backing and filling

I googled this term just before starting to write. I’d thought it had something to do with bulldozers and construction. But it’s apparently an old sailing term, describing a series of rapid changes in direction needed to maneuver through a narrow channel.

In the stock market, technical analysts use the term to describe the behavior of a stock that has just made a big upward move. It tends to zigzag for a while, repeatedly giving up ground and then reversing itself to return to the previous high. The idea is that the stock will be unable to move higher without spending some time around the new high, defining a new base–somewhere well above the stock’s level before the big move but at/below the recent high.

Anyway, that’s what I perceive the first-half market leaders are doing now.

meme stocks?

At the same time, attention has shifted to laggards, at least in good part on grounds of valuation. Buyers seem particularly interested in former pandemic darlings that have since crashed and burned, as well as more mature companies that appear to have lost their way over the past year or so. In the first group, there seems to me to be a bit of meme stock trading involved–that is to say, attacking short sellers.

short covering?

I noticed that the Boston Beer Company (SAM) is up by close to 20% this morning.

I know almost nothing about the company. Yahoo says SAM has a market cap of about $4.5 billion and is trading at 75x trailing earnings. The chart shows the stock peaked at about 3x the current value in early 2021.

The company reported profits that were higher than in the corresponding quarter of last year, even though consensus expectations were for a year-on-year decline. This is apparently what triggered the stock’s rise. My guess is the buying is mostly computer-driven, backed by two ideas–the positive earning surprise, and potential short-covering. What caught my eye is how quickly the stock has gone up by a lot, even though on the surface it appears to already highly valued based on earnings.

Two things: this sort of thing is happening with a bunch of what I’d regard as iffy stocks, and the aggressiveness of the up move suggests algorithmic trading has adjusted to act more quickly and with less price sensitivity.

All this typically suggests the consensus believes the bulk of the market is already fairly priced and that bargains are only to be had in secondary and tertiary ideas.

I was reading an article in the Wall Street Journal last week whose thrust was that the supermarket industry is facing increasing competition from non-standard grocery stores. True, And, yes, there are relatively new discount entrants in the US like the closely-linked German discounters Aldi and Lidl, seeking to build on their substantial success in Europe over the past decade or more. But, as the article points out, this process of change has been going on in the US for at least a century, with the supermarket replacing mom-and-pop stores during the first half of the period. Warehouse clubs, Walmart, dollar stores, Trader Joe’s (owned by the Aldi/Lidl family since 1979), Whole Foods…have all successfully attacked the supermarket hegemony in the almost half-century I’ve been watching the stock market.

I got my introduction to segmenting early in my investing career. I had begun covering the lodging industry, adding to my energy and tech (I barely know what a microprocessor was) responsibilities. I happened to attend to conference in held by a big, and growing, hotel conglomerate. The featured speaker was a marketing executive the firm had hired away from a big packaged goods company.

His message was simple:

…the iron law of marketing, he said, is: you don’t offer chocolate at your ice cream stand until demand for vanilla (the world’s #1 ice cream flavor) has peaked.

In the domestic hotel industry, he continued, we’d come to that inflection point. Cookie cutter hotels were everywhere. Growth for a given hotelier could only come through segmentation–high-end low-end, resort, extended stay, franchising, time shares…

That was a real eye-opener for me.

Two things the speaker didn’t say:

–for us as investors–not inside a company or maybe not even that knowledgeable about an industry–when we see chocolate and strawberry on the menu, it’s an extremely strong signal that the pure growth story is over

–it’s important to understand that a substantial part of the revenue new flavors are likely going to generate will come from cannibalizing the existing revenue base. So that base may need a lot of management effort/luck simply not to decline. Intelligent managers will go to the new multi-flavor menu immediately. They understand that sales will be lost in the legacy business, but they want those sales redirected to another arm of the same company. They will also understand that this is an unusually good opportunity to get new revenues from heads-in-the-sand managers of other firms who are in denial and spend all their efforts on businesses whose best-by date has come and gone.

