two thoughts

Target

The price action of the Consumer discretionary sector, and of TGT in particular, so far today shows the essence of a bear market. Despite being down by 20% from its high last year, TGT has lost a quarter of its market value, or about $20 billion, in trading today that in the first hour is already about 8x normal daily volume.

Yes, the quarterly results the company reported this morning were surprisingly bad. Yes, the company might have lessened the shock if it had hinted at the weakness it was seeing as the quarter developed (although I’m a holder, I don’t know the company well enough to understand its disclosure policies in this kind of situation). And, yes, we may not see positive earnings comparisons until next year. But a loss in market value this large seems a bit much.

But this is the essence of a bear market. The same bad news–in the present case, higher interest rates, supply chain disruptions, the end of extra government stimulus…–gets factored into stock prices over and over and over again. WMT, for example, which had its wings clipped by 10%+ just yesterday on earnings that weren’t as bad as TGT’s, is down another 5% in the first hour today. HD, which reported an excellent quarter yesterday, has given back Tuesday’s gains and then some so far today. Also, the market has a relentless focus on the here and now, reacting especially to bad news.

The most reliable indicator that the down market is over when companies report quarters like TGT’s and the stock doesn’t go down. We appear to be a ways away from that.

Twitter

I don’t use TWTR and I don’t pay much attention to it. The internet tells me Elon Musk is worth $200 billion+, although I vaguely recall a number closer to $150 billion being tossed around in commentary about his bid for TWTR. A good chunk of that is his 17% interest in TSLA.

My sense, having owned both TSLA and Solar City for a considerable time, is that he thinks big thoughts and is willing to take substantial risks, but that he leaves the details to others. His apparently shaky grasp of the securities laws that pertain to his proposed acquisition of TWTR are a case in point.

Knowing only this much, my guess is that Musk thought, based on his past successes, he would have no trouble obtaining third-party finance for his (fun for him) bid for TWTR. That doesn’t appear to be the case, however. Instead, he’s essentially being asked to take out a margin loan secured by his TSLA stock.

If so, if TWTR turns out to be SolarCity redux, or if TSLA stock weakens for any reason, his loan could be called and he would lose the stock put up as collateral. Embarrassing? Yes. More important, he could end up losing control of TSLA.

My guess is that Musk is only working all this out now, and that this is the source of his apparent cold feet with TWTR.

wheat vs. chaff (viii)

The most difficult area of the market to navigate right now, for me anyway, is the tech area. The main task, as I see it, is to separate stocks that are creatures of the stay-at-home economy and which are being pummeled with some justification–because their earnings depend on continuance of pandemic conditions–from those with stronger businesses, which although they benefitted substantially from the pandemic, can continue to prosper in a post-pandemic world.

It’s no accident, in my view, that tech issues peaked as soon as the new administration came into office in early 2021 and began to work to bring covid under control. The stocks been slammed again, in greater or lesser fashion, when the stock market began to make another serious move south late last year–in anticipation of the normalization of interest rates now underway.

The IT + Communication services sectors still make up a third of the S&P 500, so it’s probably not a good idea to have no strategy for this part of the market. The simplest one would be to make the tech part of one’s portfolio look like the index, through a sector ETF. That would mean no outperformance from having “good” tech names, but would be an easy way to avoid having to figure out the complicated mess that these two sectors have become.

I’ve ended up with a three-pronged approach:

–focusing on semiconductor manufacturers and on the companies that make the manufacturing equipment that goes into semiconductor fabs. This revolves around the idea, which I’ll be writing more about soon, that the world has decided that having most of its cutting-edge capacity located at TSMC in Taiwan isn’t such a great idea.

–trying to figure out stocks to avoid, meaning ones that owe a large proportion of their success to appeal that ultimately derives from the covid quarantine. SPACs in general are one. Companies like Zoom and Roku are another. This doesn’t mean I won’t be wrong about at least some of them. I just choose not to bet on them.

I don’t think any company would opt to go public through a SPAC (ceding a quarter of its value to the SPAC promoters) unless an underwritten or direct listing were simply not possible. I worry that ZM is ultimately a feature rather than an app–and that users will migrate to clunkier services from big tech companies once ZM begins to charge. I worry that a lot of ROKU’s success comes from being bundled into TCL tvs–and that manufacturers like Samsung, Sony or LG have adequate substitutes.

For what it’s worth, my biggest tech holding is MSFT, which I’ve owned since Steve Balmer was forced out.

–looking for traditional value names. That is, companies that are not necessarily the best operators, but which have been beaten down to the point that their asset value is higher than their market cap. HOOD stands out to me as one of these. Regular readers will know that I’ve (totally incorrectly, so far) thought PTON is as well.

This may also be a riskier endeavor than I’ve realized, maybe because I’m a growth investor dabbling in value. Still, I find the price action head-scratching. For example, the market has known for months that PTON’s former head built bike inventories to astronomical levels last year. I would have thought Wall Street would have factored the inevitable writedown and the consequent possibility of having to tap its credit lines into the stock price long ago. Not so. Maybe this is just the bear market. But it’s also possible that deep value investing no longer has the clout to stand up to AI-driven selling.

wheat vs. chaff (vii)

from stay-at-home to return-to-normal

Two years ago, the domestic stock market was trying to figure out the economic consequences of having a rapidly spreading pandemic (dead bodies stacked in refrigerator cars because the funeral industry was overwhelmed) and a national government that folded under the pressure. A new administration quickly took action and appears to have the pandemic more or less under control.

