Monday, June 27, 2016

Drs. Mahajan and Krause recognized for teaching excellence

CFA Institute Program Partner News

Image result for cfa program partner logo
Recently the CFA Institute offered their congratulations to Dr. Arvind Mahajan, program director at Texas A&M, and Dr. David Krause, program director at Marquette University, for their recent notable achievements. 

The June 2016 CFA Program Partner Newsletter recognized two investment professors for teaching excellence - Dr. Mahahan of Texas A&M and Dr. Krause of Marquette University.

Arvind Mahajan named a Texas A&M Presidential Professor

Dr. Arvind Mahahan
Dr. Arvind Mahajan of Mays Business School has been named a Presidential Professor for Teaching Excellence at Texas A&M University, an honor he will retain for the remainder of his career.

Texas A&M President Michael K. Young announced this year's recipients of the award, which former Texas A&M President Robert M. Gates established in 2003 to underscore the importance of teaching at a major research university.

David Krause wins Marquette's inaugural Brennan Master Teacher Award

Dr. David Krause

Dr. David Krause, director of the Marquette University College of Business Administration's nationally recognized Applied Investment Management program, has been honored with the first-ever Edward A. Brennan Master Teacher Award. The award was founded this spring through a nearly $1 million award from the family of the late Edward Brennan, former chairman, president and CEO of Sears.
Dr. Krause, who joined Marquette in 2004 and was instrumental in building the AIM program, will carry the title of Brennan Master Teacher for three years, a distinction that rewards and encourages excellence in teaching. 

Friday, June 24, 2016

Brexit - Everything Good? Not Really. You Better Get Ready for More EU Exits.

Cartoons from Hedgeye on Brexit:

More referendum likely to follow in France, Netherlands, Italy, Norway, etc. Is this the beginning of the end of the European Union / Euro? Immigration and globalization/trade will be the political issues for the remainder of 2016 in US and Europe.

Tuesday, June 14, 2016

Falling, Negative Interest Rates Concern Jim Bianco, Leading Market Observer

Jim Bianco Comments on Falling (and Negative) Long-Term Interest Rates

Most readers of this blog know that James A. Bianco, who is President of Bianco Research, is a former Marquette student of mine. He is one of the leading financial market observers and since 1990 he has been producing fixed income commentaries distributed to institutional portfolio managers and traders. 

Jim produces unique and original insights into movements in the financial markets and has been a featured speaker at many investment conferences. He is regularly featured in the following investment publications: The Wall Street Journal, The New York Times, Barrons, US News And World Report, BusinessWeek, Forbes, Fortune, The National Review, Euromoney, and Grant's Interest Rate Observer in addition to the Dow Jones, Reuters, Knight-Ridder and Associated Press newswires. He has also written for Technical Analysis of Stocks and Commodities, Financial Trader and Futures Magazine and has appeared numerous times on CNBC, CNN, Bloomberg and Fox News.

His commentary today is especially important. Jim writes:

 “In the seminal book  A History Of Interest Rates, Sidney Homer and Richard Sylla traced interest rates back to the fertile crescent in Mesopotamia 5,000 years ago. Nowhere in the book will you find negative interest rates (last update was 2005).

The chart above shows that today Germany became the third country to see negative interest rates at the 10-year tenor. They join Switzerland, who’s rates went negative in early 2015, and Japan, who’s rates went negative earlier this year.

So human history has no experience with negative interest rates. No one knows how financial markets and economies are supposed to react to them. Are lower rates, even if negative, stimulative? Or when rates go negative do we enter an alternative universe where relationships change? This is our bet. All we have are guesses, most of which have not panned out. See the yen strengthening since Japan went negative on January 29. This was not the outcome that was expected.

We better start figuring out how negative rates impact traditional relationships in markets fast. As the next chart shows, we are now up to $13 trillion of negative sovereign yields.”

You can contact Bianco Research at:

Sunday, June 12, 2016

A Table of Fixed Income Performance by Sector Over the Past Decade

In preparation for the Fixed Income course (FINA 4065) at Marquette, I came across this useful historical information from  Ziegler Capital Management on the historical returns of fixed income securities.