Historically, US Steel, or the US big-three auto firms Ford, GM and Chrysler, are examples of the denial phenomenon. Bed, Bath & Beyond is a more recent one.

more tomorrow

Stock performance over the past five years looks like this:

AAPL +301%

NASDAQ +71%

S&P +62%

CMCSA +25%

ARKK +1.4%

DIS -21.8%.

First, I haven’t owned DIS for years. I’ve been annoyed that I missed the streaming spike in the stock. But because I hadn’t been paying attention, I hadn’t realized how bad a stock it’s been.

The AAPL rumors seem to be that it’s more interested in most/all of DIS than just ESPN. That makes sense to me. The rationale would be:

–primarily that AAPL would acquire a wide array of content creation capacity to support the AAPL ecosystem much faster than it could build an equivalent

–AAPL is a cash-generating juggernaut. DIS has a market cap of around $160 billion, which is a bit less than AAPL has spent on stock buybacks over the past two years. So the company wouldn’t need much/any external financing. And Wall Street would doubtless be ecstatic about the possibility of issuing Disney-backed–or AAPL-backed junk bonds. Presumably AAPL would sooner or later spin off the theme parks as a separate entity, either as a stock dividend, a public listing of some sort or a combination of the two.

The DIS/CMCSA story may well have been spawned by the fact that DIS will likely have the rest of Hulu put to it by CMCSA on 1/1/24. That bill will be $9 billion or so. Why not do a bigger deal and trade away ESPN to CMCSA at the same time?

There’s more to it than that, though.

As a publicly-traded company owned basically by third parties, DIS executives are, in theory anyway, interested mostly in stock price appreciation. The means to achieve this is, by and large, owning businesses that are expanding, running them well and growing earnings rapidly by doing so.

CMCSA is in a different situation. The Roberts family controls it through its ownership of a special, extra votes-bearing, class of shares. With the exception of figures like Elon Musk, who seems to me to be a risk seeker, theory says as people become more wealthy, they become increasingly risk-averse (this has certainly been evident in every private company I’ve worked for).

Today’s ESPN is a cash cow, not a rising star. To pluck a number out of the air–another way of saying “my best guess,” ESPN will generate $3-$4 billion in operating income after capex for years to come. Let’s say that income stream has a present value of $30 billion. Arguably, this number is entirely factored into the DIS stock price already. So unless ESPN springs back to youthful growth (not something I’d bet the farm on), nothing it does will make the DIS stock price go up. So ESPN is sort of like a bond, a source of steady income and nothing more.

For the Roberts, on the other hand, the biggest issue is, in my view, to maintain the current income stream from CMCSA which they control through their high ownership interest. A bond is ideal for them.

Suppose DIS sold ESPN to CMCSA for, say, $26 billion, of which $9 billion would be the Hulu purchase. So, $16 billion in cash. The Roberts would suddenly be $5 billion richer …and DIS would have $16 billion to invest in the remaining business that they would have to wait for five years otherwise to get. My figures would be way off, but I don’t think the general idea is. Shift an income business out of a presumably growth-oriented company and bring in a pile of cash that can be used to create new growth with.

By the way:

–when I looked up prices, I expected CMCSA to have underperformed the S&P. I was more than mildly surprised to see DIS at the bottom of the heap. Close to half its underperformance vs. the S&P 500 has come since the DeSantis political attack on the company. Even without that, though, CMCSA has been the better of the two stocks

–I suppose there’s no reason that DIS couldn’t spin off Disneyworld as, say, a REIT, and charge a huge management/licensing fee that would drain away most of DWs operating income–essentially letting DW gradually die. Probably bad for DIS, horrible for Orlando–and likely damaging for CMCSA, which owns a Universal theme park there, as well.

Yesterday I got a note from one of the big domestic brokerage houses, a place where my wife and I have some retirement money. The note said, in effect: the S&P index is up 18% ytd!! (and ~19% total return) and aren’t things great. We’re great, too. It forgot to mention that in January it was warning about the danger in holding stocks and touting the attractiveness of shifting to Treasuries. It didn’t mention either that Treasuries are more or less flat so far in 2023.