Several pandemic-related issues remain, however:

–the fiscal stimulus applied by Washington to stabilize the economy now appears to have been too large (in contrast to the deeply inadequate government response to the 2008-09 banking crisis) and to have been applied for six months too long. The result of this is the highest level of inflation in the US in a quarter century, and a sense of urgency in raising interest rates to cool down a too-hot economy. Although the monetary authority always expresses a strong desire for a “soft landing,” i.e. an economic slowdown that doesn’t tip the country into recession, I can’t recall this aspirational outcome ever actually happening. The big question fo us as investors, I think, is what difference it will make in practical terms if the US contracts by, say, 1.0% in 2023 vs, expanding by 0.5%.

–speaking very roughly, consumer spending in the US is usually half on goods, half on services. During quarantine, that ratio shifted to 3/4 on goods. Although I have no idea of the details, let’s assume something similar most likely happened in the rest of the world. This rapid shift, which manufacturers have doubtless diagnosed as temporary–meaning they haven’t launched capacity-expansion programs– has created global shortages of goods. This has translated into higher prices for what has been available

–China continues to have pandemic outbreak problems, which it is treating by isolating affected areas. This has significantly slowed the flow of exports to the US, creating another source of inflation.

stock market issues

–as the economy shifts away from consuming huge amounts of goods toward services, who are the winners and losers?

–in particular, in a post-pandemic world, what are the prospects for the biggest quarantine winners, like Zoom or Teledoc or Robinhood (I have a small position in the last)? Do they remain relevant or fade back into obscurity?

–in a world where money is essentially free, all sorts of schemes that would appear crazy in other times abound. In the most speculative markets, black box companies, blank check companies, or ventures so lucrative they can’t be revealed emerge and go public. The pandemic’s equivalent is the Special Purpose Acquisition Company (SPAC). Do any of these have any merit in a world where government bonds trade at 4%?

–Over the past six months:

S&P 500 -14.2%

NASDAQ -25.8%

ARKK -63.2%

ZM -63.9%.

In other words, a lot of bad stuff has already happened, meaning that the market has already been struggling with these issues. How much bad news has been fully discounted?

more tomorrow

wheat vs. chaff (vi)

I was intending to post this yesterday but ended up getting sidetracked.

All bear markets have some features in common, the most obvious one being that stocks in general go down. There are also broad differentiating factors: plain vanilla down markets result from the monetary authority raising rates to cool down an overheating economy; other, more serious ones come from external shocks. Examples of the latter would be the 10x rise in oil prices during the 1970s, the covid pandemic or the Russian invasion of Ukraine.

In addition to the very broad factors, both bull and bear markets tend to have currents of out-and underperforming stocks that are also driven, in a positive or negative direction, by technological change or other secular influences.

The most straightforward of these last in the current market, I think, involve the reaction of the world to the invasion of Ukraine. As I see it,

–the invasion itself has disrupted the world market for food grains, iron and steel, assembly of durables like autos and contract coding

–the resulting boycott of Russian exports has intensified those three. By far Russia’s most valuable export, however, is hydrocarbons–by value, natural gas is the clear #1, with oil (Russia produces about 10% of the world’s output) a distant second

–the experience of the past fifty years is that oil boycotts are never completely successful. Output (usually a lot of it) is relabeled as of different origin and sold anyway. The demand for oil, however, is highly inelastic, meaning even small changes in output can lead to large change in price. So, perversely, the move to limit unit volume exports could end up increasing total income to Russia. It seems to me that the real NATO strategy is to deny Russia access to international oilfield service companies’ development expertise, thereby reducing potential output dramatically over several years

–natural gas is another matter. At the surface it’s just that, a gas. So it is either delivered to the user by pipeline or liquified and shipped in cyrogenic containers (very expensive). From Russia’s perspective, finding new buyers and delivering output won’t be easy. For the EU, locating alternate sources and building necessary infrastructure will likely take years. To me, this suggests that conservation and developing non-hydrocarbon alternatives will be the EU’s answer

–as far as agricultural commodities are concerned, shortages seem to me to be a function of the time it takes from planting to harvesting, a question of months, not years

Overall, assuming the invasion doesn’t end suddenly, I think a high oil price will accelerate the move to electric cars, the main beneficiaries being automakers without assembly operation in Russia or Ukraine.

wheat vs. chaff (v)

There have been a number of brokerage strategy reports recently describing a typical business cycle-driven bear market. The first stocks to decline tend to be smaller companies, at high PE multiples (meaning the best earnings are in the future, not the present), and in cyclical industries. Selling gradually rotates into larger, more mature (therefore lower PE) companies and into what are normally regarded as defensive industries. The rotation is typically driven by two factors: relative valuation and the gradual realization that even defensive companies suffer as spending declines in an economic downturn.

The whole process takes something like a year to play out, both in the real world and in the financial markets. The stock market, though, tends to bottom several (six?) months ahead of the economy. This is at least in part because government policy begins to shift away from its most restrictive stance.

This is a useful framework, which I think will continue to be a key part of AI-controlled trading strategies. So in a sense it’s a self-fulfilling prophesy. What I think is equally important, but overlooked in the cyclical bear scenario, are the implications of several external shocks. They are:

–the pandemic, predominantly now the negative effect on global supply chains, resulting in sometimes sharply rising prices for what goods are available

–the Russian invasion of Ukraine, which I see as triggering fundamental changes in the world market for oil and gas, as well as more temporary changes in agricultural commodity markets

–to a lesser extent (at present, anyway), the fundamental changes in the world semiconductor market being driven by the key importance of Arm Holdings and TSMC in their design and manufacture, and the precarious nature of the ownership of both firms

more tomorrow.