Category Archives: Constructing a Portfolio

trying to rotate (ii)

September 30, 2020 By in Constructing a Portfolio, economics, Strategy, Uncategorized Tags: , 1 Comment

As I wrote last week, I think the market wants to rotate away from the winners of the past 18 months or so.

Two reasons: the outperformance of tech vs. the rest of the market has been so extreme as to make many professionals (me included) worry that something else must get a turn at bat; and there are echoes of the Internet bubble of 1999-2000 in current trading–lots of chaff, to my mind, along with the wheat.

The big question is where to go. In 2000, the rotation within tech–when that sector began to decline–was to the highest quality names. The (more important) rotation away from TMT (Telecom, Media, Tech), as it was called back then, was to traditional value names that had been in the Wall Street doghouse for the better part of a decade–Utilities, Staples and real estate stand out to me, mostly because I mistakenly chose not to own them.

Also: value managers fired in 1998-99 after many years of wretched returns, of necessity formed hedge funds, and then entered (a short, and) immensely lucrative period of outperformance that established their bona fides as savvy operators. They retain much of that aura today despite weak returns for the past decade and a half.

Hence the Wall Street drumbeat, intensified by hedgies, that a return to “value” is the next big move.

I don’t think history will repeat itself, though, for several reasons:

–my overall view is that the 2000-2002 period was the last hurrah for the 1930s Depression-style investing canon (value investing) that stressed the enduring value of balance sheet assets. While price/working capital, price/book or price/cash flow all retain their roles as starting points, the internet era has enabled such rapid change in economic activity that many of the traditional “moats” value investors like to talk about no longer defend against competition the way they once did. In fact, they can be a detriment. The important advice that it’s “better to cannibalize yourself than have someone else do it to you” is extremely difficult to listen to in a traditional company where executives’ minds have atrophied and whose jobs are threatened by change.

–structural change + Trump’s worst-in-the-world pandemic response are all negatives for utilities, oil and gas, commercial real estate, as well as many types of consumer spending, like restaurant meals or going to the movies. So, yes, these stocks are all beaten up, but to my mind they’re not cheap/

–more than this, the inept/ignorant Trump macroeconomic “strategy” has been to: suppress overall growth, discourage domestic tech research, defend/subsidize non-competitive firms with tariffs, while promoting fossil fuel use (a move which stands to render US auto companies even less world-competitive than they are now). Sort of the plan Putin could only dream of for his enemy

The sum of of all this is that while Trump is in office the last place an equity investor would want to have money–except at extremely low valuations–is in traditional companies making things in the US and serving US customers.

Arguably, industrials overall will rally if Trump is defeated in November. It isn’t clear to me that the Democrats have a coherent economic program, however, so such a move may not have legs. And it’s also possible Trump’s tariff bungling has already given a coup de grace to many of these firms.

I’m not a fan of betting on politics, either.

So I think the best course is to still focus on industries of the future, but to broaden out beyond tech. Personally, I already own ETFs that focus of genomics and fintech–two areas I think are important but that I don’t know much about. I’m trying to build up my exposure to the Chinese economy. I’m not willing to buy individual names in Shanghai or Shenzhen, so I’m concentrating on Hong Kong-listed, where I know the financial statements will be reliable, and where information is available in English.

The non-tech place I typically feel most comfortable is Consumer Discretionary. Here the task is to imagine what post-covid life will be like–and how that will differ from pre-covid days.

More in two days.

parts of an email from yesterday

September 9, 2020 By in Basic Concepts, Constructing a Portfolio, economics, stock market, Strategy Tags: , , Leave a comment

I guess you’ve seen all the stuff about huge buying of options on individual tech stocks, both by Bar Stool-style traders and by Softbank, driving tech stocks up.  My guess is that has ended for now.  If so, it will probably take a week or so for trading in the big tech names to settle down.

I’ve read that when the Tokyo market found out what Son had been up to, and had made $4 billion on speculative options trading, Softbank dropped by 8% (?), losing shareholders $20 billion in market value.  That’s because what he did is bet-the-company crazy.