Strategists, many of them people who have tried their hand at money management but weren’t that good, were uniformly bearish about stocks over last winter. Now the last of them appear to be capitulating and raising their yearend S&P targets. They’re still predicting bad times for stocks, but now “bad” means something like a return to the level at which the S&P exited 2022.

This wholesale reversal is typically not a good thing for the stock market, where a consensus usually reflects thoughts that are fully factored into today’s stock prices. The trick to investing success for you and me, though, is not just to recognize that the consensus is wrong. It’s in figuring out how it’s wrong.

My guess is that the overall market will be flat for a while and that gains will come from identifying individual companies with strong earnings growth. My sense is that medium-sized US-centric companies, ones that are flexible enough to take advantage of structural change, and especially ones in non-tech industries, are a good place to look.

Anyway, I decided to look at the degree to which the gains in 2023 are just bounce back from losses in 2022. The eleven sectors, through yesterday, look like this:

2023 to date full-year 2022

IT +44.2% #9 -27.6%

Communication services +36.1% #11 -36.7%

Consumer discretionary +33.1% #10 -36.2%

Industrials +12.0% #5 -5.5%

Materials +7.7% #7 -12.3%

Real estate +3.8% #8 -26.1%

Financials +3.3% #6 -10.5%

Staples +1.4% #3 -0.7%

Healthcare -0.9% #4 -2.0%

Utilities -4.4% #2 +1.6%

Energy -4.8% #1 +64.6%

S&P +18.1% -18.0%

First, a note about basic arithmetic: if you lose 18% in year one and gain 18% in year two, you’re not back at breakeven. You’ve lost 2.2%

Not a big deal. But if you’re in a fund that loses 50% in year one and gains 50% in year two, you’ve lost a quarter of your money. The fund has to double in year two to get you to breakeven, because it’s only working with the 50% that’s left of your initial investment.

Still, what I’m doing above is a slightly apples-to-oranges comparison. The biggest distortion is with IT. Of the barn-burning 2023 first half+, it takes 38 of the 44% up in 2023 to get back the losses from 2022.

Other than Energy, there are no big two-year winners. Materials, Real estate and Financials have done the worst.

I think what Wall Street strategists got wrong in predicting a 2023 market crash was not the “concept,” the macro environment, which isn’t hugely bullish. It was the “valuation,” how much you were being asked to pay for a product that was all dented up. It wasn’t earnings growth; it was book value.

My guess is that this market phase is now in the rear view mirror (or the back-up camera) and that sideways from here is the best assumption.

This is ultimately about bitcoin, ethereum and, to a lesser degree, other cryptocurrencies.

I’m a fan of Heather Cox Richardson. She’s a history professor at Boston College, whose main area of study is the post-Civil War Reconstruction period in the US. That time was marked by an often violent struggle between forces like the KKK, which wanted a return to the old slavery-based economy with only white people as citizens (those were the Democrats) and defenders of equal rights (the Republicans). Her thesis is that we’re now seeing a reprise of that 19th-century struggle over civil rights–but with today’s Republicans as the new KKK and today’s Democrats the defenders of equal rights.

I’d add another wrinkle. Back in the mid-19th century, Marx applied Hegel’s idea that humanity advances toward perfection through struggle between opposing forces to economics. Aware of the parlous condition of factory workers in Europe, he theorized that the final step in human political evolution would come through a revolt of horribly-treated day laborers. And he thought the center of this struggle would be the most advanced manufacturing country, Germany.

To the consternation of Marxists, that didn’t happen. In the latter part of the century, Lenin theorized that what history needed was a jumpstart. He thought that a militant “vanguard of the people,” led by him (of course) would create the socialist revolution in Russia. That’s despite the fact that Russia was a manufacturing backwater. Ultimately, years later, the organization Lenin built seized power in Russia in an overnight coup, after an army revolt had deposed the tsar, during the chaos immediately after the end of WWI.

This sounds sort of like Jan 6th, except that the attempt to erase the votes that put Biden in office failed, and the ultimate aim was not to create a new workers paradise but to restore the pre-Lincoln status quo.

The crypto part: I wonder how much of the relative strength of crypto lately is based on fear of what will happen if Trump comes back into power.