Category Archives: economics

trying to rotate (iv)

October 6, 2020 By in economics, Strategy, Uncategorized Tags: , , 2 Comments

If I were still working as a professional money manager, my thought process would be very clear. I’ve had very strong outperformance of the benchmark my customers measure my performance by. I’ve probably long since maxed out the bonus payments I’d receive for my work . Therefore, the most sensible course of action, based on the instructions and the incentives my employers have laid out for me, is to make my portfolio look much more like the index I’m measured by. I wouldn’t gain any more performance. But I wouldn’t lose any of the relative gains I’ve made already. In addition, if I generate too much good performance (yes, there is such a thing in the institutional world), clients may begin to think that I’m taking on too much risk.

I’m only working for myself, however, so I’m not going to do that.

Implicitly, I’m betting that the current economic situation–the pandemic and its aftereffects–will persist for a longer time than most other stock market participants expect. That’s ok with me, since I think that’s what’s going to happen.

I’m also finding it hard to imagine what ordinary life post-pandemic will look like.

In this regard, I’ve already written about the easy part–what’s not going to work. By underweighting the clunker sectors and making my portfolio look like the rest of the market, I stand to gain performance against my benchmark. This is not nothing. Over the 25+ years I’ve worked for others, this high-level portfolio layout has accounted for about half the outperformance I’ve achieved. Individual stock selection, which is much more time-consuming and all about detailed accounting statement analysis and projection, makes up the other half.

Conceptually, I’m trying to divide Consumer Discretionary stocks according to how interesting they might be as investments:

–direct beneficiaries of the pandemic whose appeal will likely endure, like food delivery services, online gaming, entertainment streaming, suburban real estate, outdoor dining, drive-throughs. Amazon, Microsoft. Peleton (?) Etsy (??)

–beneficiaries of the pandemic, but with limited appeal as/when life returns to normal. sellers of sports/ exercise equipment, like bicycles, kayaks, backyard swingsets…

–losers today with unclear potential for recovery. high-rise offices and apartment complexes, densely packed city areas, department stores, big malls, restaurant chains, supermarkets, movie theaters (?). hotels, cruise ships. Traditional value investors will live here

–already big companies that are adapting quickly to new circumstances. Target, Nike, dollar stores Walmart (?)

Feel free to share your ideas

trying to rotate (iii)

October 5, 2020 By in economics, Strategy Tags: , , 1 Comment

Well, it’s longer than two days. Sorry.

I’m really puzzled, though, about the current state of the stock market, and how to transition away from this year’s winners by broadening out into the Consumer Discretionary sector.

For one thing, I think the election matters a lot. We can see in detail from Trump’s leaked tax returns what everyone in New York already knew–that although he excelled at playing the role on TV of a stereotypical heartless businessman, he was a genuinely terrible real estate investor who lost his shirt during a raging bull market. He has brought this “talent” to bear as president: reducing real domestic economic growth to zero, damaging business relations with the rest of the world and refashioning the image of the US from the land of the free to a white supremacist police state (not a look to inspire purchases of US goods by foreign consumers (to me, this is an important reason LVMH wants to wriggle out of its commitment to buy Tiffany, which has a huge Asian business)). If Americans sign up for four more years of this, Consumer Discretionary will look a lot less attractive, particularly high-end goods and services.

(An aside: the financial press doesn’t see things this way. To some degree this may be a result of the Rupert Murdoch strategy of trading highly partisan media coverage in return for political favors. But for whatever reason, commentators seem stuck in a pre-Reagan world where Republicans represent big business and Democrats organized labor. Also, a key facet of Trump operations also seems to have escaped his supporters’ notice (ex farmers)–that invariably the people who believe in and trust him are the worst-hurt victims of his actions. think: his limo ride yesterday or his NJ golf club meet-and-greet with fundraisers, knowing he was infected.)

In an unclear situation like this, where the areas to overweight aren’t evident, the first step, I think, is to identify areas to avoid.

