Monthly Archives: May 2015

cyclical growth vs. secular (ii)

May 15, 2015 By in currency markets, Recent Market Action, securities markets, stock market, Strategy Tags: , , , , , , , , Leave a comment

Same topic as yesterday, different starting point.

When the monetary authority begins to tighten policy by raising interest rates, it does so for two reasons:

–the domestic economy is giving signs of overheating, that is, of growing at an unsustainably high rate, and needs to be reined back in before runaway inflation results

–too much money is sloshing around in the system, and finding its way into more and more speculative investments.

For stock market investors, the tightening process implies two things:

–the rate of profit growth in business cycle-sensitive industries is peaking and will begin to decline, and

–playing the greater fool theory by holding crazily speculative investments will no longer work as excess money is siphoned out of the economy.

However the Fed proceeds, the second effect will surely happen, I believe.  But the US economy can scarcely be said to be overheating.  Despite this–and the Fed’s promised vigilance to prevent a meaningful slowdown in economic activity, I think all stocks–and cyclical ones in particular–will be affected.

Why?

…because the Fed tapping on the brakes lessens/removes the ability of investors to dream of a possible openended future cyclically driven upsurge in profit growth.  Whether specifically aimed at this or not, Fed action will have the effect of tempering Wall Street’s avaricious dreams.

What about dollar weakness, EU growth, China…?

In every cycle there are special factors.  They don’t change the overall tone of the market, though.

The main effect of a weaker dollar and stronger EU economic performance will be to increase the attractiveness of EU stocks, and of US names–principally in Staples and IT–with large EU exposure.  Look for the stocks with big holes in December and March quarterly income statements.

As for China, who knows?   My guess is that the Chinese economy won’t deteriorate further from here.  But the main China story , as I see it, will be the country’s gradual shift to consumer  demand-drive growth along with the substitution of local products for imports.  To me, both aspects suggest that well-known US, EU and Japanese China plays won’t regain their former glory.

My bottom line:  the shift from cyclical to secular may be more modest than usual this time, but it will still be there.  A more conservative mindset argues against further price earnings multiple expansion for the market.  So future market gains will depend entirely on earnings growth. The larger immediate effect will likely be in the loss of market support for very speculative stocks.

 

cyclical growth vs. secular: which to choose now?

May 14, 2015 By in bond market, currency markets, securities markets, stock market, Strategy Tags: , , , , , Leave a comment

cyclical and secular

The rhythmic cyclical economic progression from recession to expansion and back again affects everything the global economy.  Yes, there are sectors like Materials that go through their own long boom and bust cycles that can last decades.  There are also public Utilities that supply water or electricity that are well-insulated from cyclical fluctuations.

Despite these (relatively minor, in my view) complications, it’s useful for stock market investors to distinguish between companies whose profits are linked mostly to the business cycle–say,  a cement plant, or a supermarket or a department store–and those whose success is more a product of their own innovation or of being positioned in the slipstream of structural change–like Apple, or Amazon or Facebook are/have been.

How so?

In the simplest terms, the first group does particularly well as economic recovery springs out of recession. The latter typically begin to come into their own a year or two into an economic/stock market upswing, when demand pent up by recessionary fears is satisfied and economies settle into a slower, more sustainable growth pace.  In the case of the Great Recession, this process has taken a much longer time.

At some point, central banks step in to raise interest rates, reining in growth a bit further, and tipping the scales a bit more toward secular growth.

Yes, but…

By these last few keystrokes, the “yes, but”s have begun screaming loudly enough in my head to interrupt my train of thought.

They see where this post is going–how should we structure our portfolios to deal with the coming rise in interest rates in the US?–and the answer is going to be to go with structural growth over cyclical growth.

It isn’t necessarily that simple…

…what if the current slowdown in the US is all about the cold weather and port congestion, and we’ll get catchup in the summer?

–what about the weakening dollar, which is giving more evidence of having peaked against the euro?

–what about the EU picking itself up off the economic floor for the first time in years?

–what if the anti-corruption drive in China is past its worst and growth will pick up there?

–what about the bounceback in oil prices?

–how much do valuations matter?

…or is it?

What I think:

Rising interest rates always have a sobering effect on investors.  It’s a change to a more conservative mindset, rather than a precise calculation of the effect on profits of higher rates.

Valuations matter more than before, especially for smaller, non-mainstream companies.  Investors will take a harsher look at highly indebted companies that are struggling.  The same for startups with little more than a business plan and a prayer–it will be much harder than it is today for them to go public.  PE multiples generally don’t expand; if anything, they contract.  At the very least, investors will take pruning shears to the highest numbers.

To the degree that the US economy remains in low gear, interest in secular growth names will intensify.  However, I also think investors will lose their taste for “me too” smaller stocks.

More tomorrow.

