Keeping Score, September 2019

I’ve just updated my Keeping Score page for September 2019.  No sign so far of the traditional actively-managed mutual fund selloff in advance of the Halloween yearend.  I wonder why.  Is this a function of the AI era?   …the fact that passive money under management exceeds actively managed?   …is selling just late?

Will no selloff now mean no 4Q rally?    …that would be my guess.

WeWork (WE) and Wall Street: my take

I’ll start out by underlining that I don’t know enough about WE to have a usable investment opinion about the offering’s merits.  I do have opinions, though.  It’s just that they’re more like my thoughts about the Mets than a way to make money.  Anyway, here goes:

in general

–the WE structure isn’t new.  Think: a savings and loan, or a hotel chain, or an airline or an offshore drilling company, or a container ship firm–or, for that matter, a cement plant or a coal mine.  All these involve owning expensive long-lived assets which are typically debt financed and whose use is sold bit by bit.   Although there may be attempts at branding, with varying degrees of success, in the final analysis these are commodity businesses.

–in good times, this is a favorable structure for a company to have.  Costs remain relatively constant as selling prices rise, so most of the increase drops down to the pre-tax line.  Rental/purchase contracts may limit annual price increases, but investors typically factor in anticipated rises relatively quickly

–in bad times, it’s not great.  Customers may stop purchasing with little notice, sometimes walking away from contracts or renegotiating them sharply downward (using the threat of termination as leverage).  Offshore drilling rigs are an extreme example of feast/famine cyclicality

–because of cyclicality, PE multiples for mature firms with this structure tend to be low.  When such companies come to market, they tend to try to ride a wave of energy generated by previously successful IPOs–meaning that simply the appearance of their offering documents is a sign of potential overheating

WE

–in the case of WE, investor perception appears to be frosty.  This is partly because of what I’ve just written.  Also, from what I’ve heard and read, the 350+-page prospectus is not particularly illuminating (I’ve flicked through it but haven’t analyzed it myself)

 

investment implications

The arrival of the WE prospectus coincides with a sharp selloff in the shares of recent tech-related IPOs.

Two possible reasons:

Wall Street thinks that the marketing campaign for WE heralds the end of the line for the current IPO frenzy, on the argument that the underwriters would be presenting a higher quality offering if they had one.  This is what I think is going on.

The other possibility I see is the week-long, humorous but kind of scary Alabama weather discussion, an episode I think makes anyone question the mental stability of Mssrs. Trump and Ross.

In any event, given that some newly-listed tech names have fallen by a quarter or more over the past week or so, I think it’s time to sift through the ashes.

 

Having said that, I do suspect that a significant rotation away from these former market darlings, triggered by WE but based on valuation, is now underway. This will only mark a fundamentally new direction for the stock market if the tariff wars go away completely.  I don’t think this will happen.  So I’d buy a partial position now and hope to pick up more on further weakness.  Remember, too, that this is a highly speculative corner of the market, so it’s not everyone’s cup of tea.

 

 

America: a weakening brand

When I first became interested in Tiffany (TIF) as a stock years ago, one thing that stood out was that the company was doing a land office business in almost all facets of its rapid international expansion.  One exception:  the EU.  I quickly became convinced that the reason was because TIF is an American company.

For Europeans, France, Germany, Italy, and to a lesser extent the rest of the EU, are the font of all knowledge and culture.  As local literature and philosophy make clear, being situated on the sacred soil of (fill in any EU country) is the key to its superiority.  The US,  lacking requisite hallowed ground, is a semi-boorish johnny-come-lately.  Sporting a piece of jewelry from an American firm therefore implies one has suffered a devastating reversal of fortune that puts “authentic” jewelry out of reach.

 

In the rest of the world, however, the US is a symbol of aspiration.  America stands for freedom, opportunity, cutting-edge technology, the best universities and an ethos that prizes accomplishment not heritage.  It’s “all men are created equal”  “give me your …huddled masses yearning to be free” and “I am not throwing away my shot.”  Wearing, or just owning, a piece of American jewelry becomes a symbolic linking of the holder to these national values.  It hasn’t hurt, either, particularly with an older generation (paradoxically, ex the EU) that the US made a monumental effort to help heal the world after WWII.

