Crossing the Rubicon – III

Many years ago, more than I care to remember, I read a novel by Gabriel García Márquez called Chronicle of a Death Foretold (skip the rest of the paragraph if you do not wish to know how it ends, oh well, you are going to find out anyway). This is a story of a vengeance loudly proclaimed in a small town, where everybody knows two men are set to kill another but nobody seems to be able to tell it to the victim-to-be, who inevitably (or not, that is the whole point) gets killed.

Apart from the fantastic way (in both meanings of the word) García Márquez tells the story (any story for that matter), the reason this novel struck me most was because it tells of an event that seems easily preventable but, in all likelihood, inevitably happens. In capital markets this would translate to markets possessing all available information but market prices refusing to move accordingly. This, we are told by some of the best minds, cannot happen. Prices only move immediately after new information is incorporated and, if markets are efficient, no one can consistently outperform the market (produce abnormal returns). The story I’m about to talk about could very well be one of how information moves across market participants allowing some investors abnormal returns (if not consistently, at least in this case) but, any defendant of the EMH can easily show how wrong I am by moving the goalposts on what the hypothesis says. It is not that markets are not efficient. It’s just that, in my view, the Efficient Market Hypothesis is unverifiable and thus unscientific, but that is not what I want to talk about.

What I want to talk about is the collapse of the price of Apple shares, from slightly over 700 dollars to below 450 dollars since mid-September. A chronicle of a death foretold. Particularly the hit last Thursday after the company had posted record quarterly revenues and profit, while margins came down and EPS slightly lower y-o-y. It seems the market was reacting to new information as results, good as they seem, also tell how the company’s growth cannot be extrapolated from past experience. But, this was not something that hit the market overnight. If something, Apple’s financial results forced people to act upon already existing information or, better still, act upon the subjective perception of reality a significant number of shareholders had developed during previous months: that market conditions made of Apple the safest share any portfolio could own but the point had been reached where everybody considering that strategy was already over-weighted. It was public information that a significant amount of hedge-funds held significant quantities of the share in their books. Apple, with virtually no debt, sitting on a pile of cash and selling products in high-demand (and paid for in cash) was the closest thing to a safe-haven in these troubled times for stock markets. But it could not maintain that path forever.

As the stock plummeted analysts came out downgrading the share. The timing was so perfect one must suspect valuations were already in the main draw, all they needed was for a few blank spaces to be filled, waiting for the right occasion to see daylight. It must be said that, at current levels, most of these downgrades show the stock as a buy or even a strong buy. Yet that didn’t stop the fall as markets know that, everything else being normal, stock-analysts are biased. A “Buy” meaning ok and “Neutral” meaning it’s time to sell. It’s the price analysts have to pay for companies to let them have some information to work with (furthermore, almost nobody likes to listen to a good sell story). But more importantly, a lot of articles came out on the papers about how good Samsung, or any other competitor for that matter, are and how, ultimately, Apple fell victim of their own success.

It was only the weekend before I entered my local Apple Store thinking about buying a MacBook. I did not buy it, and yet, I’m pretty sure I will. I used to think Apple was a posh company that made overpriced products until I started buying them. Then I realized that I can afford to be overpriced: their gizmos work, they sell apps at affordable prices (for people that don’t have the time to find freeware or get a pirate copy) and have a wonderful commercial and technical service. Once they gave me a new ¡Phone when they could not understand what was wrong with mine (the guarantee had expired) and reimbursed me for an app I downloaded by fat finger mistake a long time after I had bought it unaware. I do not think these things will vanish now that the shares are worth less than $450.

Furthermore whenever I go into their store the employees are so nice I believe I am in America. But the best thing is they do not act like they are trying to sell you something while being nice, so it’s like being in a perfect America. And another thing, despite being such a motley crew, they have one thing in common: they genuinely seem to enjoy what they are doing. At Nespresso they try to cause the same impression but it always seems a bit phony to me. Maybe it’s because I don’t understand how drinking coffee can be so exciting. It isn’t. At least not for me, and I think I spent more money on coffee than ever will on Apple products. Anyway, the Nespresso brand seems to be doing pretty well.

Then I started to think that maybe, just maybe, it is the other way around. Maybe it is not such a great thing for the company to be worth over $700 dollars a share. Since there is no majority shareholder running the company, who can do whatever he thinks best to serve his clients without really caring how much the stock is worth as he is not going to sell it anyway, the dispersed capital will undoubtedly pressure for the company to improve their numbers to justify the $700 they just paid (or the opportunity cost for not selling), and they are entitled to do so. However, this was more or less why Steve Jobs was fired in the first place and the company (and its shareholders) seemed to come worse off. Yet, unlike a lot of people out there, I don’t think that people that bought Apple at $700 (or chose not to sell) are dumb, at least not all of them.

Maybe I’m wrong but it turns out that massive pile of cash Apple is said to have under their seats is not entirely made of…well…cash. Most companies have funds invested in very-short-term-low-risk securities they can get rid of at short notice without a significant, if any, amount of loss. But the 140 billion dollars that Apple owns in cash and securities surely stretch a great deal along the yield curve and diversify a lot more than your average company. As things are, Apple is a massive investment fund and interest rates on the rise must have produced some damage on their mark-to-market. Wait a minute, do they have to mark-to-market their funds? I don’t think they do, at least not the way investment funds have to produce a daily valuation of their portfolio. So, people were buying into an investment fund whose strategy they ignore, apart from the fact that their main asset is the operational side of Apple but, nonetheless, re-invests the bottom line of that into that same fund? Does this make any sense? When the economy is deleveraging, yes it does, a lot. After all, whatever those fund managers are doing, they are dealing with the money of their own company, they are not leveraged and they most likely do not have performance incentives to take too much risk (not really sure on this last one).

Now, the interesting question about all this is why does Apple do what it does (apart from computers I mean)? Why not distribute their profits to shareholders and let them re-invest or outright spend in whatever it is they want to re-invest? Isn’t that what we all learned made economies more efficient? Entrepreneurs finding or creating new opportunities, capital flowing through trial and error or intelligent insight to where is more urgently needed? The reason why Apple keeps such a large amount of cash is for tax saving purposes and, however competent as investors people managing that cash might be, they will not beat the shareholders of Apple in doing that job. Firstly because shareholders were the ones actually investing in Apple and more seriously because Apple managers cannot withhold, act upon or create as much valuable information. Taxing dividends over capital gains seems like a good idea to force companies to re-invest but it prevents a lot of alternative investment or consumption decisions that, because they will never happen, will never be missed. As Bastiat famously wrote:

“In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause – it is seen. The others unfold in succession – they are not seen: it is well for us, if they are foreseen. Between a good and a bad economist this constitutes the whole difference: the one takes account only of the visible effect; the other takes account of both the effects which are seen and those which it is necessary to foresee. Now this difference is enormous, for it almost always happens that when the immediate consequence is favourable, the ultimate consequences are fatal, and the converse. Hence it follows that the bad economist pursues a small present good, which will be followed by a great evil to come, while the true economist pursues a great good to come, at the risk of a small present evil”

Tax exemptions are usually seen as beneficial as they mean more money is available for private enterprise. Yet they are a political weapon to split between those who easily can and easily cannot be taxed – a political application of the divide to conquer rule – creating grave distortions in the economy. They do not foster economic growth to the same extent. And, in the process, are unintentionally pushing good companies into what they were never meant to be: financial asset managers.


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