on New Year’s Eve

First of all, Happy New Year.

I really don’t have many detailed, high-conviction thoughts about how 2021 will play out. But I do have a few more general observations:

— the key to 2021 is figuring out when economic recovery in the US will commence and how strong it will be

–current high PEs are a function of near-zero interest rates. As/when they begin to rise, which they will at some point after domestic recovery is firmly established, overall PEs will begin to contract. Investor interest will likely shift, for a while at least, away from secular growth names to beneficiaries of cyclical recovery (e.g., banks, industrials). The smallest-cap, most speculative names will likely be hurt the most

–my guess is that recovery in the US will be later to arrive than elsewhere. I don’t just mean that China is posting its tenth consecutive month of GDP expansion or that the Pacific in general is in decent shape. I think we all substantially underestimate how deeply Trump has wounded the domestic economy through his tariffs, his strong preference for industries of the past and his pandemic denial. So although I’m slowly moving away from 2020’s winners, I’m hesitant to make a big pro-cyclical bet

–the US$ has been steadily declining against other world currencies for the past nine months or so. This bout of weakness coincides with the spread of the pandemic. I’m reading it as being caused by Trump’s hoax narrative. If so, the change of leadership may stabilize the currency. On the other hand, the decline may be a reaction to the large increase in Federal debt. I don’t think that’s going to change much. What’s at issue: weak dollar = higher dollar value for the foreign earnings of US-based multinationals. Stronger foreign economies would also be a plus

–at some point in the next few months I think there’s likely to be a selloff in the big winners of 2020. This would likely affect smaller companies much more than the FAANGs, because the former are perceived as riskier and many smaller names have left the FAANGs in their dust. There’s no way I know of to time this. I think it’s a mistake to try to do so. My approach is to try to separate long-term winners from more iffy names and to gradually shift the latter into more cyclically sensitive areas. Your thoughts on US recovery will determine speed and extent of this shift

–Zoom (ZM). This is the quintessential covid stock. I owned it for a while but began to think that there’d be a time when the market would want to distinguish between apps and features (i.e., things that would fail as stand-alone entities and would end up as part of something else–vintage 2000 internet selloff). I put ZM in the feature category. Maybe that won’t be the case. And of course I missed a good part of the upward movement. The important thing, though, is that the stock peaked in October at $588 and is now $347, a 40% drop since the high. I have no idea what’s going on with ZM. I just think it’s an interesting movement and that we should keep our eyes out for similar occurrences–which would imply the start of the winnowing I wrote about in the preceding paragraph.

FAANGs in 2020

I was watching the crawl on CNBC as I was eating breakfast this morning and happened to hear several of the presenters discuss the influence of the FAANGs on stock performance this year. Then I saw an article in the FT that said that the rise of index investing had funneled, in effect, too much money into large caps, making them outperformers without much regard to their merits. Of the FAANGs, I own only Netflix, so I decided to take a look. Year-to-date prices, as of about 10:30 est this morning:

the indices

S&P 500 +15.8%

NASDAQ +43.8%


AAPL +82.4%

AMZN +79.9%

NFLX +63.8%

FB +34.0%

GOOG +30.8%

under the media radar

ARK Innovation ETF, which owns none of the above +150%

Of the FAANGs, the real star is AAPL, whose two-year performance is up there with the ARK fund. In contrast, while AMZN has gotten a tremendous boost from the pandemic this year it trails NASDAQ by almost 30 percentage points on a two-year view.

I mention ARKW because it shows the power of original research, the fact that healthcare has been a key performance driver and that the real performance stars this year have been (as usually is the case) in less headline-catching names.

a note on risk

The ARK ETFs are not for everyone, however. The overall group has a narrow focus; the ETFs are highly concentrated, with the top ten positions in the Innovation ETF, for example, comprising just under half the fund; and what the firm considers to be key names can be top holdings in more than one ETF. So holders should be able to tolerate their higher than average level of risk.


betting and man-made climate change

Many years ago, when I met one of my wife’s eccentric uncles for the first time and told him I did stock market research for a living, he replied that I misunderstood what my career was. I wasn’t a professional researcher, I was a professional gambler.

I eventually realized that he was more right than wrong about me at that time, and that he was completely correct when I became a full-time portfolio manager a couple of years later. This means that I look a most situations as bets, usually with four elements: the potential payoff, the chance of success, the amount at risk and how a given wager fits in with other bets I may already hold. A fifth element might be the length of time I’m committed to the bet, but in a world of cheap online trading and highly liquid markets, this is typically not an issue.

