the January 2016 Employment Situation

Earlier this morning the Bureau of Labor Statistics of the Labor Department released its monthly Employment Situation report for January.

job growth

The ES indicates that the economy added a net 151,000 new jobs during the month.  That’s roughly the number needed on average to absorb new job entrants, and it’s around the figure being reported each month last summer.  However, it falls short of the mammoth job addition figures achieved over the prior four months.  And it’s around 40,000 less than the consensus of Wall Street economists.

Revisions of prior months’ data didn’t move the needle much, either.  The ES numbers for November were revised up from +252,000 new jobs to +280,000; those for December were revised down from +292,000 to +262,000.  That’s a net of -2,000.

wages

Wage growth might be a different story. Over the past year, average hourly wages grew by 2.5%, which is a little better than inflation but not terrific.  And it’s not really consistent with a low unemployment rate of around 5%.  For January, however, average hourly earnings rose by $.12 to $25.39.  Of course this is only one data point, but if sustained would amount to +5.7% annual growth.  This could be (stress on the could) an early indicator of rising wage inflation (the only kind that really counts in advanced economies).

market reaction

S&P futures immediately dropped from a slight positive to a small negative.  The dollar spiked up against the euro.  My guess is that these are just knee-jerk reactions.  If we want to make more of them than that, however, Wall Street’s read would seem to be that the US is finally starting to see strong real wage growth.  While that’s good for the economy, it also would mean less worry at the Fed about continuing to raise interest rates.  In early going, it would seem the latter is what traders have latched onto.

There’s certainly risk is extrapolating from one data point, especially one that has given false positive signals in the recent past.  Traders are likely judging that there’s little chance of the stock market running away to the upside, though, so there’s less risk to making the negative bet than would seem on the surface.

My reaction is that this is giving long term investors a chance to pick through the rubble to find cheap stocks with good long term prospects.

dealing with high daily volatility

To state the obvious, we’re in a period of high daily volatility in the trading of stocks around the world.  What I find particularly striking is that we’ve had two days recently–January 20th and yesterday–where stocks in the US made dramatic intraday shifts in direction.  In both cases, heavy early selling that pushed indices down sharply was followed by a late reversal that wiped out most, or all, of the previous losses.  In my experience, this rarely happens once–to say nothing of twice, and within a couple of weeks of each other.

I’ve got little clue as to why the going is so choppy.  I imagine that algorithmic trading has something to do with it.  Sovereign wealth fund selling may be playing a role.  Investment banks reining in proprietary trading, thereby removing liquidity from the market, could be a factor, too.  I don’t believe that either oil or China are much more than straws the financial media are clutching to.

Still, I find it very strange.  The closest analog I can think of is the period following the collapse of the internet bubble in early 2000.  But even that wasn’t that much like the present.

My thoughts:

  1. The intraday reversals may be significant technical events.  Sometimes, they signal market bottoms.  In both recent cases, the market did bounce up off important support lines.  Time will tell, especially since markets have a habit of returning to prior lows after a month or so before resuming a new direction.
  2. Blackrock, the largest investment manager in the US, seems to be calling into question whether daily volatility really has any significance for ordinary investors.  Presumably, we all have equity investment horizons of three to five years.  So what do daily ups and downs matter? This is just common sense, in my view, and harks back to traditional Wall Street beliefs.  It is, however, heresy to devotees of the (wacky) academic theory of finance taught to in MBA schools.
  3. As a practical matter, you and I will never be able to outtrade high speed computers, or even low speed ones–or professional human traders, for that matter.  We don’t have–or want–the mindset.  We have lives; we aren’t interested in watching stock price feeds all day.  Our main advantage over traders is that we are willing and able to take a longer investment horizon.  We try to be aware of the shape of the forest, not the height and width of each individual tree.
  4. We can look for anomolies, though.  Yesterday is a case in point.  We can look for stocks that didn’t follow the herd.  Issues that went down less than the market in the panicky morning selling and rose more the the average during the afternoon rebound are probably worth looking at more closely as buy candidates.  The reverse is also true.  Stocks we own that sold off more heavily than the average in the morning and rebounded less have got to be reexamined for whether we still want to hold them.
  5. It’s conceivable that high daily volatility is the new normal.  Who knows.  But if so, we should consider what else we can to to turn this to our advantage.  More limit orders when we trade?  More aggressive limits?

