the ever-expanding Black Friday

For at least the past couple of weeks the Promotions tab of my email inbox has been stuffed with a gazillion Black Friday promotions.  In the bricks and mortar world, Wal-Mart (WMT) has announced that this year its Black Friday period will last for 10 days (today is day one).  [The term “Black Friday,” by the way, originated in Philadelphia, according to the Visual Thesaurus, as a police description of the extra work they had to do on the Friday and Saturday after Thanksgiving.]

In the years immediately after the Great Recession, retailers, led by Wal-Mart, began to try to push the traditional start to the holiday shopping season forward from Friday to Thanksgiving Day itself.  The theory hat lent urgency to this endeavor was that times were bad and consumers had little desire or ability to do extensive shopping.  Therefore, the first merchant to make a sale would do well; retailers who held back would find consumers’ wallets already empty.

What investment significance–if any–does the move of Black Friday from the week of Thanksgiving to the week before the  holiday have?

My take:

–I don’t think this is a sign of overall economic fragility, as it was several years ago.

–I do think, though, that spending on big-ticket items like housing and autos has left consumers with less cash for other items.  This is a normal pattern worldwide, including the US prior to the crazy bank lending spree that led to the financial crisis.

–WMT’s customer base is skewed toward the less affluent.  The company is facing increasing competition from dollar stores, as well as, I think, a rejuvenated Target.

–I suspect that there’s a Millennials/Baby Boom element to the promotional environment, with physical stores positioned to serve the latter–so that those retailers are competing in a no-growth arena.  One interesting (to me, anyway) aspect of the WMT promotion is that Black Friday prices are available today, but only in the stores, not online.

–My inbox bloat may just reflect my online shopping habits and have no further significance.  Still, any online merchant has the ability to avoid using the blunt instrument of price reduction and use couponing or customer-specific pricing to drive sales instead.  The idea is at least as old as dynamic pricing for airline tickets.  The practice is likely much more widespread than I care to believe.

My conclusions:

Most important, I don’t think signs of an increasingly promotional holiday season are a red flag either for overall US consumer spending or for the stock market.

Personally, I’m looking more for Consumer Discretionary names that are online or Millennials-oriented rather than physical store/Boomer plays.  No surprise there  …in the eternal struggle between Concept (growth) and Valuation (value), I’m normally going to be in the growth camp.  There will be times when valuation trumps potential.  I don’t think now is one of them, although I have noticed that for the first time in years WMT has begun to outperform.  If anything, this suggests to me that the holiday shopping season may be better for everyone than I’ve been thinking.

 

 

linking the Hong Kong and Shanghai stock markets

restricting foreigners

Every country has restrictions on ownership of assets by foreigners.  Some of this is unofficial, like when France said yogurt maker Danone was a crown jewel that Pepsi couldn’t buy, or when New York blocked Mitsubishi Estate from buying a decrepit Rockefeller Center.  Other limits–notably restrictions on non-citizens owning media or transportation assets–are set down in law.

why?

It’s common that emerging countries restrict foreign ownership of all publicly traded locally owned corporations.  The same thing happened in Europe as it was rebuilding after WWII.  Two reasons:

–countries don’t want rich foreigners (translation:  Americans) to be able to scoop up valuable national assets for a song, thereby disenfranchising the country’s citizens and making locals into sort of tenant farmers, and

–they don’t want the potential disruption to economic activity (the currency and the money supply) caused by mad rushes in and out of local stocks by foreign portfolio investors.

two classes of stock

The most common method of controlling foreign ownership is for a country to establish two classes of stock, one to be held by locals, the other by foreigners.  The details vary widely country by country.  What makes China unusual is that, generally speaking, locals and foreigners trade shares in different venues–the letter in Hong Kong, the former on the mainland.

problems with the system

Whenever there are two different markets, and two different prices, for the same security, the party that gets the lower price is going to be unhappy.  Given that the supply of foreign portfolio capital is large and the number of foreign-designated shares is typically small, it’s almost always the local citizen who feels disadvantaged.

In addition, raising new equity capital can be awkward.  Foreigners may balk at having to pay, say, twice what a local does to buy a new share.

Invariably there’s unofficial arbitrage between the two classes.

In China’s case, it’s possible that Beijing wants inefficient state-owned enterprises to be more subject to the goad that can be provided by professional portfolio managers.

Shanghai/Hong Kong trading opened this week

This week, China opened limited foreign trading in Shanghai-listed stocks (not Shenzhen stocks, however, which make up about 40% of China’s market cap).  It is also permitting limited trading by mainland citizens in Hong Kong.  The control mechanism being used is daily limits on the cross-border flow of money in and out of both markets.

ho-hum, so far

The plan was announced a while ago–the result being that stocks identified as possible targets for fresh money in both Shanghai and Hong Kong were bid up in anticipation in recent weeks.  However, the volume of cross-border trading has been low and highly touted beneficiaries have been selling off.