As a bet, climate change seems to me to be a no-brainer. To simplify the question, it’s whether burning fossil fuel ends up steadily and irreversibly warming the planet, to the point where lots of economic activity can no longer be carried out where it is now–like coastal cities flooding, crops no longer growing… Avoiding this is the potential payoff, which is likely enormous.

I find the chance of success hard to figure out, so my first approach is to see if there’s a way to make this not matter.

This brings me to the amount at risk–which I regard as the path to neutralizing the success question. Replace fossil fuels, to the extent possible, with renewables. This process is already well underway with solar panels, wind farms and electric cars. Deciding to combat climate change is bad news for Russia, for Saudi Arabia and the rest of OPEC, and for US-based oils (European oils are well under way in transforming themselves into energy (i.e., renewables) companies. In other words, any extra costs to accelerate development are probably small. The bigger issue is the politically powerful energy status quo.

Regarded simply as a bet, I can’t see there’s any percentage in acting on the idea that the climate change is a horrible mistake on the part of the world’s scientific community. That’s except for any oils and autos who think they don’t have the ability to evolve and that their best strategy is to use political clout to obstruct the shift to renewables for as long as possible.

electric autos: implications

automobile stocks?

I can remember holding shares of Porsche for a short while 15 years or so ago and Peugeot and Toyota (the latter a mistake), again for a short time, in the mid-1980s. I mention this to communicate two things–I’m not an expert on the auto industry and avoiding autos has never put a noticeable dent in my investment performance.

But, as it turns out, the other day I misread a headline on Yahoo Finance. It was something like “used cars are losing their value fast” and turned out to be list of famous clunker cars, like the Yugo. I had taken it to be a more general assertion that because electric cars are becoming better and cheaper, the value of used cars (including, of course, the two in my driveway) are beginning to sag. That plus AAPL’s announcement that it will sponsor an electric car in 2024 collected up the scattered fragments of car info swimming around in my head and into popped the whole car issue into the front of my brain.

The issues, as I see them:

–the auto manufacturing industry is mature in most of the world and has been plagued by chronic overcapacity for as long as I’ve been aware of it. This is why, except for the beginning of reemergence from a deep recession, which causes sales of new cars to plummet, they’ve generally been poor performers. Overall weak management hasn’t helped

–the key proprietary skill for traditional carmakers is designing and building internal combustion engines. Other components, from brakes to lights to windshield wipers, have been farmed out over the years to specialist parts suppliers. This is why, I think, controls look pretty much the same in different brands’ offerings. More important, these component suppliers own much of the auto industry non-engine intellectual property. For my money, ex engines, traditional car companies are all about brand management/product design plus what in the electronics industry would be called contract assembly

–strong consumer backlash after the recent diesel fuel economy scandal in the EU (carmakers there gave out false fuel economy data “supported” by faked test results to show they met state-mandated mileage requirements) has accelerated Europe’s move to electric cars. No one wants to be tricked a second time into buying a diesel engine. China has backed electric strongly, too, as a partial solution to its severe air pollution problem

–in the electric car age, the craft skill accumulated, and machinery used, to build IC engines for cars and most trucks will have no economic value. Not a good thing for an industry whose boosters look at book value. A side note: is AAPL planning to use otherwise idle capacity at, say, BMW to manufacture its Apple electric car?

–what happens to the vast array of aftermarket businesses aimed at servicing and repairing IC engines? …to gasoline stations? …to Jiffy Lube? …auto parts stores? Again, nothing good, although some gas stations may be able to repurpose themselves to become charging stations

–although the US is home to about 4% of the world population, it produces about 20 million barrels of oil daily, 20% of the world’s total. It consumes basically that entire amount, half in the form of motor fuel. (If I read the data correctly, the US consumes 40% of the world’s gasoline, something I hadn’t thought about before). Petroleum industry think tanks argue that the switch from oil to electricity will proceed slowly and take about two decades, so this nascent trend will not be a supply/demand issue for a couple of decades.

I suspect this is more a hope than an actual forecast. If the US gasoline market disappeared tomorrow, world petroleum demand would fall by about 10% and half of US oil production would need to be sold in foreign markets. This would mean a sharp decline in oil prices that would likely shut down drilling in all but the lowest-cost areas, like the Middle East.

my bottom line

I don’t think the switch to electric is imminent, but I think the little-by-little change over twenty+ years that the petroleum industry is projecting is equally unlikely. In addition, I think the stock market will, as usual, begin to aggressively discount future prospects well in advance of actual events. I don’t think this has really started yet.

