CAPTRUST Chief Investment Officer
A recent San Francisco vacation reminded me how differently information travels now relative to days past. I started my investment career in the City by the Bay, and with a job tied to East Coast market hours, to call it a strange existence is an understatement. I had to be in the office at 4:00 a.m. pacific time each day, and in a nostalgic bid during my vacation I decided to take a stroll to my old office during the early hour in which I used to go to work (I am not normally up for punishment during time off, but our hotel was close by and I had not yet adjusted to pacific daylight time). Hours before most of the city awakes, this band of brokers, traders, and the few restaurateurs open to serve them zip across California and Montgomery Streets, with the financial professionals sprinting to join conference calls originating in New York or London.
My first task each day was to prepare senior team members for the morning call, an event where our firm’s research professionals around the globe detailed their freshly published views. Preparing my teammates meant assembling packets that included proprietary research views from analysts in Asia, Europe, and the Americas and excerpts from financial newspapers, industry newsletters, and the local press; needless to say, the morning packets were thick and Bay Area paper companies loved us (as did copier repair people). My boss and mentor encouraged me to not just hit the “start copy” button and catch up on some elusive z’s, but instead to read what I was copying and write down what I did not understand. I share that same advice with young CAPTRUST professionals; finance is a language, after all. The morning packet was designed to synthesize information from disparate internal and external sources, but no one could possibly have read through all the material in that surrogate door stopper, no matter their financial language fluency.
Many years later, I now wake up on the East Coast, craving the same information I once compiled for more colleagues. Thanks to mobile technology, tablets, and other gadgets that can barely serve as paper weights let alone door stoppers, all the news fit to print is now delivered via electronic packets. With the advent of Twitter and its messages under 140 characters, quick updates on Facebook, the prevalence of text messages, and the general push towards consuming information smaller and faster, a lot of financial market analysis does not come in long form but instead is “bottom lined,” or the upfront conclusion is made with a bullet point or two of supporting documentation, or maybe a few paragraphs. This is intended to be a convenience; in a world with competing media outlets, research houses, and, dare I say it, advisors, having someone synthesize news and provide the proverbial punch line is a value-added service.
While the analysis may be getting shorter, what is being analyzed is actually lengthening. This is true at both the micro (individual company) and macro (broad economy) levels. University of Notre Dame researchers Tim Loughran and Bill McDonald, studying annual company filings with the SEC known as Form 10-Ks, found that when measured in terms of data size, the average 10-K totaled 92 kilobytes in 2000 but had increased almost five-fold by 2012.1 Ironically the SEC adopted the Plain Writing Act of 2010, a rule designed to help the public read government documents. According to the SEC, it — along with other federal agencies — must use “writing that is clear, concise, well-organized, and follows other best practices appropriate to the field or subject or audience.”2 This Act followed the SEC publishing “plain English” guidelines in 1998, so perhaps companies decided to use longer sentences to comply with the SEC’s wishes.
Capital markets, however, have not been kind to companies issuing longer 10-Ks. Loughran and McDonald found in a 2013 study that, when controlling for other factors, companies that issue large 10-Ks are empirically associated with, among other things, abnormal return volatility and greater disbursement of analyst expectations of future earnings.3 More succinctly, the more words, the more questions from investors.
On the macro side, one calendar-consistent and highly anticipated central bank disclosure comes in the form of interest rate decisions and policymakers’ accompanying statement. The U.S. Federal Reserve has embarked on a massive stimulus effort since 2008, recently highlighted by its quantitative easing program, which entails buying securities, specifically government and mortgage bonds, on the open market in an attempt to drive down interest rates and promote consumer spending and bank lending. The Fed’s balance sheet has grown from under $900 billion in late August 2008 to $4.2 trillion as of April 2, 2014.4 As we have cited in past articles, Federal Reserve announcement days have been empirically linked to higher equity market returns; quite simply, markets care what the Fed has to say.5
As the Fed’s balance sheet has gotten larger, so has its verbosity.
September 2008 represented the financial crisis’ epicenter, and financial markets have hung on the Federal Reserve’s every word since. A Deutsche Bank research report captures the relationship between the Fed’s balance sheet and its post-meeting communiqué, citing that since the year 2000, you can make a very well-educated guess about how large the Fed’s balance sheet (brown line, left scale) will be based on how many words it takes the Fed to describe its latest action (green line, right scale). Based on Deutsche Bank’s research, the Fed’s gift of the gab has cost $6 billion per extra word; statements that used to range in the 150- to 300-word count now exceed 700.
So it appears that investors like more verbiage from the Fed (equities have performed extremely well during the Fed’s balance sheet expansion, and it’s hard to argue that the Fed hasn’t played a large part in lifting asset prices) but investors like fewer words from individual companies. Irrespective of who is doing the ’splaining, the complexity is going up — both micro and macro. Why more complexity?
• Federal Reserve stimulus declining. The U.S. Federal Reserve has cut its open market bond purchases to $55 billion per month from $85 billion, its third straight decision to slow purchases in as many committee meetings. Unless the Fed changes course, at the present rate of slowing, it will stop bond purchases by the end of 2014.
• Chinese economic uncertainty. Data from China has been mixed, but the world’s second largest economy has been growing at a slower pace than in recent years. Beijing has an official 7.5 percent growth target, but at an early April forum, Premier Li Keqiang noted that “the downward pressure on economic growth remains. We can’t underestimate these difficulties.”6
• Japanese consumption tax introduction. Japanese policy makers have launched a massive stimulus effort since Prime Minister Shinzo Abe’s December 2012 re-election, but a tax to help counter government debt may also counter consumer spending advances Abe hopes will push the economy forward.
• European Central Bank (ECB) policy. To date, European central bankers have not followed suit with their American counterparts, and investors fear that deflation could arise should the ECB not provide monetary policy support to a growing yet still stagnant economy.
The above points are not intended for shock value; the global economy has surmounted significant challenges during and since the financial crisis, and its resilience warrants applause. What is different now is that central bank policy has been a significant aid in getting the recovery started, and it is unclear if capital markets believe that riskier asset classes can sustain recent gains without central bank involvement. While asset prices and economic growth are not always linked, at current valuations for many equity markets, investors want to see more revenue translate into earnings as profit margins are already robust, and that equation typically requires an expanding global economic environment.
In an interrelated and highly complex global economy, my CAPTRUST teammates and I are fortunate to have numerous information resources at our disposal. In an environment where crosscurrents interplay with capital markets on a real-time basis, it is important not to get caught up in what can be distracting minutiae, and it is critical to read beyond the sound bites and headlines. Financial asset prices’ path forward is unlikely to be a straightforward one, and as markets digest the complexities I laid out earlier, expect some “market chop.” Our commitment to you is to keep you apprised of developments that may change our glass-half-full mantra about the global economy and a decent, albeit more muted, return environment than in the recent past. The financial information flow over coming months may be exhausting, but I promise you no more exhausting than the walk back to my hotel from the bottom of California Street.
1 Lahart, Justin. “Stop Throwing the Book at Investors.” The Wall Street Journal, March 23, 2014. http://online.wsj.com/news/articles/SB10001424052702304026304579453712116558776
2 From the SEC website, https://www.sec.gov/plainwriting.shtml
3 Loughran, Tim and McDonald, Bill, Measuring Readability in Financial Disclosures (July 16, 2013). Journal of Finance, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1920411 or http://dx.doi.org/10.2139/ssrn.1920411
4 From the Federal Reserve website, http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
5 See New York Federal Reserve Study from September 2011, http://www.newyorkfed.org/research/staff_reports/sr512.pdf