For China, this initial indifference is probably the best possible outcome.  Still, this is another step in opening Chinese financial markets to the world.  And one day the ability for us to buy mainland stocks may be important.  It’s just not today.

 

 

slowdown in Japan

People who like black and white answers and numerical precision–whether the situation calls for them or not–define a recession as being two consecutive quarters of decline in real GDP (“real” here meaning after factoring out the effects of price changes–in Japan’s case, deflation).

On this way of looking at things, Japan entered its fourth recession since the global financial crisis when the government announced early this week that the economy had shrunk by 1.3% on an annualized basis during the September quarter.  This comes after a fall of 7.3% during the June quarter, when Tokyo implemented the first of two planned increases in the national value added tax.

Today’s situation seems to me eerily similar to that in 1997, when Tokyo stopped a nascent recovery in its tracks with a similar value added tax rise.

Prime Minister Abe reacted to the new GDP data by postponing the second value added tax increase, which had been penciled in for 2015, and calling for a general election that he intends to serve as a referendum on his policies.

Almost two years in, the fundamental sticking point for Abenomics remains unaddressed.  The idea has been to induce a large depreciation of the currency–a loss of a third of its value, so far–to lower production costs for export-oriented industry.  This makes export goods more competitive in world markets and buys time for industry to streamline and expand.  Industrial renaissance gradually repairs the damage done to national wealth through the currency depreciation.  Prosperity also induces a gradual currency rebound, restoring at least some of the wealth lost through its decline.

In many ways, Abenomics is the successful template Japan used to recover after WWII.  This time, however, Japanese industry has shown no inclination to restructure itself that I can see.  And until now Tokyo has done virtually nothing to dismantle the barriers to change of corporate control which it put in place as its economic malaise began in the 1990s and that ensure ossified managements remain in place.

For the sake of Japan, one can only hope that the point of the upcoming election will be a mandate to force industrial reform.  Without this, Abenomics will wind up merely as creating a massive loss of national wealth and a similar drop in living standards.

Jim Paulsen on 2015 (ii)

To recap:  yesterday I wrote about the latest investment newsletter from Jim Paulsen, a strategist at Wells Fargo.  In it he talks about a belief held widely (including, up until now, by me)–that the Fed’s program of raising interest rates from the current emergency-lows up to normal will be bad for bonds but have little impact on stocks.

How can stocks fare well as rates rise?

…because in past instances of post-recession rate increases, the negative effects of higher rates have turned out to be at least offset by the positive influence of stronger corporate earnings.  Hence, stocks go sideways to up.

Why is this time different?

Past tightening episodes have generally followed relatively mild recessions.  Tightening has come, say, a year after the bottom in economic activity, when the economic bounceback from the downturn is in full force.  Today, however, we’re more than five years past the recessionary low point.  Deferred demand has long since been satisfied.  So we can’t expect the same oomph from earnings comparisons that we’ve gotten in the past.  In fact, in Paulsen’s view, stocks are most likely to go down next year as Fed tightening begins.

Mr. Paulsen is smart, experienced–and has been right about stocks for at least the past five years.  So he’s someone whose opinion we have to take seriously.  He;s also a bull making a bearish statement.  For that reason alone, it’s worth consideration.

Another point in Paulsen’s favor:  the rest of the world seems not able to provide much support for S&P 500 earnings next year.  If anything, non-US businesses will be a drag on profit growth.

How might Paulsen be wrong?

I can think of three ways:

1.  It’s hard to predict the Fed’s tactics in raising rates.  The agency’s current plan is to start raising short-term rates sometime in the Spring and boost them by 0.25% every month or so, to arrive at around 1.50% by yearend.  However, if this timetable makes the stock market start to unravel, it’s conceivable–likely, in my view–the Fed will slow the pace, or even stop until stocks stabilize.  The disastrous moves by the Japanese government in the 1990s to prematurely return to normal–and the consequent lost quarter-century of economic growth–appear to be very fresh in the Fed’s mind.

2.  The Fed has been highly vocal for a long time about its plans.  They come as no surprise.  It’s possible, therefore, that investors have already made some adjustments in their thinking, and in their portfolios.  If so, the rate rise won’t be as harmful to financial markets as might be.

