Financial Myths: “A Billion Here, a Billion There, and Pretty Soon You're Talking About Real Money”

Michael McTague  |

Where are interest rates headed? The cheap money provided by the Treasury is now coming back to bite the economy. Many small and medium-sized US oil companies borrowed heavily, expecting to enjoy a windfall when they sold expensive oil. Oil prices fell as a worldwide glut enveloped the once lucrative industry. By mid-2016, the market is living through an upswing of defaults: approximately $26 billion this year so far, exceeding all of 2015.

The health of the economy dominates discussion about why the Federal Reserve may boost interest rates this year. Consider the unimpressive effect of microscopic interest rates in stimulating dormant economies in the US and Europe, which are already saturated with liquidity. Without admitting the limitations of its efforts, the Fed may bump up rates in the next few months. This will have two good and one bad effect on the economy. The harm lies in the increase of interest rate payments the Federal Reserve will owe. Exceeding $400 billion a year now, depending on which items are included, a rate increase could double interest payments. That means more taxes. The good effects include pumping life into the moribund fixed income market. In addition to attracting more investors, many of them will be international investors disappointed by low returns and defaults elsewhere. This will also raise the interest rates on junk bonds – good news for investors, not so good for borrowers.

The second positive outcome will be to tamp down the ease of borrowing for weaker companies. Like a pendulum that will start to swing the other way, weaker companies will not be able to dip into the cheap money well. Hence, fewer defaults and more predictable corporate profits.

Apple: The Former Darling of Fund Managers

The intense interest in Apple’s (AAPL) market capitalization fall is almost too easy a target. Depending on the specific dates, roughly $200 billion lost in one year. As of late-May, the stock is trading about $10 above its 52-week low. The “real money” part of the myth allows us to take a close look at the technology behemoth. Apple has shown itself wildly popular with mutual funds and pension funds. Vanguard holds more shares of Apple than its rival mutual fund families. For a number of years, Vanguard has had a good run against Fidelity, American, Templeton and the others. Apple’s recent woes will likely bring a shift away from Vanguard. And in a repeat of life at Apple as the iPhone bubble began to deflate, pressure about dividends will again reach a boil. The pain will spread from hedge funds and managers of mutual and pension funds to retirees and public employees who are watching their dreams deflate along with the sinking fortunes of the company with fifty-one consecutive quarters of sales growth.

Martha Stewart: Not the Queen of Detergents

This myth applies to all lost opportunities. Martha Stewart’s laundry detergent, Clean, is a flop. In reviewing the product, Consumer Reports and Good Housekeeping say it is no better than plain water. No research and development laid the foundation for the product launch. They could at least have given it to a few hospitals to seek affirmation that it works. By doing such a poor job, they lost a huge opportunity.

The Honest Company’s detergent bills itself as safer than the top laundry aids from Procter & Gamble (PG). This product is taking heat because it has not lived up to its safe product billing according to an article in The Wall Street Journal. Here is a missed opportunity for Martha Stewart. The Honest Company holds a $1.7 billion valuation. Had Martha Stewart and her associates done a better job of developing Clean and other products rather than simply launching it and relying on her image, they could have opened a multi-billion dollar market based on the environmentally safe aspect alone. So, instead of expanding her empire, the poor product design left the door open for Honest and tarnished Martha’s stellar image in the household area. The main beneficiary must be Procter & Gamble and its unrivaled bench of world class cleaning products.

Perhaps the most obvious missed opportunity is Yahoo’s (YHOO) rapid descent. Since its IPO (Initial Public Offering) in 2004, Google’s (GOOGL) market capitalization has risen from $23 billion to about $540 billion today. Yahoo’s unimpressive acquisitions over the years reveal its poor financial performance. No longer a competitor of Google – despite the pronouncements of Wikipedia – Yahoo acquired $17 billion worth of companies from 1997 to 2014. Yet, the company’s value including Alibaba (BABA) is only $28 billion. Obviously, the acquisitions did little to build the parent company’s worth. If you factor in inflation, Yahoo today is barely where Google was when it went public twelve years ago.

This myth stems from a comment by Senator Everett McKinley Dirksen (1896-1969) and provides an opportunity to investigate huge missed opportunities in private industry and government. Senator Dirksen was known for his insight and wit. One of the two US Senate office buildings is named for him. As we see in this review, billions mount up easily. Next month, the Myth Buster will pursue more goofs in business and government that need careful analysis.

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Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.

Companies

Symbol Name Price Change % Volume
BABA Alibaba Group Holding Limited American Depositary Shares each representing one 169.13 -7.72 -4.37 14,585,653 Trade
PG Procter & Gamble Company (The) 117.47 0.84 0.72 9,016,947 Trade
GOOGL Alphabet Inc. 1,244.41 -8.39 -0.67 1,582,320 Trade
YHOO Yahoo! Inc. n/a n/a n/a 0 Trade
AAPL Apple Inc. 236.41 1.13 0.48 24,377,166 Trade

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