 

The “brand” of the United States has taken a real beating since Mr. Trump has become president.  Surveys, one of which is reported in INC magazine, show a sharp drop in US prestige right after his victory and continuing deterioration since.   I don’t think the biggest negative issue is the president’s insecurities, his constant prevarication, his very weak record as a real estate developer or his (hare-brained) economic policies while in office.  I see the worst damage coming instead from his love of leaders with poor human rights records and his disdain for women and people of color …plus the whiff of sadism detectable in his treatment of both.

 

Whatever the precise cause may be, the deterioration of the America’s reputation under Mr. Trump is a very real worry for domestic consumer companies.  Damage will likely show itself in two ways:  weaker sales to foreign tourists, and the absence of positive surprises from foreign subsidiaries.  For domestic retail firms, it seems clear that economic recovery has finally come to the less wealthy parts of the US over the past year or two–witness the profit performance of Walmart or the dollar stores.  On the other hand, it seems to me that people who have trusted Mr. Trump in the past–like the banks that lent him money, the contractors who built his casinos, those who bought DJT stock and bonds, farmers who voted for him–have all ended up considerably worse off than the more wary.  So while they may be good temporary hiding places, holders should be nimble.

One final thought:  brands don’t deteriorate overnight but the cumulative damage can be enormous.  The first to react will be younger consumers, who have the least experience with/of the “old” brand.   They will be the most difficult to win back.  As well, as time passes, their views will be increasingly important in commerce.

 

 

 

yield curve inversion, external shock and recession

Stock markets around the world sold off yesterday in wicked fashion after the yield on the 10-year Treasury “inverted,”  that is, fell below the yield on the 2-year.  This has very often been the signal of an upcoming recession.  Typically, though, the inversion happens because the Fed is raising short-term interest rates in an attempt to slow too-rapid economic growth.  So it’s first and foremost a signal of aggressive Fed tightening, which has in the past almost always gone too far, causing an economic contraction.

In the present case, this is not the situation.  The Fed is signalling ease, not tightening.  Arguably, arbitrage between long-dated US and EU government bonds is suppressing the 10-year.

While trading robots, unleashed by the inversion, may have been behind the negative stock market action yesterday, my sense is that this is not all that’s going on.  I think the market is beginning to step back and focus on the bigger economic picture.  It may not like what it sees, namely:

–worldwide, economies are now being hit by a significant negative external shock.  It’s not a tripling of the oil price, as was the case in the 1970s, nor a collapsing financial system, as in 2008.  Instead, this time it’s the Trump tariffs, which appear to be reducing growth in the US by more than expected (not that anyone had extremely precise thoughts)

–the 2017 tax bill is not paying for itself, as the administration claimed at the time, but is adding to the government deficit instead–implying that further fiscal stimulation is less likely.  Giving extra cash to the ultra-rich, who tend to save rather than spend, and keeping tax breaks for industries of the past hasn’t bought much oomph to growth, either

–channeling his inner Herbert Hoover, Mr. Trump is trying to export the weakness he has created by devaluing the dollar.

 

Stepping back a bit to view the larger picture,

–pushing interest rates near to zero, depreciating the currency and defending the politically powerful industries of the 1970s all seem to mirror the game plan that has produced thirty years of stagnation in Japan and similar results in large parts of the EU.  Not pretty.

–on a smaller scale, this brings to mind Mr. Trump’s fundamentally misguided and ultimately disastrous foray into Atlantic City gaming, a venture where he appears to have profited personally but where those who supported and trusted him by owning DJT stock and bonds were financially decimated.