 

oil company 4Q15 earnings reports

The 4Q15 earnings reports of the biggest integrated oil companies have two common elements:

–large profits from refining and marketing.  How so?  Companies aren’t passing on to their customers, either distributors or consumers, the full savings they’re getting from lower crude oil input costs.

Also, to the extent that the integrateds still have gas station networks (gasoline is the most important refined product in the US), they seem to be maintaining huge price differentials between regular and premium.  In my travels, I see spreads as wide as $.75 a gallon at the pump, even though the difference in refining cost between regular and premium is pennies.

So far, consumers seem happy just with the fact that gasoline prices are lower.  As a result, downstream prosperity will likely continue.  But there’s the possibility of backlash if/when they figure out how refining and marketing profits have ballooned.

–big asset writeoffs.  Their size has varied widely from company to company.

The assets in question are oil and natural gas exploration and development projects.  The key variable in whether a project remains economically viable is the assumptions firms make about the long-term price of oil.  The difference between a firm that has a ton of writeoffs vs. one that has few results from a mix of two variables.

-Some may have gone all in on mega-projects in remote or hostile operating environments that hinge on oil staying above, say, $100 a barrel to be viable.  At the moment, this looks very foolish and is doubtless triggering big, if not total, writedowns.

-On the other hand, Company A may maintain that in the long term, the oil price will settle in at, say, $80 a barrel.  Company B may think the right figure is $60 (which would be my guess).  All other things being equal, Company B will make larger writedowns than Company A.

Until we find out what individual company assumptions are, we won’t know how to evaluate the writedowns taking place.  I think the winners will be companies that didn’t bet the farm on $100 a barrel oil and those making the more aggressive writedowns of their other projects.

Amazon (AMZN) vs. Apple (AAPL)

I changed radio channels from the morning news to Bloomberg Radio while I was in the car yesterday.  It was about 9am, so I figured I’d get some market news while avoiding the Today-like chitchat that begins on Bloomberg at 10am.

What I heard instead was an expression of disbelief about the relative valuation of AMZN and AAPL, with the former being inappropriately trading at 3x the price/free cash flow of the latter.   The senior talking head presented this as being so self-evidently true as to need no further discussion.

I’m not sure why this howler bothered me, but it it did.

Three points:

–Both companies were formed by visionary entrepreneurs who transformed the landscape of their industries.  However, Jeff Bezos is still innovating and AAPL hasn’t produced a big new product in the past five years.

AAPL is a high-end smartphone company.  Today, that’s a mature product that depends on replacement demand.  There are no new customers.  Network operators are trying to stretch out the replacement cycle as a way of lowering their costs.

In contrast, AMZN is all about web services, a business that’s in its infancy and growing like a weed.  And the world is increasingly shifting to online purchasing.

In other words, AAPL and AMZN are very different companies.

–The accounting principles AMZN uses are more conservative than AAPL’s.  What might appear on the AAPL income statement as $1 in profit might only be, say, $.75 on AMZN’s. That alone doesn’t explain why one should trade at 3x the other.  But the comparison is far from clean.  Dollars to donuts the talking head I heard had no idea.

–I don’t get why free cash flow generation is an appropriate metric to use in making the comparison in the first place.

Free cash flow is the money a firm generates from operations minus the capital it invests in building/maintaining the business (and, for me, minus any mandatory debt repayments, as well).  Free cash flow is the “extra” that can be used to pay dividends.  Good for income-oriented investors.  If it’s very large, free cash flow may even attract potential acquirers in related industries who have investment opportunities that are greater than their ability to fund.

At the same time, large free cash flow can signal that a business has no new investment opportunities.  So the large free cash flow may simply mean the company has gone ex growth.  That’s bad.  On the other hand, a firm may have little or no free cash flow because it has lots of new investment opportunities and huge capacity to grow.  A growth investor will pick the second over the first any day of the week.

Personally, I don’t have a strong opinion on AMZN vs. AAPL.  For years I’ve been bemused by the strength of AAPL shares despite the clear evidence that the smartphone market was nearing saturation.  I’ve also been surprised by how well AMZN shares have done.

