Yearly Archives: 2020

thinking out the end game (i)

August 24, 2020 By in administration economic strategy, economics, Strategy, Uncategorized Tags: , , Leave a comment

The Trump presidency has been an almost incomprehensibly huge disaster so far, both in terms of core American values and the operation of the economy–even before Trump’s worst-in-the-world handling of the pandemic.

Looking solely at narrowly economic factors, real GDP had flatlined, pre-COVID, as a result of his senseless tariff and immigration policies (I’m not necssarily anti-tariff, but at least try to have an objective and think out possible consequences–like destroying US agricultural exports to Asia–before putting them in place). On a longer view, he’s continuously undermining global faith in the dollar and the American banking system, as well as sowing the seeds for Shanghai to replace Wall Street as the world’s stock market capital. This will “hurt” China by speeding its ascent to world economic leadership.

In vintage Trump fashion, those damaged most badly by him have been his supporters.

In addition, Trump’s cognitive fastball, never of more than sandlot quality, seems to me to have regressed over the past year or so to somewhere south of mid-level Little League and slightly north of tee ball.

Despite all this, and in spite of his deeply anti-American cultural values, he may still be reelected.

As a citizen, this is not the outcome I want. As an investor, however, the implications are more straightforward. As I see it, initially:

–the Fed would continue to compensate for Trump’s bungling by running extra-stimulative money policy. In fact, the Fed has just signaled that it would be willing to let inflation run for a considerable while (we should be so lucky) to make up for the damage done by years of price level stagnation

–voter endorsement of Trump’s racism would reduce the attractiveness of American consumer brands in foreign markets; we could no longer say we didn’t know what he stands for

–ultra-low interest rates will underwrite continuing stock market strength

–the pattern of strong performance of stocks with the least connection to domestic GDP and deeply sub-par performance from those with the greatest GDP ties, would continue–as domestic capital continues to flee his incompetence and racism

–technology companies will maintain their Wall Street listings but would begin to shift their highest value-added operations to other countries, if for no other reason than to be able to hire based on talent. If Trump’s current attack on domestic research universities continues, this move could be surprisingly swift. The only plus here is that Xi’s attack on Hong Kong removes the SAR, the obvious non-US destination, from consideration for dual listings by US firms. Singapore?

–investment in cutting edge plant and equipment in the US by multinationals would likely decline.

The stock market I’ve been using as a very rough template for the US today is Mexico in the 1980s. A second aspect of this model, something that would have been unthinkable a few years ago, is the eventual loss of faith in the local government. This shows itself in a number of types of financial behavior: the “capital flight” character of the stock market that we’re now seeing in the US; a deteriorating currency; and eventually, capital controls imposed to prevent citizens/residents from shifting assets out of the country. We’re not there yet. Signs for worry: accelerating trade/current account deficits, national debt so large that potential buyers no longer believe they’ll be repaid in full.

Walmart (WMT) vs. Target (TGT)

August 19, 2020 By in Uncategorized 2 Comments

TGT reported after yesterday’s close, WMT after Monday’s. Both retail giants released earnings reports that blew away the consensus, including gigantic increases in online sales (due in large part to their relatively small percentage of the firms’ business). TGT is up by 11% in early trading; WMT fell in a flattish market yesterday. Both stocks have outperformed the S&P 500, although compared (unfairly, maybe) with NASDAQ they’ve been significant year-to-date laggards (the S&P is up by 5.5% ytd as I’m writing this just after 9:30 am; Amazon is up 78%, WMT 12.5%, TGT 16%, NASDAQ 25%).

Yes, TGT’s year-over-year sales gains were more impressive than WMTs. But I don’t think that explains the difference in the market’s reaction to the results. What really caught my eye is that WMT’s sales comparisons began to sag after the government stimulus checks ran out. TGT’s didn’t.

I think this has to do in large part with the differing demographic positioning of the two chains. As I see it, the poorest Americans are served by smaller local firms that are not publicly traded and are therefore below Wall Street’s radar. Of the parts of the economy we as retail stock investors can view, the least affluent tend to be customers of the dollar stores; WMT customers are one rung higher; TGT customers a notch higher than that. All are traditionally below department and specialty retail stores, where the upper half on the income scale has shopped. As the economy ebbs and flows, the customer base for all these retailers shifts down and up as consumers alternately economize and splurge, based on the overall business climate.

My impression has always been that WMT is much more rigidly than TGT following a formula that led to its great success a generation ago. That may not be entirely fair. Certainly, its large size and assorted restrictions on expansion into urban areas are much harder for a giant like WMT to deal with than its rivals. On the other hand, WMT is pretty much 0 for the internet so far, and its forays into foreign markets other than Mexico hasn’t been pretty.

Anyway, whatever the cause, what I get out of the reports is that the pandemic has pushed WMT customers much closer to the edge of the cliff than it has TGT customers. That’s the difference in the stock market’s reaction to the results.