 

 

 

 

 

 

OECD education survey–implications for economic growth

May 13, 2015 By in economics Tags: , , , Leave a comment

The BBC published the broad outline of a recent OECD survey of educational attainment for 76 countries around the world.  Data will officially be released next week.  My Google search for details suggests other news organization writing about this are simply repeating the BBC story.

The survey is based on testing of 15-year-olds on science and math.  It differs from the OECD’s previous Program for International Student Assessment (PISA) studies–the latest published in 2012–in two ways:

–it includes an extra 11 countries, and

–it doesn’t have the third PISA test, reading.

The US finished 28th.

 

Pending the full release of data, this may actually be a perverse kind of “good” news.  In the 2012 rankings, the US finished with average showings in science and reading, and below average marks (in 36th place) in math.

Generally speaking, the US beats out Latin America but loses to the EU and Asia.  As can be seen from the interactive chart in the BBC article, China, India and most of Africa aren’t included.

These surveys are presumed to be important (I think they in fact are) both because they give an indication of equality of opportunity within a given country (the US is below average but making some progress) and international economic competitiveness (unclear to me whether the US is mired in average or is slipping).

 

More when the actual report is out.

 

a surprising reaction to a so-so jobs report …trading computers at work?

May 11, 2015 By in Constructing a Portfolio, Current Market Thoughts, economics, Employment Situation report, Strategy Tags: , , , , , , 1 Comment

Last Friday, the Bureau of Labor Statistics released, as usual, its monthly employment report for April.  The numbers were good, but not surprisingly so.  The Employment Situation said the economy added 223,000 new positions in April– +213,000 in the private sector and +10,000 in government.

The revisions to prior months’ data were strongly negative, though–+2,000 jobs for February and -41,000 for an already weak March.

Wage gains remained in the +2%/year range;  the unemployment rate was stable at 5.4%.

My reaction was that the figures were about what the market had expected.  The headline figure, ex revisions, was exactly in line with economists’ estimates.  Nothing else changed much.

Nevertheless,

…the S&P rose steadily during the day end ended up by 1.3%.

Yea, I’ve been retired for some time.  But I can’t imagine any of the portfolio managers I knew/know buying stocks on this report (because it contained no new information).

Yet the market didn’t just shrug the report off.  Instead, it went up a lot.  Assuming the market went up on the Employment Situation–and I think it did–the market reacted to a just-as-expected report rather than discounting it in advance, as usually happens.

Why did the market behave this way?  I don’t know.  All I can come up with is that computers, not people, are the main actors, and that the decision rules they’re using aren’t very good.

Something to think about …and keep an eye on, since this behavior runs so counter to prior experience.

Whole Foods (WFM) and Millennials

May 11, 2015 By in earnings conference calls, Recent Market Action, Retail, Stock ideas, supermarkets Tags: , , , , , , , 1 Comment

What should we make of the announcement by WFM that it’s launching a new chain of supermarkets–smaller stores, selling less expensive merchandise, targeted to Millennials?

preliminaries

I was an early investor in WFM.  My family shops there on occasion.  But I haven’t followed the company for years.

Over almost any period during the past decade, the traditional supermarket chain Kroger (KR) would have been a better investment.

The stock’s strong performance from the depths of the recession comes in part from its starting point–a loss of over 3/4 of its stock market value and the need for a $425 million cash injection from private equity firm Green Equity Investors.

my thoughts

new brand–As I once heard a hotel marketing executive say, “You don’t start selling chocolate ice cream until the market for vanilla is saturated.”  Put a different way, if there’s still growth in the tried and true, it’s a waste of time to segment the market.  Therefore, the move to a second brand signals, at least in the minds of the managers who are doing this (and who presumably know their company the best), the end to growth in the first.

less expensive food–Pricing and brand image are intertwined.  Paying a high price for goods can confer status both on the product and the buyer.  Lowering prices can do the opposite.  It seems to me that WFM judges it can’t lower prices further in its Whole Foods stores without risking the brand’s premium image.  It may also be that WFM thinks it needs the pricing to pay for the big stores/prime locations it already has.  That would be worse.

smaller stores–This is less obvious.  The straightforward conclusion is that WFM has exhausted all the US locations where the demographics justify a big store.  My impression is that this happened years ago, however, when WFM began to decrease the square footage of its new stores.  On the other hand, it may also be that in their search for “authenticity,” Millennials react badly to big stores.

Millennials–Millennials and Baby Boomers are each about a quarter of the population.  Boomers have about twice the income of Millennials.  But as Boomers fade into retirement, their incomes will drop.  Millennials, in contrast, are just entering their prime working years, when salaries will rise significantly.  So targeting Millennials makes sense.

 

It’s not surprising that WFM shares dropped on the news.   It signals the end of the road for the proven brand and a venture into the unknown for which no details have been provided.  Why announce this now in the first place?