Some signs of worry in the politically powerful auto and oil industries are already evident, though, in the administration attempt to roll back fuel efficiency guidelines and remove conservationist barriers to more widespread oil drilling. Why else the proposed rush marriage between GM and an apparently iffy startup Nicola? Why else the nosebleed valuation for Tesla?

There are about 275 million hydrocarbon-driven autos operating in the US, according to Google. If their average value is $10,000 today (I have no idea what the actual number might be), that’s close to $3 trillion in future lawn sculpture.

I don’t think worries about climate change play much of a role in the current automobile dynamic. This is something else I don’t understand–but will write about tomorrow anyway.

heading into 2021 without a clear roadmap

That’s the way I feel, anyway.

On the one hand, I think most stock market participants are still substantially underestimating how much economic harm Trump has caused during his term in office. Three key aspects of the last four years: support for the industries of the Fifties while putting roadblocks in front of cutting-edge consumer and industrial companies; his thoroughly debunked, deeply damaging 18th-century approach to trade, especially with China; the extra trillions of dollars in government spending needed to recover from his “it’s a hoax” justification for inciting Americans not to take pandemic defense measures.

In more qualitative terms, his white racism and his continuing attempt to subvert the November election–checked not by Washington but by the courts, the military and local election officials–have given the American brand a black eye that only time will heal.

2021 issues, as I see them

Given a chance, the likelihood that most people will get vaccinated, the arrival of warm weather, and perhaps some help from the new administration (I’m only figuring he rolls back the regulatory clock to 2016, though), the economy should begin to heal itself.

Two traditional investment questions for a time like this are: how vigorous any rebound will be and when it will begin. The when is important because the stock market typically reacts six months or so in advance of changes in economic strength. The how vigorous is important because 50% or so of the earnings of the S&P come from the US, with 25% from Europe, 15% from developed countries in the Pacific and 10% from emerging markets. Does it make much difference if we bet on the US or the rest of the world in the stocks we choose?

A related issue is how powerful any business cycle upturn will be when compared with secular growth momentum for areas like IT, genomics and fintech. In other words, how heavily should we want to be exposed to a traditional business cycle rebound.

Of course, price also enters into the portfolio construction equation. That’s particularly important today, I think.

a non-issue for now…

…is interest rates. Demand for stocks is a derived demand. The more fundamental demand is for liquid investments–stocks, bonds or cash. I don’t think rates are going lower. I don’t expect them to move higher for a considerable amount of time. But as/when rates start to rise, cash will likely become more attractive vs. both bonds and stocks.

a potentially important one…

…the dollar. The dollar has dropped by 5% or more against other major currencies over the past half year. I have no idea where the dollar goes from here. If the big global banks begin to think there’s a risk the US will have trouble repaying government debt, the direction is down. If Biden proves to be better than just not-Trump, the direction will likely be mildly up. The first case is good for companies with non-$US earnings, the second for companies with costs abroad and sales in the US.

relative performance, ytd

When I was working I used to get a daily performance attribution report, that detailed (more or less accurately) how every stock in each of my portfolios had performed the previous day according to a whole bunch of metrics, including what contribution each had made to aggregate out/underperformance. That, of course, was overkill. I mention this only because I have to generate all the information myself if I want to see it. So I end up being surprised every once in a while by very near-term wiggles in the US indices. I’m not 100% sure what to make of the data below, but here it is:

ytd 1/1 to election election to 12/22

NASDAQ +42.7% +29.6% +14.2%

Russell 2000 +18.1% -0.3% +23.3%

S&P 500 +14.1% +9.0% +9.4%

Dow +5.2% -0.3% +9.2%.

Significance? The NASDAQ is full of techy multinationals; the R2000 is full of companies that make things in the US to serve US customers. The Dow is pretty worthless as an index, although there still are enough dinosaurs in there to give an indication of how the lagging edge of the economy is doing.

As I read the numbers, Wall Street is already beginning to bet on a domestic cyclical rebound. Regular readers will know I’ve been looking for this for maybe half a year. There have been fits and starts before, but nothing as strong as during the past six weeks or so. I’d already shifted about 20% of my portfolio into R2000-ish names, with indifferent success. I certainly won’t pare back but I have to think about how much more to boost this.