Loans that demant a lot of time and effort
A partnership needs to identify the objectives of the relationship. For example, I worked in a manufacturing setting establishing a partnership between a company and its union. Their common objective was to grow the business. But growth required retooling the production line and increasing automation.While the company and union had a single common objective, each also had its own separate objectives. The company wanted to improve the production rate by 25 percent while reducing work defects by 10 percent. The union did not want the company to lay off employees in the process.
This group spent a lot of time and effort documenting their objectives and involving all the partners. Because of the documentation, all stakeholders understood the outcomes expected in the partnership. They could all see what was in it for them and the other parties if the alliance achieved its goals. Before I bring parties together and develop a mutual vision of the partnership, I have each group meet separately. In these separate meetings, they create their own vision of what they want from the partnership. Then I bring the parties together to share their individual visions. Inevitably the group begins to identify areas they have in common. That is the start of the mutual vision and the first step for creating common objectives.
Equal participation in a credit
The ability to participate equally often depends on being included in the loop. Equal access to information is necessary to ensure a level playing field between partners. If certain members of the partnership have exclusive access to information, it’s incumbent on them to share it. They should make a point of including the other partners by forwarding copies, making memos, or instituting regular reporting regimens. Sharing information starts the process of building trust. If one partner hoards information, it sends a message of control, manipulation, and secrecy. It erodes confidence and destroys trust in the partnership. Another reason for sharing as much information as possible is that the “owner” of the data may get a new understanding of the information by having others look at it. If partners truly share mutual interests, what reason could there be to withhold relevant information from a partner?
Estimating the level of fixed credit costs
On the macroeconomic level, capacity utilization rates are a good indicator for the level of fixed costs of the corporate sector, because the higher the utilization rates are, the less the costs of maintaining the infrastructure to generate one unit of output will be. Furthermore, an increase in industrial output hints at rising revenues and solid cash flows for the companies. This strengthens the companies’ abilities to service their debt. Therefore, credit spreads tend to tighten when capacity utilization and industrial production increase. Yet, rising cash flows tend to invoke business investment, particularly when capacity utilization rates are above average. Historically, levels above 80–82 percent have been a threshold above which the willingness to invest has increased significantly. Like capacity utilization rates, industrial production is a coincident indicator for the state of the economy. Across the business cycle, credit spreads tighten when industrial production grows, and sell off when the economy is doing poorly. Usually, when the economy is doing well, default rates tend to fall and the more positive sentiment usually leads to a lower level of risk aversion. Therefore credit investors settle with lower spreads than in times of poor economic performance.
Low loans capacity utilization is good
Investors can also see low capacity utilization as good news since it means there is little near-term risk of demand getting ahead of supply, sparking inflation. And that means the Federal Reserve should not have to raise interest rates aggressively for quite some time. Large amounts of unused production capacity acts as a buffer that diminishes the inflation risks implicit to rising demand. The other clear sign of the high level of operating leverage in the US corporate sector is the jump in productivity.
Of course, for productivity increases and low capacity utilization to work through to corporate profits, business sales still need to pick up. Therefore, final demand has to increase. For the economy to really soar, businesses have to start spending on hiring workers, new technology and capital improvements. And usually will, once the evidence clearly shows that profits are perking up.
Introduction to credit operating leverage
For the last couple of years the broad economy has experienced an extraordinarily high level of operating leverage and consequently since 2000, companies have cut costs. The best evidence of that elevated level of operating leverage is the very low rate of industrial capacity utilization. Despite the modest improvement since 2001, utilization is still at levels not seen since the 1982 recession. On the one hand, that is a sign that businesses continue to suffer from overcapacity. Looked at it another way, however, the low-but-improving rate of capacity utilization is an indication that profits may grow above average in the future.
Growth investing has an addictive quality
Growth investing has an addictive quality. Just as the alcoholic rationalizes away hangovers and arguments in the belief that the next bottle will bring happiness, the growth investor rationalizes away P/Es, asset prices, burn rates, and all other measures of financial value for the dream of finding the next Microsoft. When growth slows and the stock price collapses, unhealthy investors try to get even. Rationalizing away the recent collapse, they invest their remaining funds as well as new savings and borrowings. A fresh collapse can then send them into deep depression.
Only investors aware that they are buying a fantasy will be comfortable with growth stocks. Idea people have fun with growth stocks. There is always a new idea that could grow into a world-beating company. Number people suffer from growth stocks. Number people do fancy calculations of sales, earnings, book value, return on capital, and growth rates to determine the likely price of a stock in five or 10 years. Number people are heartbroken when all their fancy calculations turn into losses.
Worker bees will have fun with micro cap stocks. These are companies too small to be included in the indexes or to be owned by the mutual funds. No analysts cover these companies. If you enjoy discovering stocks no one has ever heard of and are interested in working hard at finding and analyzing these companies, the financial rewards are high. You will not be able to toss out the names of your stocks at parties because no one will know what you are talking about. Patience is required because these things take time to be found by other investors and bid up in price. This is often a lonely but rewarding business.