3.  (or maybe 2a, or both)  For investors not willing to hold highly illiquid investments in large amounts (that is, for almost all of us) the investment choice is among stocks, bonds and cash.  The return on cash will be negligible for a considerable time.  So the practical choice is between stocks and bonds.  Two points:

–the 30-year Treasury currently yields 3%.  An earnings yield on stocks of 3% translates (in the way Wall Street has generally worked since the 1980s) into a 33.3x price earnings multiple.  The S&P 500 is currently trading nowher close to that level, however.  It’s at less than 20x earnings.  20x earnings is the equivalent of a 5% yield on the 30-year Treasury.

I take this to mean the markets are already factoring into today’s stock prices a considerable rise in fixed income yields.  This doesn’t mean stocks won’t decline as rates start to rise.  But I think it does mean that part of this is already in prices and that the downside to stocks could be limited.

–we’re already beginning to see European bond managers buying US bonds.  They see: safe haven, higher current yields and rising currency (in euro terms) as offsets to possible losses from rising rates.  As rates begin to move higher, this trend may accelerate, bringing a higher dollar and a subdued effect on long-term bonds from rising short-term rates.  If long-term rates don’t rise less than expected, the effect on stocks should be positive.

what I’m doing

The rising currency scenario isn’t an unadulterated plus for the US.  Currency rises act in much the same way as interest rate increases do.  They lower economic activity.  Of particular concern to stock market investors, a dollar rise against the euro will lower the dollar-denominated results for S&P companies with European exposure.  That’s about a quarter of the S&P’s earnings total.

I don’t think we have to decide right away how stocks and bonds will play out next year.  But we do have to continue to assess possible outcomes and mull over what we want to do as new news makes one or another outcome seem more likely.

Jim Paulsen on 2015

James Paulsen, PhD is a well-known strategist for the Wells Fargo investment operation, Wells Capital.  I think he’s very good, and a valuable resource. Over the past five+ years, he’s been consistently–and correctly-bullish about stocks.  Of course, he, like me, has a bullish temperament.

What makes him particularly interesting at the moment, however, is that he’s saying something in his newsletter of November 14th (not yet available on the Wells website as I;m writing this) that’s distinctly not bullish.  When a bull says something bullish, or a bear something bearish, it’s often a ho-hum event.  But then their comments go against the grain, I’ve learned to pay attention.

Here’s what Paulsen is saying about US stocks in 2015:

If we study the past thirty years, when the Fed raises interest rates from recession-emergency lows back to normal after a recession, two opposing forces act on stocks.

–On the one hand, rising rates push down the price of bonds.  This makes them more attractive as investments.  As a result, investors shift some assets from stocks, pushing their prices down as well.  Price earnings multiples contract.

–On the other, the Fed only begins to raise rates when it senses strengthening economic growth.  Faster -growing earnings and more favorable than expected earnings comparisons make stocks go up, offsetting much or all of the downward pressure caused by rising rates.

However, these past instances deal primarily with garden-variety recessions, where the Fe  is in a sense making mid-course corrections for a healthily-growing economy.  The key point in these instances is that the interest rate rises occur early in the recovery cycle, when the economic rebound is unusually strong.

That’s not the case with this recession.  The first rate rise will be happening about six years into recovery.  Company inventories have long since shifted from a bearish posture to a bullish one (such as it is).  Pent-up consumer demand, too, has presumably already played itself out.  Therefore, we won’t have the “normal” earnings growth offset to rising rates.  Stocks won’t go sideways to up during the rate rising period.  They’ll go down.

Dr. Paulsen is certainly right that past experience will be a poor guide to the stock market’s reaction to rising rates.  I’d been blithely assuming the contrary.  But there are two other factors to consider.   More tomorrow.  (The power is just about to go off in our house.  See you later!)

 

 

Buffett, Duracell and Proctor and Gamble (PG)

Warren Buffett’s company, Berkshire Hathaway (BRK), is buying Duracell from PG for $2.9 billion.

The deal is a little more complex than that, though:

structure:  PG will inject $1.8 billion in cash into Duracell prior to the sale.  It will then swap the enlarged company for BRK’s 52.8 million share holding in PG.  This makes the headline number for the deal $4.7 billion.

a win-win

PG has been interested for years in offloading Duracell, which it acquired through its purchase of Gillette in 2005.  Duracell has gone ex growth, as today’s mobile devices like smartphones use rechargeable batteries, not disposables.  Complicating the issue is the fact that Duracell is on the books at the price Gillette paid for it in the 1980s.  So a sale for cash would presumably trigger a big capital gains tax.

With this deal, PG gets rid of a no-growth brand that no trade buyers were beating down the door to get.  It avoids taxes.  It accomplishes a share buyback at the same time and takes out a large seller whose activity would depress the stock price, to boot.  So, for PG the deal is a big winner.

BRK offloads its entire holding in PG at once.  I estimate the task would take three months in the open market, during which time PG shares would doubtless be depressed as the news hit Wall Street’s trading floors.  BRK also avoids taxes on a position that’s on its books at the cost of Gillette convertible bonds it bought in 1989.

