listening to Wall Street strategy

I was driving to a nearby Home Depot to get curbside pickup of a new work table early this morning. On the way I started listening to Bloomberg Radio, something I almost always regret. Just shows everyone finds bad habits hard to break.

I heard an interview with an equity strategist from Credit Suisse, who had been very bearish all the way up from the March lows and who has just turned bullish. One tried-and-true Wall Street saying is that the bear market isn’t over until the last bull capitulates. This could be the analogue–the last bear turning bullish. The idea behind the last bull is that after him there’s no one left to create more selling. In today’s case, it’s that all of the possible fresh cash is finally coming out of hibernation.

At the same time, though “bullish,” this strategist thinks the stock market only has 3% upside. Overall, very weird. Despite that, the last bear throwing in the towel should give us pause.

Last night, I read an article that points out the very large performance differential between the NASDAQ and the Dow. Now, a hard-and-fast rule for me is that anyone who uses the Dow as a yardstick for evaluating equities shows, just from that fact, that he knows nothing about stocks. In that sense, then, the Dow has a strange sort of usefulness.

My observation is that even Dow worshipers have noticed the huge performance gap between innovative companies that serve the world and very mature firms that are closely tied to US GDP. Yet, a counter-trend rally seems unable to gather any steam. How is this possible? My answer is that the White House continues to surprise, in finding new ways to damage the domestic economy. Whether that’s the reason or not, the question is worth thinking through.

BP’s writedown …and asset writedowns in general

British Petroleum, one of the world’s largest integrated oil companies, announced last week that it will write down the value of its fixed assets ($191 billion at yearend 2019) by $13-$17.5 billion. The reasons: a drop to $55 a barrel in its estimate of the future price of oil; plus its assessment that the world will turn away from fossil fuels more quickly than it had previously thought.

The BP stock price barely moved on the news, so it was no surprise.

The stock has been trading at around 80% of the balance sheet value of shareholders equity (translation: what shareholders would get if the company were instantaneously liquidated at the values listed on the balance sheet for assets and liabilities)–meaning investors already assumed that balance sheet asset values were too high.

It seems to me that the reasons for the announcement are: to underline to investors that BP intends to be an energy company, not an oil company; and to set internal company expectations and priorities.

For what it’s worth, I think this is the right path to take. The pandemic has likely made the integrated oils’ task more difficult, though. Demand for jet fuel is likely to remain depressed for some time. And gasoline sales in the US, the world’s most profligate user of petroleum products, are likely to remain damaged as a hapless (self-destructive?) president contrives to spread the pandemic through the nation’s vacation spots.

in general

–although accounting rules require writedowns as soon as a company realizes the value of some of its assets is impaired, my experience is

they mostly occur at times like now, when enough other stuff is going on that they won’t be noticed

–one benefit to a writedown in bad times is that won’t detract from a future good earnings report

–accounting rules also say that the balance sheet value of impaired assets can’t be reduced to below fair market value–thus manufacturing a future profit if they’re sold. If I were BP, though, I’d want as low a value as my accountants would permit

–writedowns like this are financial accounting actions. In themselves, they have no effect on the company’s real world operations or their tax books. It isn’t until an asset is sold or otherwise disposed of at a loss that the loss can be used to reduce taxes. So a potential tax deduction can be preserved indefinitely by not selling the asset even though it no longer appears on the financial reporting balance sheet.

is there really a counter-trend rally underway?

A short while ago, I began to think that what I considered extreme performance and valuation differences between the NASDAQ index vs. the Russell 2000 (large multinational techy companies vs. medium-sized domestic firms) had become so wide that there had to be a period of catch up, when the R2000 would significantly outperform NASDAQ.

I thought it was possible that the R2000 might outperform by, say, 15-20 percentage points over a two-month period. The trigger could well be evidence emerging that the worst of the pandemic in the US was behind us. I was also noticing that I was checking my stock accounts closely almost every day–something that my experience has taught me to be a reliable sign that my holdings are getting near-term toppy.

The turn toward domestic, business cycle-sensitive names started shortly after I wrote about the possibility. BUT the move has stopped dead in its tracks this week. My reading of prices says that the market no longer wants to make this turn.

Of course, I could be wrong, as portfolio managers often are. And I’m not removing the small pro-domestic economy bet I made based on my sense that a market rotation was imminent.

What has changed?

Keeping in mind that the “what” is less important than the “that,” it seems to me that the show-stopper has been the White House. It’s the fact that new coronavirus cases in states like Florida, Texas and Oklahoma, which have relaxed social distancing precautions at Trump’s urging–and against the advice of medical authorities, are spiking sharply upward.

Trump is also launching a series of his signature political rallies, even though such events appear to be prime breeding grounds for infection. The Trump campaign has booked a 20,000 seat arena for the event, but claims to have requests for over a million tickets–which would be about half the adult population of the state, and well ahead of the number of votes Trump garnered in OK in 2016. None of this makes a lot of sense to me, nor apparently to Wall Street.

My guess is that at least until this situation sorts itself out the pro-business cycle rally is on hold.

losing competitiveness

IMD, a business school in Switzerland, recently issued its 2020 global competitiveness list, the 32nd in its annual series. Two years ago, the US was the #1 economy in the world . We fell to #3 in 2019 and dropped a further seven places to #10 this year. IMD’s reasoning? …the Trump administration’s anti-growth policies. IMD prizes economic openness, a strong education system. support for scientific research and a good health care system, all areas Trump has sought to undermine.

Hong Kong dropped from #2 last year to #5 and China to #20 from #14 in 2019.

Although the ranking includes some data from early 2020, as far as I can tell it does not factor in either Trump’s disastrous coronavirus response or his attempts to foment race violence. Nor does it consider China’s breach of the Hong Kong handover agreement with the UK. All of these factors would presumably have dropped rankings.

the Trump economy

Recent election polling seems to show that potential voters don’t approve of anything in the Trump administration except its handling of the economy. One might argue that in comparison with supporting white racism, subverting the Justice Department, causing tens of thousands of Americans to die needlessly from the coronavirus and trying to corrupt the military, blunting economic growth is the least bad thing Trump has done.

It appears, however, the common belief is that Trump has actually done good things for US economic growth during his time in office and that on economic grounds he would be a better presidential choice than Joe Biden. (Personally, I think it’s a sign of the extreme poverty of domestic politics that the Democrats can’t come up with a better candidate than Biden but that’s another issue.) My opinion is that Trump is worse than economically clueless; I think he has been doing potentially incalculable damage to the long-term economic prospects of the country. If so, why don’t people realize this?

I think the explanation is in the financial results of Walmart (WMT), the largest retailer in the US. WMT’s target market is Americans of average and somewhat below average income. The company started in the midwest. Political action by incumbent retailers in California and the Northeast have limited its exposure to those areas. So it’s a reasonable thermometer for economic health in the rest of the country.

EPS growth for WMT over the past seven years is as follows:

year yoy eps growth

2019 +6.3%

2018 +11.1%

2017 +2.3%

2016 -5.5%

2015 -9.9%

2014 -0.8%

2013 +1.8%.

Note: Like many retailers, WMT’s fiscal year runs from February through January of the following calendar year. So, for example, what I’ve labeled as 2019 is actually 2/19 – 1/20.

What I read from these numbers is that recovery from the financial crisis of 2007-09 didn’t reach the large chunks of America that WMT services until almost eight years after the overall economy bottomed. This coincided with Trump’s election.

Did Trump cause this pickup or is it simply the “trickle down” of recovery to a a part of the country neither major party cared that much about? I don’t see anything in Trump’s past or present performance record to make me think it’s the former.