One of the things I’ve noticed is that some second-line names are doing much better (meaning falling more slowly) than what must be Robinhood-ish favorites.


It’s never clear what triggers a market selloff.  In this case, though, it’s doing a healthy thing by readjusting relative values among different groups of stocks–something I’ve thought would happen by a temporary reversal of leadership in an uptrend.

I think the fact that at zero interest rates stocks are the only game in town means stocks will drop to some longer-term trend line, stabilize, and then begin to move up again.  A hope, not a belief–at the close today NASDAQ seems to have hit the bottom of a channel it’s been in since April.  (It’s also about 25% above its March high, which says these are not bargain-basement levels.)


Over the past 5 trading days, NASDAQ is down by -9.2%, the S&P by -5.5%, and the Russell by -4.7%, so there is outperformance of a sort by the R2000.
Very often after a big selloff, market leadership changes.  That didn’t really happen in March, although afterwards the R2000 began to keep up more with the S&P for several months.  My sense is that the market wants to broaden out to find non-tech stocks that will do well over the next year or two.  This is why consumer discretionary names have been doing well recently.  But because some kinds of tech are going to be long-term winners, the move has to be based on finding consumer names that have good growth prospects, not just that they’re in another sector. 

The market hasn’t gotten conviction yet with this idea, probably in large part because Trumponomics gets loonier by the day.  The near-term economic outlook in the US had already been deteriorating before his latest China ideas, and won’t have a chance to be better unless he’s defeated in November.

Then there’s the human side of things. Who’d have thought we’d see George Wallace reincarnated, or the Waffen SS recreated, or scary abuse of power in the Justice Department–or that the Joint Chiefs would feel the need to say they would not obey any Trump orders to use troops to deny Americans their civil rights.

 
The last two paragraphs both bear on stocks like NWL.  Arguably, NWL is a true “value” name.  That is, all the bad stuff–and more–that could reasonably be expected to happen has already taken place and been factored into the stock price.  So it has some downside protection. It’s also economically sensitive and non-tech; and maybe if management can use the company’s assets competently, good things will happen. 

Another way of putting this is that in a world where TSLA can be down 30% in a week maybe the value formula of dead money for now with the hope of upside later on isn’t so bad to have as part of a portfolio.

Trump underpins tech stocks …for now

July 22, 2020 By in Constructing a Portfolio, currency markets, Current Market Thoughts, securities markets, stock market, Uncategorized Tags: , 2 Comments

The EU has a third more people than the US, has an older population and was in worse Covid shape than the US in early April. Today, however, US daily new cases are about 15x those in the EU; daily new deaths here are 7x those in the EU. The difference? The EU followed the recommendations of US medical scientists; Trump urged his supporters to ignore them.

The economic result for the US is a deeper, longer-lasting downturn than elsewhere in the OECD, huge amounts of Federal government assistance to keep the economy afloat–with a resulting budget deficit that could soon reach $6.0 trillion, vs. $0.6 trillion when he took office.

Rather than try to mitigate the suffering the US is going through, Trump appears to have decided to try to shift national attention away from his central role in creating this tragedy by creating a second, competing disaster. After the armed forces refused to help, Trump organized a gang of from other Federal agencies. Members wear identical camouflage combat gear and carry weapons. No identification on their bodies or vehicles, however. Not a thought about probable cause or excessive use of force, either. In other words, they’re shaped on the Gestapo/KGB/Stasi secret police model. Empowered by executive order and against the wishes of state and local officials, Trump envisions sending these groups into Democratic-leaning cities to instigate violence. Portland is his test case. News reports of the Navy veteran beaten in Portland (he decided to remind Trump’s minions they took an oath to defend the Constitution) show what’s going on. Kristallnacht in America is something no one would have believed possible four years ago. Talk about the banality of evil.

Relevance for the stock market? …a lot.