Not surprisingly, high yield bonds (the riskiest of the fixed income securities included in the analysis) had an average annual return of 6.81% during the ten year period ended in 2015. What I didn't expect was to see that Municipal bonds were the strongest 3- and 5-year performer (with munis in 2014 and 2015 being the top performer). REITs were the second strongest performer throughout the 3-, 5- and 10-year periods - these have equity and fixed-income like characteristics. Asset-backed securities were the weakest performers.

Periodic Table:

Fixed Income Sector Performance Analysis

Click on chart to access report
(Sector definitions below)
The chart provides a detailed look at Fixed Income performance over the past decade, broken down by 13 sectors. This visual presentation of the performance helps point out the dynamic nature of the space and some of the sector trends in performance that have developed over the past decade.
  • Asset-Backed-Securities (ABS) have been a consistent longer term underperformer with 5-year and 10-year returns second to last. This asset class generally has a shorter duration, lower yield and is structurally more complex than other sectors.
  • Given its higher quality and yield advantage, investment grade credit has outperformed over the last 5 and 10 years.
  • Municipal Bonds have rebounded since 2014 and have been a top performer when looking at 3-year and 5-year annualized performance. This asset class has rebounded since the 2010 default scare and has benefited from its long duration and perceived safety.
  • Emerging Markets is a volatile sector and generally is either one of the best performers or one of the worst performers in any given year.
  • REITs have been a consistent top performer since 2006 which is reflected in the sector taking second across all annualized time periods. REITs have benefited from their relatively high income and dividend yields during a period of very low interest rates.
  • Global Credit has trended downward since 2012 relative to other fixed income sectors due to the challenging political and economic environment in Europe and Asia.

Ziegler Capital Management, LLC is headquartered in Chicago, IL with additional offices in New York, NY, San Francisco, CA, St. Louis, MO, and Milwaukee, WI. The firm manages portfolios across the fixed income and equity spectrum for a wide range of clients including corporations, mutual fund sub-advisory, municipalities, pension plans, foundations, endowments, senior living and healthcare organizations and high net worth individuals. Ziegler Capital Management was formed in 1991 and has grown significantly in recent years through strategic business combinations with experienced investment teams nationwide. Through these combinations, we have expanded our investment strategy offerings and broadened our portfolio management teams to best serve our expanding client base.
Learn more at

Fixed Income Sector Descriptions
Asset-Backed Securities (ABS)- A security whose income payments and value are derived from and collateralized (or “backed”) by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets which are unable to be sold individually.
Agency - Debt issued by a federal agency or a government-sponsored enterprise (GSE) for financing purposes. These types of debentures are not backed by collateral, but by the integrity and credit worthiness of the issuer. Officially, agency debentures issued by a Federal Agency are backed by the full faith and credit of the United States government.
CMBS Commercial Mortgage-Backed Securities (CMBS) - A type of mortgage-backed security backed by commercial mortgages rather than residential real estate. CMBS tend to be more complex and volatile than residential mortgage-backed securities due to the unique nature of the underlying property assets.
Emerging Markets - International government bonds issued by emerging market countries that are considered sovereign (issued in something other than local currency) and that meet specific liquidity and structural requirements.
Global Credit  - A global bond may be issued in the domestic currency, but the same issue may be offered in several countries at the same time. Global bonds may be traded either in domestic or foreign markets.
High Yield  - A high-yield corporate or credit bond is a high-income paying bond with a below investment grade rating. Because of the higher risk of default, these bonds pay a higher yield than investment grade bonds.
Investment Grade - Bonds issued by corporations which are rated BBB- or higher by Standard & Poor’s or Baa3 by Moody’s. These corporate bonds have a relatively low risk of default.
Mortgage-Backed Securities (MBS) - A bond secured by a residential mortgage or collection of these mortgages. These bonds can be issued by either GNMA, Fannie Mae or Freddie Mac and have maturities of either15, 20 or 30 years
Muniipal Bonds (Muni)- A municipal bond is a debt security issued by a state, municipality or county to finance its capital expenditures. Municipal bonds are exempt from federal taxes and from most state and local taxes, especially if the holder resides in the state of issue.
Real Estate Investment Trust (REIT)- A REIT is a type of security that invests in real estate through property or mortgages. They receive special tax considerations and typically offer high dividend yields.
Term Loans - A term loan is a loan to a corporation which generally has a floating interest rate, is senior in the capital structure and is secured by a pledge of assets as collateral in the event of default.
Treasury Inflation Protected Securities (TIPS) - A treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. TIPS are considered an extremely low-risk investment since they are backed by the U.S. government and since their par value rises with inflation, as measured by the Consumer Price Index, while their interest rate remains fixed.
Treasury - A treasury instrument is a marketable, fixed-interest U.S. government debt obligation. Treasury securities make interest semi-annually and the income that holders receive is only taxed at the federal level.

