I’ve just updated my Keeping Score page for June/1H 2019.
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.
It doesn’t appear to me that the economic or political situation in the US has changed in any significant way overnight. Yet stocks of most stripes are rising sharply.
What to do? …or if you prefer, what am I doing?
Watching and analyzing.
A day like today contains lots of information, both about the tone of the market and about every portfolio’s holdings. Over the past month, through 2:30 pm est today, the S&P is down by 4.8%. The small-cap Russell 2000 has lost 7.7%, NASDAQ 7.8%. All three important indices are up significantly so far today—NASDAQ +2.2%, Russell 2000 +1.9%, S&P 500 +1.8%. So this is a general advance. Everything is up by more or less the same amount, meaning investors aren’t homing in on size or foreign/domestic as indicators for their trading.
What we should all be looking for, I think, is what issues that should be going up–either because they’re high beta or have been beaten up recently–are shooting through the roof and which are lagging. (“Lagging” means underperforming other similar companies or underperforming the overall market.) The first category are probably keepers. The poor price action for the latter says they should be subjects for further analysis to figure out why the market doesn’t appreciate their merits. Maybe there aren’t any.
We should also note defensive stocks that are at least keeping up with the S&P. That’s better than they should be doing. They may well be true defensives, meaning they stay with the market (more or less) on the way up and outperform on the way down. This is a rare, and valuable, breed in today’s world, in my view, and can be a way to hedge downside risk.
Another topic: Over the past few days, I’ve been in rural Pennsylvania filming my art school thesis project–yes, I’ve gone from stills to video–so I haven’t kept up with the news. I’m surprised to see that the UK, which still remembers the enormous price it paid a generation ago resisting fascism, has done an abrupt about-face and allowed Mr. Trump to make a state visit. The anticipated consequences of Brexit must be far more dire than the consensus expects.
Wall Street woke up today to an announcement from Mr. Trump that he intends to place a tariff on all goods coming into the US from Mexico. The levy will be in effect until that country prevents immigrants/asylum seekers from reaching its border with the US. The initial rate will be 5%, escalating to 25% by October.
As an American, I think I can understand the issues the administration wants to address. But I find it more than a little unsettling that there seems to be no coherent, well-reasoned plan being implemented. I’m pretty sure tariffs are not the way to go. Also, both sides of the aisle in Congress appear to be eerily content to watch from the sidelines, rather than make it clear that Mr. Trump does not have authority to levy tariffs without legislative consent (my personal view, for what it’s worth) or limit/revoke that authority if the president does have it now.
As an investor, however, my main concern is the much narrower question of how Washington will affect my portfolio.
As to Mexico: let’s say the US sells $300 billion yearly to Mexico and buys $350 billion. Most of that is food and car parts. Even if we sell less to Mexico because of retaliatory tariffs and if imported goods are 15% more expensive–to pluck a figure out of the air–the total direct negative impact on the US + Mexican economies would probably be a loss of around $100 billion in GDP. How that would be split between the two isn’t clear, but the aggregate figure is 8% of Mexican GDP and 0.5% of US GDP. So, potentially much worse for Mexico than for the US.
Given the nature of US-Mexico trade, the negative economic impact in the US will be concentrated on lower-income Americans. If earnings reports from Walmart and the dollar stores are to be believed (I think they are), these are people whose fortunes have finally, and only recently, begun to turn up post-recession.
From a US stock market point of view, neither autos nor food has large index representation. My guess is the negative impact will be roughly equally divided between negative pressure on directly-affected stocks, including names that cater to the less affluent, and mild downward pressure on stocks in general from slower domestic growth. Because small caps are more domestically focused than the S&P 500, only half of whose earnings come from the US, the Russell 2000 will likely suffer more than large caps.
There are deeper, long-term questions that Washington is raising–about whether the US is an attractive place to establish manufacturing businesses and whether it can be relied on as a supplier to buy from. In addition, it’s hard to figure out what government policy today is–for example, how new tariffs on Mexican imports square with just-reworked NAFTA, or how imposing tariffs that hurt domestic car manufacturers square with the threat of tariffs on imported vehicles, which do the opposite.
Neither of these concerns are likely to have a significant impact on near-term trading. But heightened Washington dysfunction must even now be becoming a red flag in multinationals’ planning.
There’s no solid connection among the three topics above, but the title gives me the chance to write about three only-sort-of connected ideas in one post.
The crazy up-and-down pattern of recent stock market trading in the US is being triggered, I think, by Mr. Trump’s tweets about trade–and about tariffs in particular. I think a lot of the action is being caused by computers trading on the President’s tweets themselves, or some derivative of them–likes, media mentions, reflexive response to stock movements (or a proxy like trading volume).
–it’s hard to know whether the misinformation Mr. Trump is spewing about tariffs is art or he simply doesn’t know/care.
Tariffs are paid to US Customs by the importer. In some small number of instances, a Chinese exporter may have a US-based, US-incorporated subsidiary that imports items from the parent for distribution here. In this case, a Chinese entity is paying tariffs on imported Chinese-made goods. To that degree. Mr. Trump is correct. Mostly, however, the entity that pays a tariff on Chinese goods is not itself Chinese.
This is not the end of the story, however. The importer will attempt to recover the cost of the tariff through a higher price charged to the US consumer and/or through a discount received from the Chinese manufacturer. In the case of washing machines, which I wrote about recently, for example, all US consumers ended up paying enough extra to cover the entire tariff …and some paid more than 2x the levy. The prime beneficiaries of this largesse were Korean companies Samsung and LG.
–one of the oddest parts of the current tariff saga is that Mr. Trump has decided not to work in concert with other consuming nations. In fact, one of his first actions as president was to withdraw from the international coalition attempting to curb China’s theft of intellectual property worldwide. The Trump tariffs are only bilateral, so there’s nothing to stop a Chinese company from shipping a partially assembled product to, say, Canada, do some modification there and reexport the now-Canadian item to the US.
