Pamplona On Tap: Large-Caps Ready To Run

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David Evanson and Oliver Pursche

Forbes.com, Spring, 2013

The harsh reality for investors is that low interest rates are here to stay—in my opinion for many years to come.

Yes, there are some signs of strength in the U.S. economy, but globally the environment is still shaky.

Europe’s purchasing manufacturing index for March fell more than expected. March U.S. employment report showed just 88,000 jobs were created that month. Japan continues to be in a deflationary cycle, and Latin America is experiencing higher than desired inflation and tightening credit conditions.

Not encouraging data points, but the perfect ingredients for a multinational, large-cap bull run. Think of the Running of the Bulls in Pamplona, with perhaps a few overly bearish investors— certainly ones with the temerity to short large stocks—getting gored in the Street.

According to data compiled by Morningstar, globally, investors pulled some $124.7 billion dollars from equity funds in 2012, while pouring $535.2 billion into fixed-income funds. However, in a long-awaited shift that trend has started to turn around.

More monies flowed into equities (mutual funds and ETFs) in the first quarter of 2013 than monies flowed into fixed-income funds. Historically, tepid investors have gravitated to large companies they are familiar and comfortable with—the Procter & Gamble (PG), Pfizer (PFE) and McDonald’s (MCD) of the world. This holds true for individual as well as institutional investors.

Low interest rates are great for large companies for the simple reason that they are able to substitute debt for equity at very low borrowing costs. Venerable IBM, for instance, used the proceeds of a 2010 bond offering (which pays a 1% yield) to repurchase shares, which had a 2% dividend yield at the time.

Others have caught on to the strategy: In 2012, American companies spent more than $400 billion to buy back their own shares. In the first quarter of 2013, U.S. companies have announced more than $120 billion in new share buybacks.

This easy credit is not universally available, however. For smaller companies, credit is still tight and low interest rates have not induced the robust job growth. This lackluster recovery will perpetuate the low interest rate environment, as driving the worlds’ fragile economies back into recession are too great for Central Banks to tighten monetary policy. It will also tilt the playing field in favor of large-cap companies utilizing their cash to repurchase shares and raise their still tax advantaged dividends.

Here’s a list of companies, all owned the GMG Defensive Beta Fund (MPDAX), which I co-manage, and most of which are held in separate accounts managed by our firm. They all have increased their dividends and had share buybacks within the last year according to Bloomberg data. I can almost hear the hooves on the cobblestones.

Exxon Mobil (XOM)
Johnson and Johnson (JNJ)
United Parcel Service, (UPS)
CVS Caremark, CVS
Wal-Mart (WMT)
Chevron, (CVX)
Microsoft, (MSFT)
Home Depot, (HD)