, acquiring Pixar (where Job’s owned 50.1% and was CEO) which lead to a board seat at Disney for Jobs, and beginning a new era.
Often that is where the story ends, when truly that is a mere footnote to the team that supports the enterprise. The Disney brand, given its corporate culture, has been able to attract the best in each of the fields in which the company is active. We would argue that in the age of the mega-brand Disney’s brands have never been stronger.
What appears to be a great leader, a mere individual, is a reflection (an amplification) of the work performed by the team behind it.
The power of the Disney brand is evidenced in its Parks and Resorts segment. A ticket for admission to Disneyland in 1955 was $1 for an adult (with an additional $0.10–0.30 per ride); even adjusted for inflation, that original ticket would only be 10% of the cost to get through the gates in 2017.
An interesting thing is going on here. Disney is continually earning large returns on its invested capital, that is, it is generating a great deal of cash. This spread between cash invested and cash generated (in our estimation) stands as a real-world example of exceptional brand power.
While we believe there is a virtuous cycle ongoing between an expanding moat and positive corporate culture, don’t worry that we forgot the elephant in the room (no, not Dumbo!). The world is changing, but is Disney continuing to change with it? To a finer point, how is Disney weathering the shift to streaming video on demand? Or theatrical demand? Or cord cutting?
These are fair questions. While revenues are fairly well-balanced, ESPN has become a large driver of Disney’s income, and ultimately it is the bottom line that matters to us investors. On this front, we believe Disney has been prudent; it hasn’t simply been throwing money at the situation, hoping something sticks. Instead it has been managing its current business efficiently and effectively, all the while preparing for likely changes to the landscape.
A recent example was Disney’s negotiation with Altice (an East Coast cable operator); it had already negotiated pricing on the content (in this case live sports such as the NBA), and it was time to price the reselling of that content, to wit, get ESPN re-signed with Altice. All accounts point to success accomplished here in what was deemed to be an early test, highlighting a strong demand base for traditional distribution. If we look back further, Disney was the first to put full length television shows on Apple’s iTunes, in 2005!
Content distribution has been the loci for the management team, and instead of a big flashy purchase Disney has gone for mission-critical assets. Major League Baseball was ahead of the curve with the technology needed to stream live sports, and now Disney controls these assets. News that Disney had looked at Twitter but only for its distribution technology and just recently deciding to in-house its content (that is, pull it from Netflix) highlights a simple fact: Ultimate control lies with the content creators. All you need to do is look at the billions of dollars that new creators (such as Amazon, Apple, Netflix, and the like) are pouring into projects, though with little to show for it thus far. Could direct-to-consumer actually be a positive here? We believe so. But you need to take the long-term view.
Disney has exposure to an aggregator (Hulu) and will create its own premium distribution platform. Ultimately, it has some of the most compelling and sought-after content. Disney has made smart acquisitions in the past, not for the commodity side of the business but instead for the creative side.
Pixar, Marvel, and Lucasfilms have all been excellent additions, adding depth and breadth to an already-solid content pipeline. While 2017 was something of an in-between year, we believe that 2018 and beyond will be strong. With a robust slate of theatrical releases, Disney should concomitantly bolster interest in its parks and consumer products. We believe “Mr. Market” is being myopic, spending too much time worrying about ESPN. If the economy cooperates, we believe Disney is set to have all cylinders firing in 2018, and beyond.
True, Disney is not a grand dividend payer, a deep-value entity, nor a hypergrowth company. Nonetheless, it has created substantial shareholder value through market cycles. It has achieved this through methodical business decisions, ample creativity, and an eye to the future.
On the Environmental, Social, and Governance (ESG) front, a quote by former Disney CFO Jay Rasulo resonates with us: “If we don’t act in accordance with the stories we tell, the experiences we offer, and the images that we project, we lose our authenticity. You can’t entertain a family on the one hand and then totally disregard the world and circumstances in which they live. Acting responsibly is core to our brand.”
In 2016, Disney and its employees gave more than $400 million in cash and in-kind support for philanthropic programs. Disney has numerous goals, from power and water consumption to food advertising and waste diver- sion, all tracking on or ahead of its 2020 goals.
Currently, Disney is trading at a discount to its own historical valuations, its peers, and the market in general. Those depressed multiples are on equally muted expectations. As long as we believe that the virtuous cycle between corporate culture and an expanding moat is present in the company, we will find comfort in the ability of Disney to weather and excel in varying economic conditions, so we will be investors. As always, we will remain tuned in to the company and to industry trends.
Sources: The Walt Disney Company, Bloomberg, WorldBank, Themed Entertainment Association
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