 

It seems to me that Wall Street is starting to come to grips with two possibilities:  that there may be only impulsiveness, and no master plan or end game to the Trump trade wars; and that Congresspeople of all stripes realize this but are unwilling to do anything to thwart the president’s whims.  In other words, the real issue being pondered is not recession but Trump-induced secular stagnation.

 

 

 

$30 billion in new tariffs–implications

Yesterday Mr. Trump announced by tweet that he intends to impose a 10% duty, effective next month, on all US imports from China that are not yet under tariff.  That’s about $300 billion worth, which would produce an extra $30 billion in tax revenue for the government, were imports to continue at the pre-tariff rates.

What’s different about the current move is that tariffs will be predominantly on final goods, that is, stuff that’s completely made and ready for sale, things like like toys and everyday clothing.  For the first time, tariffs won’t be disguised.  Up until now, they’ve been mostly on raw materials or parts, where the connection between the tax and price increases of the final product is obscured–the political fallout therefore milder.   The new round will be more visible.

 

Standard microeconomics will apply:

–the cost of the new tax will be borne in part by US companies and in part by consumers, depending on how much market power each has

–over some period of time, companies and consumers will both look for lower-price substitutes for items being taxed.  Firms will, say, offer lower quality merchandise at the current price point; consumers will either buy fewer items or shift to cheaper merchandise

 

The new tariff amounts to a subtraction of about $250 from family discretionary income, meaning income after taxes and all necessities are taken care of.  That’s not a big number.  As with the other Trump tariffs, however, average Americans will be disproportionately hurt.  The bottom 20% by income have less than nothing after necessities now, so they will be the worst off.  Residents of the poorest states–eight of the bottom ten voted for Trump–as well.  So too anyone on a fixed income.

 

Netting out the positive effect of the 2017 income tax cut, the only winners are the top 1%, traditional Republican voters.  Other Trump supporters appear to be the biggest losers, although far they don’t appear to have connected the dots.  Nor does anyone in Congress seem to be questioning the administration rationale that national security does not require better infrastructure and education but does demand more expensive t-shirts and toys.

 

The stock market selloff underway today doesn’t seem to me to be warranted by the new tariff.  And it’s not exactly news that Washington is dysfunctional:  we’re led by a man who thinks our independence was won by controlling the airports; the leading opposition candidate somehow mistakenly thought his businessman/repairman/car salesman father was a laborer in the Pennsylvania coal mines.  So the most likely explanation is that in August human traders/portfolio managers head for the beaches, leaving newspaper-reading robots in control of Wall Street.

If that’s correct, the thing to do is to look for stocks to buy where the selloff appears crazy, getting the money from clunkers, which typically hold up in times like this or from winners whose size has gotten too big.

 

 

 

 

 

 

 

 

 

 

navigating through confusion

a (very) simple sketch

I can’t recall a more complex, hard to read, time in the stock market than the present.  There have certainly been more panicky times–like October 1987 or early 2000 or late 2008.  But all of these, however frightening, were about financial markets building a speculative house of cards which ultimately collapsed of its own weight.  The basic framework in which the game was played remained more or less the same:  continuously declining interest rates, the growth of multinational companies, revolutionary developments in computer technology, the shift in developed economies from laborers to knowledge workers, continuing dominance of the US economy.

what has changed?

–the Internet is here, with its attendant powerful hardware (servers, smartphones) and software (the cloud, Amazon, Facebook…  e-commerce, information, entertainment) devices

–the aging–and, ex the US, increasing lifespans–of the populations of developed economies

–ultra-low interest rates, negative in parts of Europe

–the rise of China, and to a much lesser extent, India as global economic powers

–most recently, the Huawei moment, sort of like Sputnik, when the US realizes that a Chinese company is producing more advanced/ less expensive cutting-edge telecom equipment than it can

–fracturing of belief in the invisible hand aka trickle-down economics, the (ultimately religious/Enlightenment philosophical) belief that individuals acting in their own self-interest somehow create the best possible outcome, both for the world as a whole and for each individual.  This fracturing fuels the rise of the radical right in the US and Europe, I think.

 

more tomorrow