confidence and narratives

Two recent items coming across my inbox:

I’d known there has been a striking favorable turn in consumer confidence in the US since the presidential election, but I hadn’t focused on how large a jump there has been until I read the latest strategy piece by Jim Paulsen of Wells Fargo.  We’ve gone from being mired deep in the bottom half of confidence readings over the past thirty years to high in the top quartile–over the 90% mark by some measures, and at the highest levels since before the Internet bubble burst in early 2000.

Paulsen’s conclusion:  earnings growth may be higher, and stock market performance in 2017 better, than the consensus expects.  I’m not sure I’d bet the farm on this, but it is at the very least a reason to refrain from selling–and to be wary of becoming too defensive.

 

I’ve also read the Presidential Address for the American Economics Association, titled Narrative Economics, by Robert Shiller, a former Wall Street economist who is now a professor at Yale (he’s also the Shiller from the Case-Shiller Home Price index).

I’ve never been a particular Shiller fan, and this is a weird paper, but it’s relevance is in its attempt to identify and measure the psychological influences that affect economic performance.  Its point is that story lines like those encapsulated in slogans like “Drain the Swamp” or “Make America Great Again” can have an unusually strong positive influence on actual economic outcomes.  This can come well in advance of delivery on the promises being made.  So even though my reading of Donald Trump’s career is that his sole personal success has been as an actor portraying a successful businessman on a reality show, it may be that his being a symbol of the need for change may be enough to energize the US for a while.  If he actually can achieve tax reform and an infrastructure spending program, so much the better.

 

 

a steadily rising Fed Funds rate into 2019

That’s the thrust of Fed Chair Janet Yellen’s remarks yesterday about rates in the US.

She said that there would be “a few” increases in the Fed Funds rate in each of 2017 and 2018.  Assuming that a few = three and that each increase will be 0.25%, Yellen’s statement implies that the rate will rise steadily until it reaches 2.0% sometime next year.

In one sense, two years of rising interest rates sounds like a lot–I know that’s what I thought the first time I was facing this prospect as a portfolio manager.  But if the neutral target rate for overnight money is the level that achieves inflation protection but no real return, 2% should be the target.  If anything, it’s a bare minimum.

In my view, two surprises to the Yellen forecast are possible:

–if President Trump is able to launch a significant fiscal stimulus program, the rate rise timetable will likely be accelerated, and

–if the inflation rate rises above 2%, which I think is a good possibility, then the Fed Funds rate may need to rise above 2% (2.5%?) to keep inflation in check.

Typically, a time of rising rates is one in which stocks–buoyed by increasing corporate earnings–go sideways, while bonds go down.  In the present case, earnings growth will likely depend on an end to dysfunction in Washington.

 

 

disappointing 4Q16 sales for Target (TGT)

TGT just announced that its 4Q16 sales (the fiscal quarter ends in about two weeks, on January 31st, which is normal retail practice) will fall below its previous estimate of +1/- 1%.  The company now figures that sales will be down by -1.0% to -1.5%.

Online sales grew year-on-year by 30%+ during November/December, while sales in physical stores fell more than -3%.

In its press release, TGT also gives a breakout by major categories.

The company doesn’t say explicitly what the split is between online and physical store sales, but a little arithmetic will will get an approximate figure.  And that’s the core of the company’s sales growth problem, in my view.

The Commerce Department hasn’t yet released its calculation of the percentage of retail sales in the US that occurs online.  We can safely assume, though, that the number–which continues a steady upward march–will be around 9%.  This is the portion of overall retail that’s growing, and carrying the waning physical store business.  The TGT online figure, in contrast, is just slightly over 1%.

refinancing/repricing bank loans

One way that an investment bank can win merger and acquisition business is to offer financing to bidders through what are called bank loans.  These are essentially long-term corporate bonds that carry high variable-rate coupons based on libor.   The successful bidding company issues them to the bank to pay for an acquisition.  The bank resells the loans to institutional investors.

There has been strong interest in such loans over the past couple of years for two reasons:  yielding, say libor +4%, they offer high current yields; and, at least in theory, there’s the possibility of rising income as libor increases.  Some of these bonds have the further fillip that the variable (libor) portion can’t go below a fixed amount, say 1%, no matter what the actual libor rate is.

Three-month libor is now approaching 1%, up from as low as 0.2% in 2015.  This benchmark rate is certainly heading higher.