Thursday, June 9, 2016

Composition of the Current AIM Small Capitalization Equity Fund (All Holdings by Sector)

 AIM Small Capitalization Equity Fund Holdings 
(as of 6/9/2016)

Composition of the Current AIM International Equity Fund (All Holdings by Sector)

 AIM International Equity Fund Holdings 
(as of 6/9/2016)

Monthly Performance of the AIM Class of 2017's Student Managed Equity Funds

AIM Small Cap and International Funds are both up since the Class of 2017 began managing the portfolios on April 1, 2016

The students in the Applied Investment Management (AIM) program at Marquette University are responsible for managing two equity portfolios with a market value in excess of $2 million. 

According to AIM Director, Dr. David Krause, “The student-managed AIM funds provide valuable, real-time applied learning in investment analysis and portfolio management. The AIM students gain real world experience related to the topics and theories that are presented in the curriculum. These student-managed funds serve as a capstone to the finance and accounting courses the students take during their junior and senior years at Marquette. It is truly one of the best forms of applied learning I’ve seen.” 

How has the newest group of AIM students (the Class of 2017) performed thus far? Below you will see a table that shows the first two months of performance for the AIM Small Cap and AIM International Equity portfolios. 

The answer is that they've done fine. The two funds are both holding their own thus far - and both are up, but slightly below their respective benchmarks as of the end of May. 

The Class of 2017 has added about 20 stocks to the two funds since April 1st, so they will need some time for their various investment ideas to play out. We'll continue to provide regular updates regarding the Class of 2017's equity performance.

(Click on the tables to enlarge)

Wednesday, June 8, 2016

Marquette University AIM Student, Leo Martinic, Recently had a Paper Published on Zerohedge

Thad Beversdorf via

In January, I began teaching Applied Financial Modeling at Marquette University.  Part of the curriculum was to discuss real time real world markets.  As such, we began each class with a review and discussion of market pro perspectives and discussed viewpoints from various financial media outlets.  I pressed the importance of collaboration, drawing ideas and concepts from others but to ensure the viewpoints and arguments we use to draw our own conclusions are balanced.  While the bullish case is the predominant case as it is the paid objective of mainstream economists and bank strategists, Zerohedge is a great balancer of mainstream perspective.

And so I introduced the students to Zerohedge as part of the curriculum.  At the beginning of the course I reached out to Zerohedge with an idea.  I had planned that the final exam would take the form of a take home project whereby each student would be tasked with some analytical problem.  My proposal to Zerohedge was to publish the best final report.  Zerohedge responded with an immediate “Absolutely”.
Now a little context of the course.  Typically this is a heavy text book laden DCF curriculum.  However, from my time in banking I found that college grads seriously lacked the ability to think critically and to problem solve, or in other words lacked an ability to analyze.  And so I didn’t use a textbook and this brought great apprehension to most of my students who have grown up through an educational system that is laser focused on scoring well on standardized testing as a means to secure school funding.  These students have been trained to disregard the concept of learning in lieu of scoring well on a test.  Memorization and regurgitation is what they know.