I divide the areas to avoid into three types: left-behinds from structural change, accelerated by Trump’s coronavirus mishandling, like department stores, autos, cable TV, fossil fuels, financials (because they do best when interest rates are rising)…; coronavirus victims, like restaurants (and their suppliers), high-rise urban real estate; and casualties of the loony-tunes way Trump is waging his trade wars, like farmers and farm equipment.

The second step is to look at what’s left and comb through that for positive ideas to invest in. More about this tomorrow.

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.

following the money; the fashion industry and working capital

September 17, 2020 By in Accounting, economics, fashion, financial accounting, Industry Analysis, Uncategorized Tags: , , , , Leave a comment

I was reading an article in the Financial Times the other day about pandemic-created issues in the high-fashion modelling agency business–something I’ll confess to knowing virtually nothing about.

Part of my interest is just securities analyst nerdiness. Part is that the FT is a highly reliable source, providing information that’s almost always accurate. Also, I think the story illustrates the more general point for us as investors that a simple look at receivables and payables on the balance sheet can provide a lot of insight into the economic power relationships in an industry.

The main players here:

–the models. They’re freelancers. They get assignments from modelling agencies, pay all their own expenses and get paid after they do the work (in arrears, as the accountants say)

–the agencies. They’re middlemen. They get assignments from branded merchandise companies and fill them with models they’re in contact with. The agencies also get paid in arrears

–the fashion brands. After crafting selling campaigns for their merchandise, they hire agencies to fill their need for photography and runway models. The brands pay in arrears.

in general…

…in a commercial relationship the entity that receives credit (or services in advance of paying for them, which is basically the same thing) is in a stronger position than the one that supplies it.

–Models would seem to be in the worst position of the three groups, since they pay for all their working expenses in advance and get paid only after the assignment is over. In accounting jargon, they are converting an asset on their personal balance sheets, cash, into another, less valuable, asset, receivables (meaning trade IOUs)

–Agencies are in a somewhat better position. They make a few phone calls, get an assignment from a fashion brand (the money from which they list on their balance sheet as a receivable) and line up a model (whose compensation they list on the liabilities side as a payable). Assuming the agency is a money-making enterprise, the receivable is considerably larger than the payable)

–Fashion brands hold the market power. They order a model and pay the agency for services afterwards. They list what they’ve promised to pay the agency on their balance sheets as a payable.

This is the first round of analysis: having all payables and no receivables is the best position to be in; having receivables without payables is the worst. For firms with both, the net of the two–payables minus receivables–is what counts.

round two

Round one is usually enough to get a sense of market power. There are a couple of wrinkles to consider.

–not everybody pays on time; in fact, not everybody pays, period. The balance sheet reserve for doubtful accounts will reveal what a firm’s historical experience has been

–if receivables are due to be paid to you in three months but your payables are due in two weeks, you have a cash flow problem. The typical solution is a growing amount of short-term debt. This situation is also a sign of lack of market power. Customers can demand very favorable payment terms, while suppliers insist on being paid almost immediately.

about the modelling industry in particular

According to the FT, modelling agencies are facing hard times for several reasons. Fashion houses are doing what many big firms do when times are tough–they are slowing down payments to their suppliers. As well, some smaller clients have gone out of business before paying their bills, making those receivables worth little, if anything. Both developments make it harder for agencies to pay models who have already completed assignments.

more changes brewing

Worse for agencies and models, the FT says fashion brands are being forced by travel restrictions and social distancing rules to innovate away from the elaborate, model-intensive runway shows they traditionally stage to introduce new merchandise. The same for elaborate photo shoots used to generate publicity materials. In fact, Gucci and Burberry have both used their own employees as models to launch new collections.

My guess is that many pandemic-forced “fixes” by the fashion brands will become permanent. Two typical motivations: the firms will find that eliminating large in-person events and lavish photo displays will have little negative effect on revenues, so their necessity will begin to be questioned; it’s usually much easier to convince the board of directors to cut large outlays than it is to get the funds reinstated.

Perhaps most important, if I’m correct, the weakening of the scope and influence of these expensive displays, or their demise, will remove a significant barrier to entry for newer, smaller brands.

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.