The administration has been artful in selecting intermediates rather than consumer end products for its tariffs so far. This makes it harder to trace price increases back to their source in Trump tariffs. However, the fact that the administration has taken pains to cover its trail, so to speak, implies it understands that tariff costs will be disproportionately borne by Americans.
–in trading controlled by humans, a lot of tariff developments should have been baked in the cake a long time ago. Continuing volatility implies to me that much of the reacting is being done by AI, which are learning as they go–and which, by the way, may never adopt the discounting conventions humans have employed for decades.
–I think it’s important to examine the trading of the past five days (including today as one of them) for clues to the direction in which the market will evolve. Basically, I think the selling has been relatively indiscriminate. The rebound, in contrast, has not been. The S&P and NASDAQ, for example, are back at the highs of last Friday as I’m writing this in the early afternoon. The Russell 2000, however, is not. FB is (slightly) below its Friday high; Netflix is about even; Micron is down by 4%. On the other hand, Microsoft and Disney are 1% higher than their Friday tops, Paycom is 2.5% up, Okta is 5% higher.
No one knows how long the pattern will last, and I’m not so sure about DIS, but I think there’s information about what the market wants to buy in these differences. And periods of volatility are usually good times for tweaks–large and small–to portfolio strategy. This is especially so in cases like this, where the movements seem to be excessive.
One thing to do is to confirm one’s conviction level in laggards. Another is to check position size in winners. In my case, my largest position at the moment is MSFT, which I’ve held since shortly after Steve Ballmer left (sorry, Clippers). I’m not sure whether to reduce now. I’d already trimmed PAYC and OKTA but if I hadn’t before I’d certainly be doing it today. I’d be happiest finding areas away from tech, because I have a lot already. On the other hand, I think Mr. Trump is doing considerable economic damage to American families of average or modest means, with no reward visible to me except for his wealthy backers. Retail would otherwise be my preferred landing spot.
–Even if you do nothing with your holdings now, make some notes about what you might do to rearrange things and see how that would have worked out. That will likely help you to decide whether to act the next time an AI-driven market decline occurs.
Mr. Trump’s tweet threatening increased tariffs on products from China came while the US market was closed–but in plenty of time to affect Monday trading in Asia and Europe.
The tweet has been the occasion, if not the reason, for selling stocks worldwide.
I think the most interesting thing about today–and most important for investors to note–is what panicky investors are choosing to sell.
My experience is that the stocks being sold on a day like today will not necessarily have anything to do with tariffs per se. Instead, they’ll be the things that the sellers have the least confidence in–stocks they’ve been wanting to sell but haven’t been able, for one reason or another, to pull the trigger on. In all likelihood, there’s more behind the amounts being sold now.
On the other hand, stocks that traders leave alone–or stocks that there’s enough buying interest in that they go up–are most likely the crown jewels, and are going to continue to be outperformers.
So today may well provide a good roadmap for future relative performance, even if, like me, you don’t choose to participate in either direction.
issues for the S&P 500 in 2019:
–about half the earnings of the S&P come from outside the US. For 2019, that’s not a good thing, since China is slowing down (more tomorrow) and the UK’s ham-fisted approach to Brexit is stalling business activity in the EU
–in the US,
—-last year’s corporate tax cut is no longer a source of year-on-year aftertax earnings growth
—-tariffs continue in place. Tariffs redistribute, but in the aggregate also slow, economic growth. The current ones are designed to shift economic energy toward sunset (often private) industries and away from ones with better prospects. Some, like those on steel and aluminum, appear arbitrary, adding a layer of uncertainty to the whole process
—-the government shutdown is already pushing the US economy from a plodding advance into reverse, according to White House economists. The central issue is a border wall, which, if news reports are correct, was originally intended only as a memory aid for a candidate who couldn’t remember his key policy positions very well
—-the lack of sensible–or even coherent–economic strategy from Washington is making corporations accelerate domestic restructuring plans and to question future investment in the country. The administration’s hostility to admitting highly skilled foreign workers based on their religion/ethnicity is making the shift of r&d activity across the border to Canada an easy decision
In short, an embarrassing parade in Washington of own goals/self-inflicted wounds.
where to look for growth
The business cycle isn’t going to be much help. In times like this, the defensive sectors–utilities and telecom, and, to a lesser extent healthcare and consumer discretionary–typically come to the fore. But utilities + traditional telephone now amount to much less than 10% of the S&P. More important, both areas are in the throes of fundamental alteration that is damaging to incumbents. This leaves us with healthcare and consumer discretionary.
In both these areas, I think it’s important not to implicitly take a business cycle approach. A key factor here is Millennials vs. Baby Boomers.
In very rough terms, a Baby Boomer earns about twice what a Millennial does. But Millennials are entering a period of rapid growth in wages. In contrast, as Boomers retire, their incomes are typically cut in half. It seems to me that in all consumer areas it’s important to concentrate on firms that serve mostly Millennials, and avoid those (department stores are an easy example) that serve mostly Boomers, no matter what the level of current profits is.
My personal belief is that Americans don’t approve of making money from others’ illnesses. That’s the simplest reason (there are others) I can give for avoiding hospitals or nursing care or other healthcare service providers. But the premise of no business cycle help implies as well looking for smaller, more innovative, say, medical treatment development, firms …early-stage companies with the potential for explosive growth.
In the tech area–a more business cycle-sensitive area than healthcare–I think seeking out smaller, more innovative firms is also the way to go (but I always say this). In a so-so economy these should continue to prosper. The big risk is that they would likely be hurt very badly if the administration continues to add to the damage to the domestic economy that it is already doing.