Great post by Michael Stokes at MarketSci Blog on the impact that historically low treasury rates could have on Tactical Asset Allocation (TAA) models. A large portion of historical gains from both backtested TAA models and balanced portfolios have been from the huge increase in treasury bond values over the past 30 years as yields have fallen from a peak of over 15% to less than 2% today.
If yields were to stay relatively stable, the lack of increase in the value of treasuries combined with the low yield would significantly reduce the returns contributed by the bonds portion of a balanced portfolio. Barring any significant stock market out-peformance, this is likely to bring balanced portfolio returns down significantly from what investors have previously experienced.
A worse scenario is if yields rise rapidly and drive down the value of an investor’s existing bond portfolio. The yield would be higher but it would take years for the extra yield just to restore the loss in principle value. A large rise in treasury rates could also lead to a reduction in equity PE ratios to offset the increased rates of “risk free” returns. Meaning that investors could see simultaneous losses in both the bonds and equites portions of their portfolio.
As the saying goes – “Whenever you figure out the key to Wall Street, they change the locks”. Most investors and advisors believe the current key is to have a large bond position to provide steady and consistent income, a plan that has worked well for 30 years. What will happen to these portfolios if the bond portions begin to earn minimal returns or become money losers?
I just finished watching Bill Ackman’s CNBC interview where he described the current state of JC Penney (JCP). Prior to watching the interview most of the comments about it were surprisingly negative. I felt he did a good job making the bullish case and I appreciated that he actually took the time to explain the situation in depth with real numbers instead of providing the usual CNBC sound bites.
The core of the thesis is that JCP is in the process of rolling out 100 “mini brand stores” inside each current store. They have currently rolled out 10 of the “mini brand stores” and those stores are seeing $270 in sales/sq-foot versus $135 for the rest of the store. The assumption is that as they roll out the other 90, the overall store will now be at ~$250 in sales/sq-foot.
What I wish was better explained is what the breakdown of merchandise currently is between the 10 “mini brand stores” and the rest of the store. If the most desirable JCP merchandise is in those new stores, then it makes perfect sense that they would show a huge increase in sales/sq-foot versus the rest of the stores. But as they roll out another 90 stores, they can’t all be premium in relation to the overall store so what will that do to the sales/sq-foot. Are the 10 current mini stores currently generating a disproportionate percentage of total revenue available to JCP?
The second issue is that if they do scale the sales/sq-foot linearly it becomes a very large number. Ackman mentioned taking it from 7 million sq/feet to 111 million sq/feet. Adding $115 per sq/foot across 104 million of space generates an additional $13 billion in revenue. That’s a huge number and to achieve it they have to add more revenue in the next 3 years than Bed Bath & Beyond currently generates.
Where will that revenue come from? Unlike in Johnson’s previous experience in Apple where the iPod and iPhone were part of new categories, $13 billion in department store style retail sales does not just materialize. It will have to be composed primarily of lost sales from other retailers. Which ones is still to be determined. One last thing to consider as the JCP press continues to be negative is that the list of big names lined up in support for the turnaround continues to grow. Both Lee Ainslie of Maverick Capital and Ricky Sandler of Eminence capital bought a significant number of shares last quarter.