Ethics And Legislation

Unfortunately, most legislation is the result if unethical behavior. As part of the Sarbanes-Oxley Act, the SEC passed Rule 13a-14 that said CEOs and CFOs are required to sign and attest that the financial statements filed with the SEC do not include material misstatements or omissions. In 2013, a judge found that the CEO and CFO of Basin Water were not liable for sham transactions since they were not directly involved in the transactions. The 9th U.S. Circuit Court of Appeals recently overturned this decision and stated that "a mere signature is not enough for compliance" and is allowing the SEC to sue for disgorgement of gains. The recent ruling makes it even more important for CEOs and CFOs to run ethical companies.

Accounting Cash Flow Makeover

The Accounting Statement of Cash Flows received a makeover as FASB updated the treatment of eight different cash flows. As you will read, whether the updates provide any meaningful change is not clear, as two Accounting professors interviewed have differing opinions on the update. Unfortunately, FASB did not address what we feel is a glaring weakness in that interest expense is still considered an operating cash flow, rather than being included correctly in the financing cash flow section.

Currency Trading Shrinks...Maybe

So how much currency do you think is traded daily? According to a recent report published by the Bank for International Settlements (BIS), average daily trading in April 2016 was about $5.1 trillion! This was down from $5.4 trillion per day in April 2013. However, if the dollar had not appreciated over the period, average daily volume would have risen about 4 percent. Spot currency trades were about $1.7 trillion per day, swaps accounted for about $2.4 trillion per day, and the rest of the trading was for other over-the-counter foreign currency derivatives. The U.S. dollar was on one side of 88 percent of trades, while the euro was on 31 percent of trades.

Negative Yield Triangular Arbitrage

A question we often get is if the material we discuss is actually relevant to the real world. However, we can see the application of triangular arbitrage with the seemingly strange desire of investors to purchase the $9 trillion in below zero interest sovereign debt. A Japanese 3-month government bill is currently returning about negative .24 percent. The buyer can borrow at the yen 3-month LIBOR, which is about negative .02 percent and receive the dollar LIBOR at .82 percent. The buyer then executes a yen-dollar swap, which results in a dollar-hedged yield on the trade of 1.24 percent. With the 3-month U.S. Treasury yield about .25 percent, and increase in annualized return of about one percent is a huge increase for portfolio managers.

High Yield Bond Defaults Expected To Rise

Standard & Poor's Ratings Services expects default rates on high yield bonds to increase to 5.6 percent over the next 12 months, which implies that 99 issuers will default. The increase is due in large part to the decline in oil prices, although a delay in an interest rate increase by the Federal Reserve could offset the increase risk. However, in large part due to the low and negative interest rate environment, investors are pouring money into high yield investments resulting in a decline in the yield spread of high yield bonds dropping from 815 basis points in February to 560 basis points in July.

Indexes Win Again

One method that has been used to examine if the stock market is semistrong form efficient is the performance of actively managed mutual funds. A recent study by S&P indicates that most actively managed mutual funds still lag the appropriate market index. From 2011 to 2015, over 88 percent of mutual funds failed to beat the S&P Composite 1500. And 84 percent of large cap funds failed to outperform the S&P 500. In fact, over the past five years, the fund category with the best performance for retail investors relative to its index was the mid-cap value category, with only about 30 percent of mutual funds in that category outperforming the S&P Midcap Value 400. Small cap growth funds were the worst, with only about 8 percent of funds beating the S&P SmallCap 600 Growth index. So, even if you don't believe the stock market is efficient, as this shows, it is very difficult to outperform the stock market.

2016 Working Capital Survey

CFO just published the 2016 working capital survey by REL Consulting. The 1,000 large U.S. companies included in the survey had about $1 trillion in excess working capital based on companies in the survey matching the top quartile performers. Overall, the cash conversion cycle increased by 2.5 days, although much of this was driven by the oil & gas sector. If this sector was excluded, the cash conversion cycle actually fell by .1 day.

The best performer in the cash conversion cycle was Murphy Oil a negative 463 days due to a payables period of 600 days! Some of the other top performers in the cash conversion cycle were Noble Energy (negative 295 days), ITC (negative 282 days), Anadarko Petroleum (negative 245 days), and Apple (negative 66 days). On the other end of the performance scale, some of the longest cash conversion cycles were at United Therapeutics (794 days), Zoetis (344 days),  Eli Lilly (277 days), and KLA-Tencor (246 days).