Investors shouldn't fear higher interest rates

Back on Febuary 6th a subscriber to this blog sent me an email that included the following question:

"Can you do an article on what happens when interest rates rise and investors pull out for more favorable returns through bonds and if we should hold or sell and buy at a lower price"?

The inference is that with interest rates climbing, that means that fixed income type instruments and other vehicles such as bonds, that they'll be more attractive and could lead to people taking money out of the market.  

My opinion?  I'm not worried about interest rates climbing, in fact I consider it to be extremely bullish for stocks.  This is something I've written about before, and its one of the reasons why I think retail investor so often lose out when playing the market.  

Central banks use interest rate policy in an effort to influence the broader economy.  When interest rates drop retail investors will often get excited, thinking that it bodes well for the future because the cost of money is dropping.  Likewise when rates climb some retail players get scared, fearful that higher rates will lead to money leaving equity markets.  

But investors need to understand that when interest rates climb, it means that central banks are bullish about the overall economy.  Conversely when they drop rates, it means that the broader indicators are showing weakness.  The take away is that when you see interest rates climbing higher, in my opinion its a signal to be bullish on stocks, and when rates drop...that's the time to be fearful.

I'll toss in another couple of thoughts on broader market issues. The question from the subscriber suggests that bonds will be offering more favourable returns as rates climb.  Not true, not in the broader bond market.  Understand that with bond yields, the return is inverse to interest rates.  As rates climb bond yields drop, and as rates drop bond yields increase.

Huh?  When interest rates climb bond yields go down???  Yeppers.

Bonds trade like stocks, and there are two things in play.  The interest rate they pay and the coupon value.  Say you hold a $5,000 government bond paying 1.5%. and interest rates go to 3%.  Who's going to want to buy your $5,000 bond paying 1.5% when the ones being issued now pay 3%.  The coupon value (what your bond trades at) is going to drop, resulting in a lower yield.  

The flip side is when interest rates drop.  You're holding that $5,000 bond paying 3% and then rates drop to 1.5%....now the coupon value of your bond increases because its paying twice the interest as the bonds being issued currently.

I have money in ETFs and Mutual Funds, but its been over a year since I reduced my bond exposure to 0.  I'll look to move back into bonds when the central banks start signalling that cuts to the overnight lending rate are coming.

Okay....and my last thought, its about the volatility the market has been displaying of late.  My opinion, Fughettaboutit.  The reasons?  The changes to the US tax codes that take affect this year.

Right now we're in earnings season, but the numbers being reported aren't for 2018, they're for the 4th quarter and year end of 2017, before the tax changes came into effect.  I expect we'll be seeing companies taking whatever charges and write downs they can to reflect lower earnings than what might have been foretasted and for the capital markets to continue with the volatility we've been seeing of late.

Why?  Its that old buy low sell high bromide.  To buy low you need others willing to sell low, and nothing makes people more nervous than seeing the value of their holdings drop by 10% or more.  But if some people are scared and selling, there have to be others willing to buy.  

Come June when results from the first quarter come out I expect we'll see improved results, with the benefits of lower corporate taxes starting to show up on the books of profitable companies.  Do note that I'm expressing a broader market opinion here, and its with respect to profitable companies....I'm not commenting on money losing speculative companies.  Companies that are simply adding to their accumulated deficits won't see any benefit to lower taxes on corporate profits, because they don't have profits.

That's it for now.....happy trading, be careful out there and remember, nobody ever goes broke taking profits.  

Vuzix - The reason for my fixation on this money losing and constantly diluting company

A question I'm frequently asked on social media sites like Stock Twits where I post with the user name growacet, is why I'm so fixated on a company like Vuzix when I have such a negative opinion.

Its a fair question certainly, and one I will attempt to explain.

Firstly let me deal with the subject line wherein I describe Vuzix as a company that is losing money and constantly diluting.  Is that factual?  There can be no question that Vuzix is a money losing company, all you have to do is read their filings.  Their last released 10Q quarterly report came out on the 9th of November 2017 covering third quarter results up to Sept 30th 2017.  Here's the link:

http://secfilings.nasdaq.com/filingFrameset.asp?FilingID=12372885&RcvdDate=11/9/2017&CoName=VUZIX%20CORP&FormType=10-Q&View=html

Just The Facts

All you have to do is a Ctrl F search for the "loss attributable to common stock holders" and you'll see that for the three months ending Sept 30th 2017 the company reported losses of over $5.9 million.  For the 9 months ending September 30th the losses come in at over $15 million.  

So depicting Vuzix as a money losing company is certainly accurate.  But what about constantly diluting?  

That will depend on one's definition of "constantly".  Obviously Vuzix isn't printing shares every single day of the week.  You might have a friend who is "constantly borrowing money" from you.  For some that might mean getting hit up every week, for others being asked 3 or 4 times a year for cash to "tide me over" would qualify as constant.  

So how often is Vuzix hitting up investors to raise much needed cash?

Dilution Dilution Dilution

-On August 9th 2017 the company announced raising a little over $8.6 million less fees and commissions by issuing 1,500,000 shares.  