Investors without patience or research skills may be tempted to buy micro cap mutual funds. Unfortunately, the micro cap mutual funds have all the problems of other mutual funds: they all buy the same stocks, get caught up in manias such as tech mania, tax you for gains that were not yours, siphon off fees, and focus on gathering assets and marketing rather than increasing your returns. And micro cap funds buy such large amounts of stock that they bid up the price of shares as they buy, then they depress the price as they sell. Micro cap mutual funds have many built-in resentments.
Are we talking personal growth or portfolio growth?
Stocks that collapse in price were once known as dogs and cats. Brokers started calling them value stocks and were able to peddle them to individuals and mutual fund managers. Unfortunately, value stocks are highly unstable. Many are troubled companies headed for bankruptcy. Others are turning around. In today’s markets, value stocks can quickly become overpriced.
Then value fund managers sell them to growth managers. Investors looking to value stocks for low volatility will not find it. Growth stocks are overpriced stocks that are hyped as having huge earnings potential. Growth investors are gullible sorts who believe a few years of fabulous growth will be repeated for decades. They are willing to pay any price for this dream.
The tech mania of 1999 was an extreme example of this magical thinking. Growth investors convinced themselves that untested Internet companies would take over the American economy in a few years. Tech mania has a long and sad history in stock investing. Tech mania generally ends badly. Railroad stocks got up a full head f steam and then jumped the track in the late 1800s. Electricity plays and auto stocks had huge booms and busts in the early 1900s. Long-term studies show that tech stocks do no better than the overall market. However, they are subject to periods of extreme volatility. Tech stocks, when the mania is on, double and triple in a few months. Then they lose 95 percent of their value in the crash. Tech stocks are for dreamers and speculators, not investors. People who do not mind losing a few thousand dollars for the potential of extreme wealth are comfortable with tech stocks. Investors with low self-esteem, who may throw good money after bad, should stay away from tech stocks and other growth stocks.
What value is value?
One of the great marketing tools for stocks is the promise that there is a product that will work for every investor. Companies, brokerage firms, and mutual fund houses are constantly putting out new products to sell to discouraged investors. Financial professionals never miss an opportunity to sell a gullible investor a stock. They have invented a wrench to fit every nut.
No stock style or category eliminates the basic problem with stocks. Style is supposed to take the sting out of investing. Unfortunately, all stocks, regardless of category, are subject to the whims of the herd.
Utility stocks are marketed as steady income vehicles akin to Treasury bonds, yet they are often as volatile as tech stocks. Utility stock prices were cut in half when Three Mile Island threatened to ruin the power business.
They were whacked again when deregulation eliminated their monopoly position in many markets. Recently, increased gas prices sent the once steady and reliable PG&E into bankruptcy and put Southern California Edison on the brink of bankruptcy.
Each type of stock creates its own emotional complexities. Preferred stock was one of the marketer’s first products. When common stock investors realized that in financial stress, the company canceled dividends but paid bond interest, they sold stock and bought bonds. Companies then began to issue preferred stock with fixed dividends. Preferred stock dividends are paid when a company is in stress, but in bankruptcy, preferred stock is canceled, the same as common stock. Few investors are comfortable with this netherworld between bonds and stocks. The complexity of determining how to value preferred stock keeps many investors away. These days stock is considered a pure capital gains vehicle and bonds are used for income.
Problem with Complete powerlessness
Panic has a bad reputation as an investment emotion. Brokers, mutual fund companies, journalists, and others who profit from the stock market know that panicked investors often avoid stocks for decades. They portray panic as the worst response to powerlessness in all circumstances. However, panic is a healthy response to many powerless situations. Investors who panicked out of the stock market in 1929 at the low reacted well. The market continued down for three more years and never returned, on a sustained basis, to the 1929 low until the early 1950s. Tech investors who listened to the stock promoters and did not panic in April 2000 made a grave error. Many still sit on tech stocks that are worth a fraction of what they were in March 2000.
For the emotionally mature, powerlessness is a relief. There is great freedom in recognizing powerlessness, surrendering, and moving on. For the immature, powerlessness can lead to desperate acts, usually selfdestructive. Consider how you react to powerlessness.
Discretionary income is the key
With an increase in positive cash flow, you can direct more toward your debt. The more debt you pay down, the less interest accumulates during the following week, month, or year. The less interest accumulates, the greater the amount of your next payment that gets applied to the balance, and so on.
By increasing your positive cash flow, you can ultimately increase your debt payments. Instead of being caught in a downward and negative spiral, you find yourself in a positive, upward spiral. There is a name for this “positive cash flow” that you need to increase in order to eliminate your debt. It’s called discretionary income.
While the term sounds complex, it’s simple when you stop and think about it. It’s the income that’s left after all your required bills have been paid; you choose how to spend it. To accelerate the process of getting out of debt, you ultimately have to increase the amount of discretionary income left at the end of the month.