I’ve been writing for a while about the divergence between NASDAQ and the Russell 2000. The former is the part of the US stock market least tethered to the US by customers, revenues or physical assets; the latter represents the part most closely linked to domestic economic health. NASDAQ is up by about 55% since the beginning of 2018; the Russell 2000 is down by 4% over the same span. I read this 60 percentage point divergence as the stock market’s response to the ongoing economic damage Trump is doing to the US. The spread is very long in the tooth. It’s also so wide that it is begging for at least a temporary reversal of form. So far, however, every attempt at a counter-trend rally has been nipped in the bud.

How so? I think the pro-NASDAQ portfolio configuration has a second motivation. It is also the first step in capital flight from a country moving in the wrong direction.

Recently, coinciding with Trump’s more explicit white racist actions and the resurgence of Covid in the South and Midwest, we’ve begun to see a second aspect of capital flight–a 5%+ decline of the dollar vs. the euro over the past few weeks. The US currency has even lost ground to perennial weaklings sterling and the yen.

It’s hard to know how this all will play out. A Trump win in November is the easier case. I imagine it would create a seismic negative shift in global attitudes toward the US. That would result in a steady outflow of our most productive human and financial capital. The dollar would continue its decline. Maybe, government bonds would begin to sag, too. At some point, Washington would presumably close the border to outflows, a la Mexico 1982. NASDAQ would likely go up, led by firms announcing the relocation of intellectual property-creating operations abroad. Maybe dual listings in New York and China. China and the EU stand to be the big long-term winners.

I think a Trump loss would much more complicated. There’s the issue of repairing the enormous economic, financial and cultural damage he has done to the country. There are also the former heavy industry areas, core sources of Trump strength, which have been ignored by both parties for decades at great national cost. A counter-trend rally might finally happen–maybe even pre-election if a pro-Biden outcome were clear. Would it have legs, if so?

tariffs and the stock market

September 18, 2018 By in Constructing a Portfolio, Strategy, strong earnings, tariff protection, tariffs, Uncategorized Tags: , , , , 1 Comment

The Trump administration has just triggered the latest round of tit-for-tat tariffs with China, declaring 10% duties on $200 billion of imports (the rate to be raised to 25% after the holiday shopping season).  China has responded with tariffs on $60 billion of its imports from the US.  Domestic firms affected by the Trump tariffs are already announcing price increases intended to pass on to consumers all of the new government levy.

It isn’t necessarily that simple, though.  The open question is about market power. Theory–and practical experience–show that if a manufacturer/supplier has all the market power, then it can pass along the entire cost increase.  To the degree that the customer has muscles to flex, however, the manufacturer will find it hard to increase prices without a significant loss of sales.  If so (and this is the usual case), the company will be forced to absorb some of the tariff cost, lowering profits.

From an analyst’s point of view, the worst case is the one where a company’s customers are especially price-sensitive and where substitutes are readily available–or where postponing a purchase is a realistic option.

 

Looking at the US stock market in general, as I see it, investors factored into stock prices in a substantial way last year the corporate tax cut that came into effect in January.  They seem to me to be discounting this development again (very unusual) as strong, tax reduction-fueled earnings are reported this year.  However, the tax cut is going to be “anniversaried” in short order–meaning that reported earnings gains in 2019 are likely going to be far smaller than this year’s.  The Fed will also presumably be continuing to raise short-term interest rates.  Tariffs will be at least another tap on the brakes, perhaps more than that.

Because of this, I find it hard to imagine big gains for the S&P 500 next year.  In fact, I’m imagining the market as kind of flattish.  Globally-oriented firms that deal in services rather than goods will be the most insulated from potential harm.  There will also be beneficiaries of Washington’s tariff actions, although the overall effect of the levies will doubtless be negative.  For suppliers to China or users of imported Chinese components, the key issues will be the extent of Chinese exposure and the market power they wield.

PS   Hong Kong-based China stocks have sold off very sharply over the past few months.  I’m beginning to make small buys.