Uber and corporate control

Uber…

The continuing troubles at Uber have placed renewed focus on the dominant form of corporate organization among internet companies in Silicon Valley:  voting control concentrated in the hands of a small number of founding principals, with the vast majority of shareholders having little or no say in corporate affairs.

The companies in question have more than one class of stock.  The shares the public holds have either no say at all or, at best, a small fraction of the voting power each of the founders’ shares have.

Tech entrepreneurs didn’t invent the idea of multiple share classes.  Companies like Hershey, the NY Times or News Corp. have had this structure for decades.  And, yes, it does create problems.  Insiders are free to ignore the concerns of outsiders, who have little recourse other than to sell their holdings.  Of course, in the case of Uber, that’s easier to say than to do.

vs. GE

I think it’s striking, however, that the other prominent corporate name in the news today is GE, a company with a long history and a wide-open corporate register.  GE’s CEO, Jeff Immelt, is being forced to retire after 17 years at the helm–during which time GE has been a chronic underperformer.

I have some sympathy for Mr. Immelt, who, as far as I can see, inherited the terrible mess that his predecessor, Jack Welch, had created at GE by the turn of the century.  Even if we say Immelt’s first half decade was spent cleaning things up, though, it took a subsequent lost decade before the board decided to make a change.  And that is arguably only because an activist began to stir the pot.

…vs. J C Penney (JCP)

Then there’s the cautionary tale of JCP, where an investor group led by Pershing Square took control of the board a number of years ago.  The newcomers carried out a number of disastrous changes in JCP’s strategy that caused the firm’s profits–and its stock price–to crater.  They then convinced the board of directors to repurchase their stock at what I judge to have been an extremely favorable (for them) price–and disappeared.

In this case, having only one class of stock, and no dominant insider, worked to ordinary shareholders’ disadvantage.

my point?

To be clear, I’m not an advocate of having several share classes.  But I don’t think that’s the Uber problem.

As I see it, early investors backing Uber made a bad mistake in their assessment of the quality of the company’s management.  And by not providing enough mentoring they allowed a toxic corporate environment to proliferate.  The fact of multiple share classes makes it harder to rein in a renegade culture.  But take the multiple classes away and Uber would still have become what it is, I think.

 

 

 

 

 

 

last Friday’s US stock movement

Last Friday the S&P 500 opened at 2436, rose to 2446, fell to 2416 and rallied at the end of the day to close little changed at 2432.  Volume was maybe 10% higher than normal.  Sounds ho-hum.

Look at Financials, Energy or Technology and the story isn’t one of a sleepy summer-like Friday.  It’s violent sector rotation instead.

According to Google Finance, the Energy sector was up by +1.4% for the day and Financials by +0.8%.  Technology fell by -2.7%.

But that understates what happened beneath the calm surface.

Oil exploration and production stocks, which have been in free fall recently, rallied by 4% or more.  Large internet-related names fell by an equal amount.  Market darling Invidia (NVDA) rose by 4% in early Friday trading, then reversed course to fall by 15%, and rallied late in the day to close “only” down by 7%+.  That came on 5x recent daily volume.

What’s going on?

Well, to state the obvious, Friday’s stock market action in the US runs counter to recent trends.  To my mind, the aggressive buying and selling are both based on relative valuation rather than any sudden change in the fundamental prospects for any of the companies whose stocks are gyrating around.  It’s an assertion by the market that no matter how grim the outlook for oil, the stocks are too cheap–and no matter how rosy the future for tech, the stocks are too expensive.

This is part and parcel of equity investing.  There’s always someone, usually with a long investment horizon, who is willing to bet against the current trend, on grounds that current price movements are being driven by too much emotion and not enough by dollars and cents.

what’s unusual

What’s unusual about last Friday, to my mind, is how sharp the division between winning and losing sub-sectors has been and how aggressively stocks have been both sold and bought.