Wall Street and US elections

August 17, 2020 By in Basic Concepts, economics, Portfolio management, stock market Leave a comment

There are two pieces of Wall Street lore about market performance around presidential elections that have passed their sell-by date but which continue to float around. They are:

–the last year of a presidential terms is a good one for stocks; the first year of the new term is a bad one.

The idea behind this is that the incumbent president would successfully pressure the Federal Reserve into a looser-than-necessary money policy in the runup to the election. This would give an artificial boost to the domestic economy, enhancing his reelection prospects. This extra stimulus would be reversed after the election, slowing the economy down in the first months of the new term. Gerald Ford’s refusal to follow this custom is often cited as the reason he lost the 1976 election to Jimmy Carter.

With the exception of Donald Trump, who has continually pressured the Fed to loosen money policy throughout his term, this no longer happens. I’m not 100% sure why. My leading candidates: the world is a much more complex and mutually integrated place than it was a generation ago, so it’s not so easy to use the domestic money supply to give the economy a pre-election jolt; over the past quarter-century there have been a succession of crises, from Y2K/Internet bubble to 9/11, to the Great Recession, to Trump’s wrongheaded tariff wars, to his coronavirus bungling, that have dwarfed any monetary tweaking the Fed might contemplate .

In any event, there’s no reason to believe that the world economy will be weaker in 2021 than it is now or that a post-election tightening in money policy is on the cards.

–Republicans are good for stocks, Democrats are not.

The idea here, from a generation ago as well, is capital vs. labor. A high-level Republican goal is to protect the accumulated wealth of its country club backers. This means having low taxes and low inflation. The Democrats, on the other hand, represent workers whose chief asset is their labor. Their main economic goal is to obtain real wage/benefit gains. The inflation that results doesn’t hurt them because they have no wealth to begin with. And it makes them better off by eroding the real value of the goods and services they need to buy from Republicans.

Again, the class warfare that defined the old Democrat/Republican battle lines is mostly gone. As a former work colleague of mine was already writing thirty years ago, neither party has a relevant economic program for today’s world. Ironically, despite its business roots, the current Republican administration is supported mainly, I think, by workers disenfranchised through the demise of heavy industry in the US (and ignored in a worst-in-the-world fashion by both parties). And the head of the party is a stunningly inept businessman who continues to do enormous economic damage to the country.

A more reasonable worry about the election might be that a Democratic administration would partially reverse the corporate income tax cuts of 2018. That might lead to after-tax results from the S&P 500 next year being, say, 3% lower than expected. 3% is not a big number, though. And there might be positive effects on growth from reopening the borders, a more intelligent approach to the potential threat from China than shoot-yourself-in-the-foot tariffs, removal of some of the white racist tarnish of the American brand abroad…

two common market fallacies

August 13, 2020 By in economics, Portfolio management, Strategy Tags: , , Leave a comment

market cap/GDP

I was reading an article on Yahoo Finance the other day that cited what it claimed was a Warren Buffett rule to gauge whether the US stock market is under- or overvalued. The idea is that if the total market cap of US stocks exceeds annual GDP (of the US) then stocks are overvalued. If market cap is less than GDP, stocks are undervalued.

On the surface, this sounds like it might make sense, since it is the US stock market, after all. And the health of the Treasury bond market is tied to the vigor of the US economy. Also, the idea was big in the 1980s, when market cap/GDP was used by Americans and Europeans as a rationale for not becoming involved in the Japanese stock market during a decade-long domestic economy boom there.

Two issues this idea ignores:

–multinational companies. In the case of the US, a good guess is that half the earnings of the S&P 500 come from outside the US. In fact, a very simple but effective way of approaching structuring a portfolio in the US market is to ask whether the US economy will likely do better than the rest of the world in the year ahead or worse. In the first case, the portfolio should overweight domestic-oriented stocks; in the second, internationally-oriented.

–how much of the domestic economy is publicly traded. In the case of the US, big sectors like real estate and housing have little representation. Germany, whose market cap has seldom, if ever, exceeded half of the country’s GDP, is the biggest counterexample for the cap/GDP idea. Two reasons: almost nothing is listed in Germany, and German citizens have historically had little interest in stocks.

For the record, I can’t imagine Buffett thinks this.

strong stock market = strong economy

Typically, this is the case, in my experience. But there are exceptions, like Mexico in the 1980s–and Germany almost always. In today’s US, it’s easy to see, by comparing the global NASDAQ with the US-centric Russell 2000, that stocks are strong in spite of weakness in domestically-oriented issues. In fact, somewhat like Mexico back then, the US market is underpinned by the near-zero interest rates made necessary by our extreme economic weakness.

A side note: over the past three months, the R2000 (+22.7%) has held its own with NASDAQ (+24.5%). Both have far outdistanced the S&P 500 (+17.5%). Why the R2000 strength? Three possible reasons (translation: I don’t know): counter-trend rally; the worst of the pandemic is already baked into R2000 prices; anticipation that Trump will not be reelected. My guess is some combination of the first two. I think it’s too early to be trying to figure out the election, although belief in four more years of Trump dysfunction should translate into shorting the dollar and the R2000.

