starting out in 2020

January 9, 2020 By dduane in bond market, Current Market Thoughts, Foreign markets, managing in a flat market, market rotation, Recent Market Action, securities markets, stock market, Strategy, Uncategorized Tags: bonds, Current Market Tactics, current market thoughts, stocks, strategy 1 Comment

The S&P 500 is trading at about 25x current earnings, with 10% eps growth in prospect, implying the market is trading at around 22.7x forward earnings. During my working career, which covers 40+ years, high multiple/lower growth has virtually always been an unfavorable combination for market bulls.

Could the growth figure be too low, on the idea that forecasters give themselves some wiggle room at the beginning of the year?

For the 50% or so of earnings that come from the US, probably not. This is partly due to the sheer length of the expansion since the recession of 2008-09 (pent up demand from the bad years has been satisfied, even in left-behind areas of the country–look at Walmart and dollar store sales). It’s also a function of shoot-yourself-in-the-foot Washington policies the have ended up retarding growth–tariff wars, suppression of labor force expansion, tax cuts for those least likely to consume, no infrastructure spending, no concern about education… So I find it hard to imagine positive surprises for most US-focused firms.

Prospects are probably better for the non-US half. How so? In the EU early signs are emerging that structural change is occurring, forced by a long period of stagnation. The region is also several years behind the US in recovering from the recession, so one would expect that the same uptick for ordinary citizens we’ve recently seen in the US. Firms seeking to relocate from the US and the UK are another possible plus. In addition, Mr. Trump’s life-long addiction to risky, superficially attractive but ultimately destructive, ventures (think: Atlantic City casinos) may finally achieve the weaker dollar he desires–implying the domestic currency value of foreign earnings may turn out to be higher than the consensus expects.

The biggest saving grace for stocks may be the relative unattractiveness of fixed income, the main investment alternative. The 10-year Treasury is yielding 1.81% as I’m writing this That’s 10 basis points below the dividend yield on the S&P 500, which sports an earnings yield (1/PE) of 4. I say “may” because, other than Japan, the world has little practical experience with the behavior of stocks while interest rates are ultra-low. In Japan, where rates have flirted with zero for several decades, PE ratios have declined from an initial 50 or so into the low 20s. Yes, Japan is also the prime example of the economic destructiveness of anti-immigration, anti-trade, defend-the-status-quo policies Washington is now espousing. On the other hand, it’s still a samurai-mentality (yearning for the pre-Black Ship past) culture, the population is much older than in the US and the national government is a voracious buyer of equities. So there are big differences. Still, if the analogy with Japan holds–that is, if the differences don’t matter so much in the short term–then PEs here would be bouncing along the bottom and should be stable unless the Fed Funds rate begins to rise.

That’s my best guess.

The consensus was of viewing last year for the S&P is that all the running was in American tech industries. Another way of looking at the results is that the big winners were multinational firms traded in the US but with worldwide markets and very small domestic manufacturing and distribution footprints. They are secular change beneficiaries located in a country whose national government is now adamantly opposing that change. In other words, the winners were bets on the company but against the country. Look at, for example, AMZN (+15%) vs. MSFT (+60%) over the past year.

The biggest issue I see with the 2019 winners is that on a PE to growth basis they seem expensive to me. Some, especially newer, smaller firms seem wildly so. But I don’t see the situation changing until rates begin to rise.

Having said that, low rates are an antidote to government dysfunction, so I don’t see them going up any time soon. So my practical bottom line ends up being one of the gallows humor conclusions that Wall Streeters seem to love: the more unhinged Mr. Trump talks and acts–the threat of bombing Iranian cultural sites, which other governments have politely pointed out would be a war crime, is a good example–the better the tech sector will do. As a citizen, I hope for a (new testament) road-to-Damascus event for him; as an investor, I know that would be a sell signal.

Trump, tariffs, trading

May 16, 2019 By dduane in Analyzing performance, Current Market Thoughts, foreign trade, managing in a flat market, market rotation, performance attribution, tariff protection, tariffs, Trump, taxes and trade, Uncategorized Tags: market tactics, market thoughts, stock market, tariffs, trade 1 Comment

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).

my thoughts

–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.