For what it’s worth, I also think it’s odd that this should happen on a Friday. Human buyers/sellers of this size tend, in my experience, to worry about whether they can execute their plans in one day, preferring not to let the competition mull the situation over on the weekend.  But that’s a minor point.  (One could equally argue that if the buyers/sells were looking for maximum surprise, Friday would be the ideal day to act.)

If this is indeed a counter-trend rally, meaning that after a period of valuation adjustment the prior trend will reassert itself (which is what I think), the most important investment question is how long–and how severe–the pro-energy, anti-tech rotation will be.

My experience is that it’s never just one day and that a counter-trend movement can run for a month.  On the other hand, this doesn’t look like the typical work of traditional human portfolio managers.  It looks to me more like trading done by computers.  If that’s correct, I’d imagine the buying/selling will cut deep and be over relatively quickly.  But that’s just a guess.  And I know my tendency in situations like this is to act too soon.

For myself, I’ve been thinking for some time that US oil exploration companies have been battered down too much.  As for tech, I still think it will be the most important sector for this year.  So I’m happy to use this weakness to rearrange my overall holdings, nibbling at the fallen tech names and offloading a couple of REITS I own that I think are fully valued.

 

 

the fiduciary rule; the UK election

advisers as fiduciaries

The fiduciary rule for retirement assets issued by the Labor Department goes into effect today, despite intense lobbying against it by the brokerage industry.

The rule requires financial advisers involved with retirement assets–with the notable exception of the 403b pension assets of government workers–to put their clients’ interest ahead of their own in dispensing investment advice.

In essence, this means that the financial adviser will no longer be permitted to recommend high-cost products with poor performance records to clients simply because they pay a high commission or that the broker gets an “educational” weekend for two at a beach resort for doing so.

The conceptual defense (such as it is) for such practices, which are still allowed for non-retirement assets, by the way, is that while the client is still not well off, he’s better off than if he had no advice at all.

No wonder Millennials are willing to take a chance on robo advice.

the British election

The British prime minister, Theresa May, called the election held yesterday with the intention of increasing her party’s four-seat majority in Parliament in advance of the first Brexit talks with the rest of the EU.

With one seat not yet decided, the Conservatives have lost 12 seats instead, according to the Financial Times.

As exit polls came out overnight predicting this unfavorable result, both Asian stocks with interests in the UK and sterling weakened.

Interestingly, as I’m writing this an hour before the US open, both sterling and the FTSE 100 are up slightly.  S&P 500 futures, which had also dipped slightly in Asian trading as the UK news broke, are trading two points higher this morning.

To me as an outsider, it looks like UK citizens are having serious second thoughts about Brexit (politicians in Scotland advocating it’s breaking with the rest of the UK lost, as well).  My point, though, is that except in extreme circumstances–like when Republican opposition torpedoed a proposed economic rescue plan in early 2009 and the S&P dropped 7%–politics make little day-to-day difference to stocks.

continuing apparel retailing woes

I haven’t been watching publicly traded apparel retailers carefully for years.  For me, the issues/problems in picking winners in this area have been legion.  There’s the generational shift in spending power from Baby Boomers to Millennials, the move from bricks-and-mortar to online, the lingering effects of recession on spending power and spending habits.  And then, of course, there’s the normal movement of retailers in and out of fashion.

I’m not saying that retail isn’t worth following.  I just find it too hard to find solid ground to build an investment thesis on.  Maybe the pace of change is too rapid for me.  Maybe I don’t have a good enough feel for how Millennials regard apparel–or whether retiring Boomers are using their accumulated inventories of fashion clothing rather than adding to them.

Having said that, I’m still surprised–shocked, actually–at how the current quarter for apparel retailers is playing out.  It seems like every day a new retailer is reporting quarterly earnings that fall below management guidance, usually the latest in a string of sub-par quarters.  That itself isn’t so unusual.

But the stocks react by plummeting.