Leo Martinic presenting in AIM Room
The first half of the semester was spent learning the basic concepts of growth, risk, time value and cash flows.  I drafted all lecture notes and distributed to the class.  The second half of the semester I stopped drafting notes and because there was no textbook this forced the students to focus on what was being discussed.  

The second half of the course was spent applying the concepts of analysis to real world data.  In effect, the concept of applied financial modeling is not DCF or any other specific formulaic model but the application of data in a useful and meaningful way toward some objective.  This requires a deep understanding of the inter-relatedness of all stimuli within the context of risk, growth and cash flow.

Leo Martinic, AIM student
While my students had some fairly grave concerns about the class structure they came around and in the end I believe (by way of their evaluations of the course) to really appreciate having developed the skill of analysis, critical thinking and problem solving rather than just plugging and chugging in some preformed DCF models.

The winning final report was done by Leo Martinic, a junior and not surprisingly Leo is a member of the AIM program, a student run investment group led by Business Faculty, David Krause.  This group manages about $2M of the school’s endowment fund.

The assignment was one question: Which is the better buy – Amazon or Walmart?

Below is the analysis presented by Leo Martinic.

FINA 4360                    Leo Martinic                    Final Paper


Image result for, Inc. (AMZN) and Wal-Mart Store, Inc. (WMT) is the classic example of old versus new school. Both firms sell just about everything imaginable, but how they go about making those sales is completely different. Amazon offers retail products solely online along with a myriad of technological services such as movie streaming. Amazon prides itself on getting a customer’s product to them as fast as possible and offers “Amazon Prime”, the firm’s two-day shipping service for an annual fee of $99. 

Image result for walmartWalmart is the typical “brick-and-mortar” retail store, featured in almost every small town to large city in the U.S., along with a presence internationally. Walmart does offer an online segment, but does not have the internet pedigree Amazon possesses. Walmart just came out with their own two-day shipping service to combat Amazon, called “ShippingPass” for an annual fee of $49. As Amazon has plowed massive amounts of capital back into the business to generate growth, Walmart has continued to open stores while adopting a consolidation approach by creating “Supercenters”, resulting in increased total square footage. With these drastically different strategies for retail in the 21st century, only one question remains: As an investor, is Amazon or Walmart the better buy?

A Look into Amazon

Amazon’s revenues have soared since its inception, generating YoY growth of 20.2%, 19.5%, and 21.9% for 2015, 2014, and 2013. Estimates for 2016 are even better, sitting at 24.7%. This staggering revenue growth is due to CEO Jeff Bezo’s dedication to massive capital expenditures and a current no dividend policy, averaging about $4.7 billion spent on capital expenditures per year over the past three fiscal years. The capital expenditures have increased operating margins 943% in 2015 and 761% over the LTM. Although the huge plowback of cash into the business has generated corresponding growth, it does not come without potential risk. It is no guarantee that the large capital expenditures heading into the future will yield Amazon’s historical growth rate. The ever-present risk with such large capital expenditures is the fact that if it does not pay off by generating top line results or cost efficiencies, then it is effectively flushing money down the drain that could have otherwise been paid back to investors. This is something Amazon and investors need to consider.

The organic growth is great, but operating expenses have grown 27.1%, 33.5%, and 35.8% for 2015, 2014, and 2013 along with similar, but not as severe, increases in COGS. The brunt of these hikes in cost are due to the increasing cost of shipping. In fact, the firm has been losing money on the shipping aspect of “Amazon Prime”. In 2015, Amazon charged $6.5 billion for shipping and ended up spending $11.5 billion, resulting in a shortfall of $5 billion. The shipping cost issue needs addressing if margins are going to improve. An issue with Amazon’s huge growth is that it has only yielded break-even bottom line results. It seems as if investors are infatuated with the staggering growth, but are not worried about current profit generation given Amazon is trading at a current P/E of 295.93 and the firm’s P/E has reached as high as 537 over the past year.