On the surface, it appears that BRK doesn’t make out so well.  It has aguably swapped a slow-growth dog for money plus a no-growth cat.  But let’s look at the numbers.

Let’s say sale of the PG shares in the open market would bring in $4.7 billion but trigger taxes due of $1.2 billion (a number I just made up).  So the net to it is $3.5 billion.  By doing this deal instead, BRK gets $1.8 million in cash plus 100% ownership of a company that generated $400 million+ in cash over the past year.  This means BRK only needs Duracell to stay afloat for four more years to recover the price it’s paying.  In addition, PG disappears from the portfolio everyone watches (as a 100% holding, Duracell never makes it in). Looks like a good deal.

what catches my eye

I hadn’t realized before, but I’ve read in the Financial Times and the Wall Street Journal that this is the third such deal BRK has done in the past year.  This looks a lot to me like portfolio housecleaning.

Warren Buffett’s trademark has long been to buy consumer-oriented stocks with strong brand names, superior products and excellent distribution networks.  All are “moats” that defend against competition.  However, all these competitive advantages are being steadily eroded by generational and technological change.

It looks to me like a big (and overdue) strategy shift may be underway at BRK–one that the company, understandably, wants to keep under wraps for as long as possible.

 

 

technical analysis: double bottom

Regular readers will know that I’m not a particular fan of technical analysis, at least as a primary tool in determining the investment attractiveness of the equity market or of individual stocks.  A hundred years ago–maybe even sixty years ago–it was the tool, because there was nothing else.  Before the SEC, company financials were a joke, and they weren’t easily available in a timely manner.  Watching the trading patterns of the “smart money” was arguably the best an average person could do.

Nowadays, the SEC’s Edgar site has all US-traded companies’ filings available for free the instant they’re made.  Most companies also have extensive libraries of their own available on their sites.  Firms now webcast their earnings conference calls for all to hear.  If you don’t feel like listening, transcripts are available for free soon afterward from Seeking Alpha.  

So it isn’t so much that technical analysis is bad per se.  It’s just that like the horse-drawn cart it’s been replaced by fundamental information that’s quantum leaps better.

support/resistance

Still, there are some aspects to technical analysis that I find useful.  One is support/resistance.  This is the idea that price levels where there has been significant past trading volume, preferably over an extended period, will act as floors to support stocks as they fall, as well as ceilings to impede their advance.  Both holding at and breaking through these levels are often significant events.  In particular…

double bottom

When the market has been declining for an extended period of time, or has dropped particularly sharply (the “magic” numbers technicians use are typically losses of 1/3, 1/2 or 2/3 of the prior advance), it often stabilizes for no apparent reason and begins a significant upward bounce (+10%?).

The fact that prices are now going up isn’t enough by itself to establish they have reached an important low.  In almost all cases (March 2009 was, on the surface at least, a significant exception–see below), stocks begin falling again within a few weeks and find themselves approaching the previous low.  If the market touches–or almost touches–the previous low but begins to rebound again (in the US, the market may briefly trade lower than the previous low–we’re daredevils, after all), this is often a strong sign that resistance is forming at the old low.  This revisiting of the low is the necessary second part of the double bottom.

There can be a triple bottom, too.  More often, in my experience, the market begins a new, upward pattern of higher highs and higher lows after the second bottom.

Fundamental conditions must also be in place for this bottoming to happen.  Stocks have to be cheap; investor pessimism must be high; the downtrend must be protracted enough for at least some investors to think that conditions won’t get worse.

In essence, what the double bottom tells us is that intense negative emotion that has been driving prices sharply (often irrationally) lower has begun to play itself out.

current examples

Double bottoms happen with individual stocks and stock groups, too.

Look at the Macau casinos traded in Hong Kong.  Some, like Galaxy Entertainment, have lost half their value over the past ten months.  But the group appears to have bottomed in late September-early October.   The stocks bounced off their lows, returned near them several weeks later and appear since then to have established a new upward pattern.

I haven’t looked carefully at energy stocks–but the oils are a group where I’d be looking for similar behavior.

the March 2009 case

The S&P 500 appeared to me to be bottoming in early 2009.  As is usual during recessions, government programs were being put in place to stop the economic bleeding.  Anticipating this, investors had pretty much stopped selling.  However, in late March investors were horrified to hear that Congress failed to pass the proposed bank bailout bill/  Some (Republican) Representatives were even saying they would prefer a rerun of the Great Depression to a bank bailout.  The S&P fell more than 7% on the news, but recovered all its losses when the bill was passed the following day.  If we erase those two trading days, early 2009 exhibits a “normal” bottoming process.

 

 

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