You’d think that the market would have caught on that Retailland is facing structural headwinds.  Or at least, that the retail area that made the careers of so many active managers over the past twenty or thirty years doesn’t exist any more.

 

Is it robot traders?  Is it an effect of continuing buying by index funds?  I don’t know.  But the continuing inability of investors to factor into stock prices the continuing slump of apparel retailers is certainly odd.

what about last Wednesday?

That’s the day the S&P 500 took a dramatic 2% plunge, with recent market leaders doing considerably worse than that, right after the index had reached a high of 2400.

Despite closing a hair’s breadth above the lows–normally a bad sign–the market reversed course on Thursday and has been steadily climbing since.  The prior leadership–globally-oriented secular growth areas like technology–has also reasserted itself.

My thoughts:

–generally speaking, the market is proceeding on a post-Trump rally/anti-Trump agenda course.  Emphasis is on companies with global reach rather than domestic focus, and secular change beneficiaries rather than winners from potential government action that have little other appeal

–while trying to figure out whether the market is expensive or cheap in absolute terms is extremely difficult–and acting on such thoughts is to be avoided whenever possible–the valuation of the S&P in general looks stretched to me.  Tech especially so.  This is especially true if corporate tax reform ends up being a non-starter.  My best guess is that the market flattens out rather than goes down.  But as I wrote a second or two ago absolute direction predictions are fraught with peril

–tech is up by 17.0% this year through last Friday, in a market that’s up 6.4%.  Over the past 12 months, tech is up by 35.2% vs. a gain of 16.8% for the S&P.  Rotation into second-line names appears to me to be under way, suggesting I’m not alone in my valuation concerns

–currency movements are important to note:  the € is up by about 10% this year against the $, other major currencies by about half that amount.  Why this is happening is less important, I think, than that it is–because it implies $-oriented investors will continue to favor global names

–the next move?  I think it will eventually be back into Trump-motivated issues.  For right now, though, it’s probably more important to identify and eliminate faltering tech names among our holdings (on the argument that if they can’t perform in the current environment, when will they?).  My biggest worry is that “eventually” may be a long time in coming.

 

 

discounting and the stock market cycle

stock market influences

earnings

To a substantial degree, stock prices are driven by the earnings performance of the companies whose securities are publicly traded.  But profit levels and potential profit gains aren’t the only factor.  Stock prices are also influenced by investor perceptions of the risk of owning stocks, by alternating emotions of fear and greed, that is, that are best expressed quantitatively in the relationship between the interest yield on government bonds and the earnings yield (1/PE) on stocks.

discounting:  fear vs. greed

Stock prices typically anticipate or “discount” future earnings.  But how far investors are willing to look forward is also a business cycle function of the alternating emotions of fear and greed.

Putting this relationship in its simplest form:

–at market bottoms investors are typically unwilling to discount in current prices any future good news.  As confidence builds, investors are progressively willing to factor in more and more of the expected future.

–in what I would call a normal market, toward the middle of each calendar year investors begin to discount expectations for earnings in the following year.

–at speculative tops, investors are routinely driving stock prices higher by discounting earnings from two or three years hence.  This, even though there’s no evidence that even professional analysts have much of a clue about how earnings will play out that far in the future.

(extreme) examples

Look back to the dark days of 2008-09.  During the financial crisis, S&P 500 earnings fell by 28% from their 2007 level.  The S&P 500 index, however, plunged by a tiny bit less than 50% from its July 2007 high to its March 2009 low.

In 2013, on the other hand, we can see the reverse phenomenon.   S&P 500 earnings rose by 5% that year.  The index itself soared by 30%, however.  What happened?   Stock market investors–after a four-year (!!) period of extreme caution and an almost exclusive focus on bonds–began to factor the possibility of future earnings gains into stock prices once again.  This was, I think, the market finally returning to normal–something that begins to happens within twelve months of the bottom in a garden-variety recession.

Where are we now in the fear/greed cycle?

More tomorrow.