Fro the perspective of holders, one flaw with these bank loans, however, is that they offer little call protection.  What’s now happening on a massive scale is that banks are approaching institutional customers who bought high-yielding bank loans and offering to replace a loan yielding, say,  libor +4% with an equivalent loan from the same borrower yielding libor +3%.

Customers are taking up such deals in droves.  How so?  Technicially, the original loan instruments are being called, meaning the issuer is exercising its right to pay the loans off at par.  The customer can either get his money back in cash–and therefore be forced to find a new place to invest the funds–or accept payment in a new, less lucrative, loan.

The customer has two incentives to take the latter:  the new terms are still attractive; and the borrower will have developed deeper confidence in the issuer through continuing study of company operations and a history of on-time coupon payments.

 

The real winners here are the banks, who collect another round of fees for providing this service. In all likelihood, this won’t be the last round of repricing, either.

 

productivity diffusion

Happy Friday the thirteenth!

The Financial Times has an article today that talks about productivity diffusion, referencing a prior FT article and an OECD study on the topic, both of which I somehow missed.

In its simplest form (which suits me fine), economic growth can be broken down into two components:  having more workers (or having existing workers put in more hours); or being more productive, meaning investing in machines, new business processes or worker training.

One of the bigger economic issues facing the world (US included) is the sharp dropoff in productivity growth over the past ten years or so.  The OECD report that sparked the FT articles argues that the problem isn’t a drop in innovation across the board.  Rather, the most productive firms in the world continue to show strong productivity growth.  What’s changed is that the once-fast followers are only adopting best practices today at a much reduced rate.

Why is this?  The OECD answer, which best fits the EU, I think, is that big banks are protecting low-growth, heavily indebted “zombie” firms.  Their reason?  The banks keep the zombies afloat (mixed metaphor, sorry) so they won’t have to write off the dud loans–calling into question the banks’ own financial viability.  What’s scary about this analysis is that it calls to mind the experience of Japan in the 1990s, the first of that country’s three lost decades.  Given that the Tokyo government actively protects managements from the consequences of failing to innovate, the problem of economic stagnation still afflicts Japan today.

To me the real relevance of the current lack of productivity diffusion for the US is that it speaks to the thrust of Donald Trump’s macroeconomic ideas.  However well intentioned, the effect of dissuading firms from adopting productivity enhancing measures for fear of being publicly shamed and of shielding non-competitive firms from import competition will likely be the zombification of the affected portions of American industry.  That is not a long-term outcome anyone wants.

 

Dow 20,000, S&P 2260

I’m not a fan of the Dow.  It’s a weird index whose main virtues are that, way back when, it was the financial media’s first try at measuring the US market and that, despite its peculiarities, it’s easy to calculate.  It’s no longer a useful gauge of US stocks, however.  So it’s never used by professionals, only by media people who have little industry background.  (One caveat:  the Dow indices are now controlled by the same people who own the S&P–who now have a vested interested in keeping the Dow alive, despite its drawbacks.)

Still, it’s striking that for the past six weeks 20,000 on the Dow has shown itself to be a strong point of resistance to the US stock market’s upward movement.  The equivalent figure for the S&P 500 is 2260, not a memorable number.

Whether the resistance level is 20,000 or 2260 makes little economic or financial difference.  Psychologically, however, 20,000 is much more daunting, I think, than 2260.  This is especially so now that the US stock market has risen far above former highs.

My bottom line is that, whatever number you choose, the post-election rally has run into its first substantial roadblock.  It’s also at least thinkable that the Dow is developing, at least for the moment, more relevance than I’m willing to give it credit for.  This would suggest that the balance of market power is shifting away from professionals to individual investors who have little stock market experience.    I find this hard to believe, but it’s something I should keep an eye anyway.

 

reading a financial newspaper

Early on in my investing career, I came to realize that it’s better to read financial newspapers by starting on the back page and working toward the front.

How so?

As investors, we’re searching for information that is potentially important but not yet well known.  Arguably, the best information won’t yet be in print.  But as it does appear, it will usually come in the form of small articles on the back pages.  Typically, when information is on the front page, or when it appears as a magazine cover, investors normally begin to think hard about adopting the contrary stance.

At first blush, reading from back to front is hard to do with online news services.  Worse,  the order of online news is constantly being curated, meaning that the most popular items are pushed toward the front.  The less well-received–that is, the more interesting for us–are progressively pushed toward the rear.

Interestingly, the Wall Street Journal and the Financial Times both have introduced what is being described as a “new” way of reading the newspaper, a digital form of the print newspaper.  Personally, I prefer the print newspaper.  But I find this digital form just as useful when I’m on the road.