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Bad news for blue chip investors

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October 01, 2010 – Comments (6)

As you may know, I am still very bullish on the indexes. But bullishness has some reservations.

The thing I find worrying is the same thing that makes Fool writers optimistic: record levels of cash held by S&P 500 blue chips.

There is one party line that I disagree with: that they hoard cash in anticipation of a double-dip recession. It's not very convincing. If we double-dip, the second dip will not be anything like the first one. Any double-dip recession will be highly inflationary and it will be foolish to hold too much cash.

The other party line which I also disagree with is that they mean to return more cash to shareholders through dividends and buybacks. Unlikely. We haven't punished CEOs for shareholder-unfriendliness barely enough to make them shareholder-friendly. For that we would need to drive S&P 500 index down to 400 or less, and maybe then they would start noticing us. They will increase dividends of course, but only to the 2007 levels.

My own hypothesis is that they mean to use the cash for corporate acquisitions. And corporate acquisition means overpayment. In other words, we may see some transfer of wealth from the largest companies in the index to the midcap and smallcap companies. And considering the easy availability of credit at insanely cheap rates, we may have reason to worry.

If I am right, then midcap indexes may outperform blue chips in spite of blue chips' superior fundamentals.  

6 Comments – Post Your Own

#1) On October 01, 2010 at 4:08 PM, russiangambit (29.25) wrote:

May be it is the result of short-term stock price oriented mentality that rules the coporations these days?

The line of reasoning is like this -  they have lots of cash because they don't see attractive investment opportunities. Why? Because thety underinvested into long term development strategies, research, scouting new markets and so on. They did it in order to pretty up the earnings picture by cutting costs. R&D and finding new markets, new products, new lines is very expensive with uncertain ROI. It is so much easier for corporate management to buy a company with a know how.

As for divivends - they can't do that easily because they would ahve to repatriate the cash from ovreseas and pay the tax on it.

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#2) On October 01, 2010 at 4:17 PM, davejh23 (< 20) wrote:

"The thing I find worrying is the same thing that makes Fool writers optimistic: record levels of cash held by S&P 500 blue chips."

Many have pointed out that the "record level" of cash held represents debt...companies have taken on record debt levels at favorable interest rates just because they could.  The most likely scenario is that the cash on their balance sheets will not be used to increase dividends or for acquisitions.  If we get another turn down in the economy, it will be used to maintain operations for as long as possible...kind of like why Ford was able to weather the storm better than their competitors.  If decent growth resumes, it will be used to service the existing debt...it will have served no purpose...

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#3) On October 01, 2010 at 4:48 PM, GermanInvestors wrote:

No matter if we see a double dip. I think that blue chip investing is the right way to survive a recession. Here is a dividend list of the best blue chips with some fundamentals in comparison:

http://long-term-investments.blogspot.com/2010/09/best-dividend-paying-stock-list-as-of.html

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#4) On October 01, 2010 at 5:15 PM, rhallbick (99.64) wrote:

"some transfer of wealth from the largest companies in the index to the midcap and smallcap companies"

With little organic revenue growth, operating margins at record high levels and strong balance sheets, it would seem likely that they would look at acquiring companies that provide goods and services to the trade-surplus countries, whether or not those companies are US-based.

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#5) On October 01, 2010 at 9:51 PM, Valyooo (99.45) wrote:

Great blog. But at some point the treasury market will implode, and I think a lot of investors may switch to blue chips then (a lot of gold too, but some blue chips)

But look at this:

http://finance.yahoo.com/echarts?s=SPY+Interactive#symbol=SPY;range=my

Mid caps and especially small caps outperform over time anyway, so idk what the obsession with blue chips is. blue chips outperform in a recession...but they still do poorly, and bonds/cash do better.

I have a chart on my wall. if you invested 1 dollar in 1925 and pulled out in 2001 (charts out of date but whatever) into :

long term gov bonds, you would have $51

Long term tbills, $17

large caps, $2,279

small caps: $7,860

Small caps outperform by over 300% in a 76 year period. How are blue chips "Safer" ? With all the ETFs around, its so easy to diversify....avoid headline risk just by buying IWM.

Yeah, they do worse than blue chips when the market does bad...to me thats like saying "if Im gonna get an STD I would rather get the clap than AIDS". Yeah, or you could pull out (pun very much intended) and get neither.

So in short, I agree with you, but I think blue chips should be a smaller part of ones portfolio than small caps at all times

And inflation makes that $1 into $10

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#6) On October 02, 2010 at 7:55 PM, rwebankrupt (78.52) wrote:

Great reminder that Small caps outperform by over 300% in a 76 year period and that was before liquif ETFs were around

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