overall…

my view is that the stock market in the US is just drifting as it waits for an upturn in corporate profits to begin to take place.

I see two opposing currents in this overall sideways movement, though:

–a rolling downturn that began with TGT and WMT announcing they had gigantic amounts of excess stay-at-home inventory last May, just as the pandemic was giving up the ghost. TGT lost a third of its value back then and has gone sideways since. WMT was down by about 25%, but has steadily recovered to the point it’s pretty much unchanged since then.

MU

The latest to be hit are the makers of computer memory chips like Micron (MU). This is pretty much a commodity business, meaning there’s either shortage or surplus. But semiconductors are more like food products than, say, gold, in that rapid advance in design and manufacturing techniques means that they have a finite shelf life.

In any event, MU says we’re now in oversupply. Typically, when glut hits this kind of end-of-the-cycle company, we’d be close to the final negative economic shoe dropping

–the second is portfolio readjustment in anticipation of a modest economic upturn to come later this year or early next. This itself has two complementary targets: bombed out business-cycle-sensitive stocks where the hope is that all the current negatives have already been discounted; and companies that are coping with the current flux more deftly than the market has been anticipating.

MCD

good news and bad. The good news is that MCD just reported better than anticipated quarterly earnings. This is also the bad news. That MCD doing well appears to be a sign the consumers in general are trading down from higher-priced rivals. This is similar to the way in which WMT is gathering new customers for its grocery offerings–people who are economizing as they feel an economic pinch

gold

Gold is up by about 20% from its October lows, and 10% ytd. The big buyers are foreign central banks. This could be recognition that the handiest alternative–US Treasury bonds–were going to be a bad bet until interest rates peak in the US. If so, you’d have to guess the rally is on its last legs.

TSLA

Cathie Wood of ARK, a very early, anti-consensus-but-very-right, TSLA bull is now arguing that the company could be trading at 12x the current stock price by 2027. Her idea, if I understand it correctly, is that subscription sales of self-driving car software will make up 2/3 of the company’s revenue by then, and presumably a much larger portion of the company’s profits. (In fact, she may be saying that this is a case of razor/blade or copier/paper, where the manufacturer sells the basic equipment at/below cost in order to lock the client in to the recurring consumables purchase.)

What I find most striking about her projections are that by 2027 she estimates that TSLA will be selling about 15 million cars a year, or 11+ times the 2022 production rate. This would give the company a 20%+ share of the world auto market four years from now. That would handily surpass the market share of current world leader, Toyota, which sold 9.5 million cars last year.

Although this may sound a bit old fashioned, there’s no discussion that I can see of potential PE multiple compression as/when the bullish case unfolds. TSLA currently trades at around 50x eps, or more than double the multiple of the S&P 500, presumably in kind of fuzzy anticipation of a rosy future. In contrast, Toyota, the world leader, trades at 10x, and #3, HyundaiKia, trades at less than 4x. GM is at 5x, as is VW. The group isn’t made up of real world beaters, but to a considerable degree, I think, the low multiples express the market’s opinion that at 10%-ish market share, growth prospects are limited. As far as I can make it out, the ARK analysis is that this won’t be the case for TSLA.

There are lots of factors in today’s world economy that aren’t run-of-the-mill. Near-term ones include:

–the invasion of Ukraine and its effect on world politics as well as the supply of fossil fuels. This also has implications for the speed at which the world shifts toward alternatives

–recovery from the pandemic and its reshaping of the way economic activity is conducted. Negative effects on demand for office space causing investors to reconsider the blue chip status of this sector among real estate investments, for example. Or the failure of Silicon Valley Bank underlining the stunning incompetence both of some smaller bank managements and of the corporate treasurers who placed their (uninsured) deposits–earning far below money market rates–in them

–the worry that extremists in Congress will remain so caught up in theatrical performance that the country will default on its sovereign debt

–the revival of Reconstruction-era white racism, with its attendant anti-education and anti-immigrant beliefs (I’m a fan of Heather Cox Richardson–although I think hers isn’t the whole story of current economic stagnation)

Thinking not as a human being and an American but as a stock market investor, it’s hard to see an easy way to factor these last two thoughts into an equity strategy. No shock that crypto has rebounded sharply since the November election, though.

I’ve been asking myself recently: if right now were the beginning of a normal business cycle (which it isn’t), where would we be? Typically, we would have already had the first informal indications that things were beginning to get better. Stocks would begin to move up in anticipation of the return to normality. Signals from the Fed that the next move in money policy would be toward looser money, not tighter would strengthen the advance. After that, the market would go sideways for six months or so, until company announcements began to show significant earnings gains. This would be the final all-clear signal that would get the market rolling again.

Does this pattern apply to our situation now? If so, where are we in the progression?

My guess is that it does and that we’ve already gotten, and reacted to, the initial all-clear signals. We’re now in the two quarter or so waiting period for earnings growth to kick in.

One other point: typically new leadership emerges in the up market, outpacing by a wide margin the past cycle’s strong performers.

Over the past few months I’ve read many recommendations that US investors can avoid possible turmoil in the domestic stock market by reaching abroad both to western Europe and to emerging markets around the world. This is a strategy that has worked well since I began managing portfolios in non-US markets in the mid-1980s. There was also an argument to be made that the euro was substantially undervalued vs. the US$ late last year (whether a rebound in the euro automatically translates into a relative gain in EU stock markets is a slightly more complicated issue) and that recovery from the pandemic was only happening with a lag there.

There may be a stock here and there that’s interesting, but the world has changed enough in the past half century that I think reallocation to foreign markets is a bad idea.