-Then on December 14th 2017 they raised another $12.5 million, again less fees and commissions, by issuing another 2,066,116 shares.  That raise included issuing 1,033,058 warrants priced at $7 per share which can be converted 6 month after being issued.  This is significant because if Vuzix can manage to keep its share price above $7 into the summer then those warrants would be "in the money" which could result in further dilution.  Of course if VUZI falls back below $7, then they're basically worthless.

-The most recent raise was announced Jan 24th of 2018.  This one was for $30 million, and again that's less fees and commissions, by issuing 3,000,000 shares.  They also issued 1.2 million warrants with an exercise price of $10, but given the drop in the PPS those warrants are obviously well out of the money.  

So in less than 6 months Vuzix did three raises, issuing 6,566,116 shares raising a little over $51,000,000 less fees and commissions.  I don't know if everyone would qualify that as "constantly diluting", but its close enough in my books.  Especially considering there are warrants still outstanding.  

Then of course there's Intel's position, back in November of 2016 they ended their headset partnership and disclosed that they were looking for alternatives for their investment in the company.  If they liquidate you can add another 5,000,000 shares to the pile on conversion.  If that happens there won't be a cash infusion coming, Intel's $25 million from 2013 must be long gone or the company would not have needed to keep printing more and more shares.  After all, the accumulated deficit up to Sept 30th 2017 was already over $90.5 million.

Alright, I hear what you're saying.  I still haven't explained my fixation on this company.  All I've done is present some simple factual data which anyone with the time and inclination can research and verify.  

And that's what it comes down to.  Simple facts.  I love the capital markets the same way some people love politics.  When it comes to political arguments you see people fixated on an issue or a personality all the time.  Maybe never more so than with the battle between supporters of Hillary Clinton and Donald Trump in the most recent U.S. presidential election.

Why do people get fixated on Donald and Hillary?  I put it down to ego engagement, they want to express their opinion.  And personally I don't have an issue with someone supporting Clinton or Trump, but I do get my shorts in a bit of a knot when people misrepresent simple facts.  

Imagine a Hillary supporter saying:  "The fact is Hillary Clinton has never reversed herself on any position and has never accepted money from big business interests".  The Trump supporter's head would probably explode, mine too.  Or if a Donald fan said:  "The fact is Donald Trump holds women in the highest regard and has never used sexist language to describe any woman". You'd have to be living under a rock to not know how out to lunch that statement is. 

Support Clinton or Trump, I don't care because I thought (and still think) that they both suck. But for God's sake don't distort or simply ignore basic facts just to get people to agree with your point of view. 

The same thing holds true with a company like Vuzix, don't distort or ignore factual reality just to get people to risk money on the stock. That's what I see every day on stock forums and social media sites like Stock Twits.  

Of late I've been crossing swords with a user who posts with the name cthompson.  This individual loves to post about things like a "buyout" like there's an actual deal on the table, instead of just a mindless pump pulled out of his nether regions. Others tout Vuzix as having "solid fundamentals".  How you can describe a company that does three cash raises totalling over $50 million in roughly 6 month as being fundamentally solid is beyond my comprehension.

So put it down to ego engagement, that's why I fixate on a company like Vuzix.  My opinion is that this company is using promotional IR firms to get investors excited about a business that ultimately is not viable.  And when the PPS climbs big, there are individuals who think that a rising PPS confirms that the company's prospects must be good.

What does viable mean?  For me it means a business that is able to generate sufficient revenues to cover expenses with profits left over, if not now at least sometime in the next few years.  Others may view viable as meaning having an idea or a product capable of exciting investors enough for them to finance huge losses year after year, by this definition Vuzix is very viable in my opinion.

Dislcosure

Its always nice to have some skin in the game of course.  Shorting though is an incredibly risky proposition.  

Some people caught onto the fact that Nortel was a disaster waiting to happen when it was trading under $100 per share.  Another example would be Cynk Communications when that company was trading for $5 or even $10 per share.  Followers of the tech space know neither of those two stories ended well for those who bought and held on until the bitter end.  

But those who decided to sell short, even though their opinions were ultimately right....if they shorted Nortel when it first climbed to $80 or CYNK when it first went to $5 or even $10, they faced huge losses.  

Rather than going short by borrowing and then dumping shares back into the market, and exposing myself to potentially big losses as happened to Nortel and CYNK bears when those stocks got pumped to high heaven, instead I own put options.  With futures contracts like puts the risks are far less, and there's an absolute floor in terms of the potential for losses.  Short sellers on the other hand, theoretically at least the potential for losses is limitless.

I know that, even if I'm ultimately right in my opinion that Vuzix will never realize significant enough revenue to be earnings positive, that doesn't mean the stock still can't get pumped sky high.  All it would take is for a media personality with a big following to tout an investment in Vuzix as rock solid.  

I remember back in 2005 and 2006 when some sharp minds saw what was coming to the US housing market.  Still there were media "experts" out there telling people that buying a house was the best investment they could make, and as housing prices continued to climb the naysayers were trashed.

So go ahead Vuzix pumpers, trash me all you like.....but in the end I don't see this ending well.  With stocks its a zero sum game, some people will end up with shares, others will end up with money.  

Good luck, here's hoping my readers put cash in the bank.