Management has continually stated their current focus is on free cash flow, which they expect to generate a significant bottom line result when the growth phase scales back. The belief is that the massive capital expenditures will have set a foundation for revenues to continue their climb while the focus shifts toward cost efficiency. The promise of cash flow finally came to fruition in 2015, as Amazon generated $7.33 billion in free cash flow yielding a 276% increase over the prior year. Analysts believe this is the turning point for Amazon and expect these staggering numbers to continue, starting with the top line and filtering to the bottom line.

One worrisome fact with Amazon is that total debt has also increased at a similar rate as just about every one of the firm’s glowing statistics, increasing at a 58.6% CAGR over the past five years. With Amazon we have massive revenue growth, high debt and expenses, slim to no margins (other than gross margin!), and no true profit (as of yet). As I was sifting through Amazon’s SEC filings, I found an 8-K worth noting from February. 

Amazon’s board of directors authorized a $5 billion share buyback plan, which I believe indicates that management is weary about earnings growth and will resort to considerable buybacks to inflate the stock price heading into the future. The buyback could be a signal that the growth story is nearing its end and this authorization could be a back-pocket option to hold up the stock price along with distributing cash with which the firm cannot find another productive use. The counter argument is that if substantial negative interest rates permeate over to the U.S., then Amazon would rather hold their own stock than lose money by sitting on idle cash.

A Look into Walmart

Walmart is a completely different story. Walmart’s revenue growth has slowly deteriorated from 11.8% in 2007 to -0.7% in 2016. This deterioration is signalling the world is moving away from the “brick-and-mortar” provided by Walmart and more towards the currently preferable online shopping. And perhaps more alarming the growth deterioration may be signalling that consumption could actually be in decline.. With the decrease in revenue growth, Walmart has seen its operating income, pretax income, and net income decrease 12.6%, 14.2%, and 10.2% respectively from 2015 to 2016. This is the first time Walmart has seen such a pullback in their historically superb results. Walmart’s workforce also received a substantial wage hike of around $1.5 billion, which is bound to increase notably in the future.

Walmart’s P/E sits at 14.71, not far off from its five-year average of 14.83. It is obvious that Amazon and its online-only platform has eaten into Walmart’s grip on the retail sector. With the fall in performance, Walmart continues to pay a 2.95% dividend yield amounting to a $6.3 billion payout for 2016. The firm only carries $8.7 billion in cash on its balance sheet, so as cash flows begin to descend Walmart’s ability to fund a high dividend payout will be questionable at best. Cash dividend coverage has decreased from 6.39 in 1999 to 2.33 today, including an alarming 10.3% drop from 2015 to 2016 alone. Walmart will continue to run into trouble generating the cash necessary to pay their high dividend and soon enough the firm will have to borrow in order to continue to satisfy shareholders.

With no growth, Walmart will have to adjust in order to combat Amazon for the crown of the retail sector. Walmart is the perfect case of how investors are looking for immediate gratification, whether through stock price appreciation or through dividends. Such a strategy ignores the fact that Walmart is being forced to cannibalize itself from the inside out by trading future growth to satisfy investor hunger today. In addition, Walmart has slowly bought back shares since the turn of the century. In 2000, Walmart had 4.4 billion shares outstanding in contrast to the 3.1 billion outstanding today. The firm has decreased its outstanding shares about 1-4% every year, while repurchasing 7.1% in 2011 alone. I view this as management’s attempt to artificially prop up the stock price along with maintaining ratios as results have plateaued and begin their inauspicious descent. It also takes significant cash to maintain these repurchases again a form of economic cannibalization..

Up to this point I seem to be forecasting a disastrous spiral into irrelevance for Walmart, but let me be clear that the firm is not going away any time soon. Walmart has about 4.8x the annual revenue of Amazon and the firm’s accessibility around the world is unmatched. Also of similar importance, Walmart is a good risk averse investment for those who depend on large dividends from blue chip companies as annual income. However it is my opinion that these very things that make Walmart a risk averse asset in the short term could spell trouble further out; decreasing cash flows, waning profitability, breached competitive advantage, a high dividend payout to appease shareholders, and the continuous eating of shares to prop up the stock price all portray Walmart’s imminent cash problem for the future.