1990s Japan/the US today

August 12, 2020 By in Uncategorized Leave a comment

I’ve been trying for some time to find a shorthand way of describing how I view the current economic situation in the US. I think I’ve found one: it’s like Japan entering the 1990s, only without the threat of higher interest rates.

Japan’s lost decades

Last year Japan racked up its third consecutive “lost” decade of virtually no real GDP growth. It has started decade four with, as I see it, little prospect of change. That’s partly because the government continues to pursue the same anti-progress agenda it has followed for over a generation. It’s partly the lack of an effective political opposition to the ruling Liberal Democrats. It’s also a result of the elevated status accorded to hereditary wealth and the deeply ingrained Japanese cultural, religious, linguistic tendencies to respect the “wisdom” of elders.

What’s most of interest and concern to us as investors is not the cultural underpinnings of today’s Japan but rather the fact that Tokyo’s economically ruinous policies are virtually the same as those the Trump administration has been blithely putting in place in the US over almost four years–and which had already transformed the US from rude health into the emergency room, even before Trump’s pandemic debacle.

similar mistakes to Trumponomics

The major economic policies that have led to Japan’s dismal economic decline are very familiar:

–a strong preference for industries of the past. Especially true for the zaibatsu conglomerates, like, say, Mitsubishi or Mitsui, that make up today’s industrial and political royalty. They feature industrial companies whose heyday came in the 1980s–autos, ships and heavy machinery. Same now for the US, except Trump also supports the mining and energy industries that were in their glory much earlier

–barring foreign workers needed to bolster an aging–and long since shrinking–domestic workforce. Strong bias against domestic minorities, as well. No ICE equivalent in Japan, though. No secret police to incite violence, either, although the yakuza might occasionally perform a similar function

–strict barriers, formal and informal, against foreigners exercising corporate influence or ownership control, even to rescue dysfunctional, but politically connected, companies in any industry. Japan has always been xenophobia, but put in stout legal barriers in the early Nineties. The US uses, for example, the increasingly aggressive Committee on Foreign Investment

–strong anti-innovation bias. In Japan this expresses itself in a reluctance to support businesses not sponsored by the old guard, and especially those in new industries and/or run by women. The US equivalent is the administration’s strong anti-science bent, its protective measures for the Detroit auto firms, its defense of a laggard telecom industry and its failure to modernize infrastructure. Some of this isn’t new. For the past fifty years or so, the US has propped up the domestic auto industry, but Trump has intensified government protection. He also whiffed on the chance to address the special tax breaks natural resource firms enjoy in the US in his tax-cuts-for-big-donors bill in 2017, while also increasing the amount of environmental damage they are allowed to do. One difference: Japan wants to defend the status quo; the goal of Trump’s trade war with China is to return to the US the sweat shops and manual labor industrial jobs that left long ago and which China no longer wants.

investment implications

I think the current sorry state of the US economy and of the empty-headedness of administration economic thinking have been very well understood on Wall Street for a long time. This is reflected in the deep underperformance, even pre-pandemic, of names that depend on domestic GDP growth and the rocket ship rise of capital flight stocks.

Recently, I’ve been thinking that on valuation grounds alone there must be at least some sort of stock market rally in the left-behind domestic economy-sensitive areas. To a degree this has already started to happen. Last month, for example, the Consumer discretionary outperformed IT, which has been the hands-down winner over the past year or so.

Will this rally have meaningful legs? I think the answer lies in whether/when we can expect to see domestic GDP growth again. The Japan comparison suggests to me that under Trump this is highly unlikely.

bad news is sometimes good, on Wall Street

Here’s where the twisted turn of mind that moves Wall Street comes into play. Put aside Trump’s racism, his constant lying, his ignorance, his denigration of public servants and his apparent mental decline while in office. His chief economic characteristic is he has no idea what he’s doing. While he is in office, the economy will remain a train wreck.

But having a know-nothing in the White House has its pluses:

–continuing favors for his wealthy financial backers and

— the near certainty of ultra-easy money policy as far as the eye can see, as the Federal Reserve tries to blunt the impact of Trump’s blundering. This, in turn, implies buoyant stock and bond markets.

That gets Trump lots of Wall Street support, especially from private equity and hedge fund recipients of special favors. Ironically, the ordinary Americans who vote for him will continue to bear the brunt of the damage he does.

if Trump loses

I think the course of the stock market is much less clear if Trump loses the upcoming election. Doubtless, the country will be far better off, even if the Democrats don’t have a coherent economic program, which I don’t think they’ve had for years. Certainly, interest rates will remain at intensive-care lows for a long while, although speculation will likely begin about when–and how high–rates will eventually rise. The air will doubtless come out of the most speculative “concept” stock winners of 2020 to date. Capital flight will cease to be the dominant investment theme. Consumer names will likely get a better reception than they have until very recently.

The important question will not be whether the market will rotate away from the capital flight and pandemic names that have dominated the market this year. It’s, rather, how sharply and when. Arguably, the market will begin to react before Election Day, reacting to poll results predicting who the next president will be.