My point is that there was a children-playing-with-matches aspect to the discussion I heard.  There was no recognition that AMZN and AAPL are very different kinds of companies and the comparison metric was, yes, a little more sophisticated than PE–but completely wrongly used.

Maybe CNBC isn’t so bad, after all.

 

Sharp Corp (6753) and Abenomics

Abenomics in brief

Prime Minister Shinzo Abe’s well-known plan for reinvigorating the Japanese economy has three “arrows.”  The first two are large government deficit spending and ultra-loose money policy, which were designed to buy time for structural reform of Japanese industry.   The two have had toxic side effects:  they have mortgaged Japan’s future with lots of new government debt and, through the currency depreciation they engendered, have reduced national wealth by a third.

Regular readers will know that from the outset I’ve believed that Japanese corporations won’t restructure voluntarily and that the Tokyo government had no interest in forcing corporate leaders to do so.  In other words, Abenomics a very expensive farce, that had no chance to succeed.

the Sharp case

The latest case in point is Sharp, a heavily indebted chronic money-loser which is in the process of being nationalized by state-owned Innovation Corporate Network of Japan (ICNJ).  ICNJ is offering shareholders a total of $2.5 billion for their shares and the company a continuing supply of the opium of state support.

Hon Hai Precision, a Taiwanese company best known in the US as Apple supplier Foxconn, has bid twice that figure.  It has pledged to keep all Japanese employees and to transfer its management and manufacturing technology into Sharp.  As I’m writing this, news is breaking that Hon Hai is about to sweeten its offer by pledging to invest a minimum of $850 million in Sharp operations after acquiring it.

the board decision…

So, which will the board of Sharp choose:

–twice the money for shareholders plus an infusion of new technology and world-class manufacturing management?, or

–what’s behind the curtain marked ICNJ?

Although no final decision has been made, all the press leaks indicate that Sharp is going to choose ICNJ–and that the Tokyo government is encouraging the company to do so.

a wake-up call?

The Financial Times seems to believe that the Sharp case will prove to be the ah-ha moment that will cause foreign investors to understand that Mr. Abe never intended to fire the crucial third arrow of Abenomics.  It thinks an outflow of foreign capital will follow this realization.  For the sake of Japanese citizens who are bearing the burden of the first two arrows, I hope the FT is wrong.  My private reaction is to ask why it’s taking foreigners so long to smell the coffee.

 

Millennials as socially aware investors

I’ve been at least peripherally conscious of the Socially Responsible Investing (SRI) segment of the investment management business for a very long time.  The criteria for a company or security being “socially responsible” have primarily been negative–typically no “sin” stocks, namely, tobacco, alcohol, gambling or weapons.  Maybe no heavily polluting industries, as well.

It’s also been a niche business, with high costs and poor performance results.  I don’t get the results part.  I don’t understand why any portfolio manager would hold tobacco stocks, thereby lowering the cost of capital for a terrible business and enabling in the harm it causes.  Polluters, who will inevitably be caught, fined and disgraced, are a poor bet, too.  In my experience few PMs in the US hold these sorts of stocks (how the ones who do justify this remains a mystery to me), although lots in Europe do.  I have less trouble with the other three industry groups, but all are relatively small parts of the index.  Holding Faceboook, Google or Netflix would more than offset any loss of performance avoiding the sin stocks would cause.  So I’ve never understood why SRI investing results haven’t been better.  Could  SRI investors want underpeformance to validate their virtue?

According to the Institutional Investor, however, the SRI backwater is undergoing a transformation.  That’s because Millennials are showing themselves to be genuinely socially aware investors.  Yes, there are industries where they don’t want to put their money.  But they also appear to be much more knowledgeable about publicly traded companies than older investors (the Internet?  PSI?).   And they have a much greater desire to own companies that aim to solve social or environmental problems, rather than simply avoiding doing harm.

As I mentioned above, most thinking PMs are socially aware in their stock selection anyway.  It’s the right thing to do  …and it makes good business sense.  Just don’t tell a potential client, or he’ll conjure up the image of a performance-indifferent hippie, despite your conservative suit and tie.

My guess is the the first evidence of SRI-aware Millennials will not be in a flowering of SRI funds and ETFs.  Rather, we’ll see it in incrementally better performance of companies with highly ethical managements and in industries that target social good.  If SRI funds could post competitive investment performance, they may participate, too.

 

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