Overall, I think the better buy is Amazon, but not for the reasons you might think. Personally, I do not believe Amazon’s future lies with their online retail, but rather the firm’s AWS (Amazon Web Services) subsidiary. With strong growth prospects for their AWS segment, my DCF came to a price target of $924.34 per share for Amazon. Amazon is an incredible growth story with endless potential in a world where people demand to get products quickly without any real effort, but the firm’s core online retail business has not made money.

The business idea is terrific, but in order for Amazon to make money they need to raise the annual “Amazon Prime” fee well above $99. The issue is that price increases will steer customers away, so Amazon needs to make a choice. Should they continue their low priced “Amazon Prime” to increase their customer base and revenues while making no profit? Or should they increase prices, which will drive away some customers but will result in profit generation?  The question is whether Bezos can slash costs, most notably shipping costs, while maintaining a high quality and expedited shipping process.

As of now, that seems more like a pipe dream than a reality.  However, this past week, Amazon entered into a partnership with Atlas Air in order to add twenty Boeing airplanes to its operations, so it is not for a lack of trying. Amazon’s core business reminds me of the tech bubble of 1999-2000. Amazon’s P/E of 295.93 is nothing short of crazy and already prices in projected best case success for the firm. The reality is that Amazon has been operating for 22 years and their core business still cannot generate a profit. The core business’ inability to generate a profit will catch up with the firm and its stock price unless they adapt. The laws of finance can be bent, but they will not break. Fortunately for Amazon I believe the fundamental growth prospects from high investment has and will continue to produce ground breaking innovation resulting in realized growth.

If Amazon is going to generate a substantial profit, it will be realized through their promising AWS subsidiary. This may sound contradictory, as I said Amazon reminds me of the tech bubble, but here I am championing their “tech” segment.

  Source: Techcrunch

However, the situation is quite different. Amazon’s AWS segment has posted increasing profits and is well ahead of the competition in the cloud computing industry. From Amazon’s website, “Amazon Web Services (AWS) is a secure cloud services platform, offering compute power, database storage, content delivery and other functionality to help businesses scale and grow”. The segment is posting a bigger operating income than Amazon’s core business.

AWS accounts for about 8% of the firm’s revenue but over half of their profitability in the first quarter of 2016. Businesses are buying into AWS faster than any other cloud-computing firm in the industry. Netflix delivers its streaming capabilities through AWS; runs partly through the service, and music giant Spotify is built on the service as well, just to name a few. Amazon even engineered a custom cloud for the CIA and other intelligence agencies in order to share information. It is apparent that AWS has quietly become a vastly important service.

Source: MKM Partners

In this table we see that Amazon’s AWS is witnessing the best of both worlds that it cannot quite find within its core business, which is tremendous growth in revenues along with profit generation. The operating margin is in line with the industry while swiftly increasing market share at an unmatched pace. Overall, I believe AWS is the future for Amazon. All businesses need cloud computing to operate in the 21st century. Businesses contemplating making the switch seem to flock to AWS in droves. Deutsche Bank recently stated that if AWS were a standalone business, it could easily be valued at around $160 billion.

Walmart had its success in the past, but the decrease in revenues and overall financial performance in 2016 foreshadow what will be a slow descent from atop the retail pedestal. My DCF resulted in a price target of $65.03 for Walmart. With tremendous growth and profitability in AWS, Amazon essentially buys itself time to figure out how to iron out their core online retail business to generate profitability. If Amazon does continue its burst onto the retail scene and finally improve margins, Walmart will have to adjust its strategies or cash flows will erode while the firm continues to spend huge amounts of cash on dividends and share buybacks, effectively leading the firm into self-cannibalism. 

So if I had $700 sitting around, I would much rather have one share of Amazon than ten shares of Walmart!