Europe

The four largest economies there are:

–Germany, where locals are generally uninterested in stocks and many companies remain private, financing themselves through bank loans

–the UK, perhaps the ghost of US future, which decided to cut off the flow of immigrants by exiting the EU, thereby losing access to to its largest export market. And–what a surprise–all the non-EU companies that were using the UK as a staging area for their own European manufacturing efforts left

–Italy hasn’t had economic growth for 25? years (maybe more)

–this leaves France, which has very strict rules on foreign ownership (some years ago it declared Dannon yogurt to be a national treasure that foreigners can’t own, the kind of thing that has driven entrepreneurs to pick up stakes)

Europe has better infrastructure than the US (who doesn’t?) and is generally way ahead of us on most social issues, ex immigration. On the other hand, the overall population is maybe a decade older than us, so it’s demographically less attractive.

the Pacific

–Japan. France on steroids, except with the working population shrinking since before the turn of the century

–Australia. The only place so for on the list I’d feel safe in. A pretty small market, though

emerging markets

–eastern Europe = ways to reach into Russia, which is not a high priority item at the moment

–Africa, the Middle East and Latin America, ex Mexico (which I have no opinion about). These are places for super-experts. The biggest issues I see are political stability, the completeness and integrity of financial statements, and the ability to sell if need be. This last is a lot more important than it sounds. In some places, a $5 million position might amount to several months’ trading volume. A seller would be lucky to keep his intentions secret for a week, before the stock price would collapse.

–the Pacific. In the emerging markets heyday maybe a quarter century ago, the biggest stars were:

——Hong Kong, an investor’s paradise under Deng; a place to avoid under Xi.

——Singapore, small market without China sizzle, but relatively safe

——Thailand, Malaysia, India, Pakistan… unstable governments, not particularly friendly to foreigners

In sum, I can see the conceptual appeal of trying to go elsewhere to avoid near-term risks in the US stock market. And a small percentage shift is probably ok. But for me the risks outweigh the rewards.

This is a very complex topic that I’m deliberately and shamelessly simplifying.

A reasonable way to think about the asset value of a publicly traded company is its liquidation value–that is, what a savvy buyer would pay for the company if it were being offered for sale. If we were confident in the accuracy of the company’s financial reporting books, the appropriate reference figure would be shareholders’ equity (total company assets – total liabilities).

This has very little to do with current earnings.

During the Great Depression of the 1930s, a period of great uncertainty–and one in which the accounts of Silicon Valley Bank would have been astoundingly good revelations of its financial position, Benjamin Graham advocated that investors disregard long-term assets like plant and equipment entirely and pay only for a company’s net working capital. That’s cash + receivables + inventories – payables and all debt.

Warren Buffett added importantly to this discussion of value with his observation that in the post-WWII world, many companies had developed strong brand names (Coca Cola being a prime example) and distribution networks but these very valuable intangible assets only appeared in the company accounts as subtractions of value (expenses). In today’s world, the same is true of proprietary software development.

If you believe this, as I do, then there’s a price where you’d be an eager buyer of a stock even though current earnings are in a slump.

In fact, during typical cyclical downturns, the stock market has tended to bottom around half a year before earnings begin to rebound from their cyclical lows. To some degree, this is anticipation of better times ahead, but it’s mostly based on asset values.

A cartoonish (yet possibly correct) version of this would be: the US economy will begin to rebound early in 2024; therefore, the market is either bottoming now or will be doing so within the next month or two. This is too simple. We’re now in a world of index funds and trading bots trained to be rabid disciples of earnings momentum. So there may not be that many entities either doing bottom fishing in a sophisticated way, or on the sidelines waiting for the right opportunity. In addition, we’re also dealing with the hangover from the wild party that zero interest rates induced. And, given the parlous state of national infrastructure and education, and the country’s strong anti-immigration bias, recovery is unlikely (I think) to be a rip-roaring affair.

Still, I think it’s important to imagine what positive earnings momentum might look like and to begin sifting through the rubble for areas of possible growth.

I’ve recently gotten a number of emails from small- or medium-sized companies that I’ve bought from in the past. They have a similar theme: item xxx that has been in short supply since the pandemic began is now back in stock and available for sale. I’m one of the lucky few getting advance notice of this.

As far as I can see, the shift is not from having nothing to sell to having something. It’s from having limited inventories, where it makes no sense to spend advertising dollars to create demand that can’t be fulfilled, to having at least enough on hand that potential sales need a helping hand.

My sense is that this is a reprise of last year’s Walmart/Target, except on a smaller company-by-company scale but broader overall. Last year, WMT and TGT pulled out all the stops to ensure that tons of pandemic electronic necessities–big TVs, entertainment centers, game consoles…were on their showroom floors. They doubtless (translation: I haven’t tried to find out, the companies would likely not confess, but experience tells me this is what happened) double-and triple-ordered, paid earlier than usual and limited their right to return unsold merchandise.

Then pandemic-induced demand dried up. So the firms were forced to quickly reverse course from acquiring the latest merchandise to converting the inventories they had into cash–preferably at a measured pace, so as to avoid losses as much as possible and maybe make a small profit. But converting inventories into cash was a much bigger priority. I said “quickly,” meaning the companies did the smart thing by turning on a dime. However, I think the inventory reduction took nine months or so.

My recent emails give me the sense that the same inventory shortage issue is now appearing for smaller companies, who have less clout with suppliers than WMT/TGT. On the one hand, this suggests that overall supply chain issues have been solved. On the other, it suggests that we’ll see a reprise of the 2022 profit struggles of WMT/TGT this year, but among medium-sized firms.