trying to rotate (iv)

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)

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)

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.

trying to rotate

This is an elaboration of my last post.

I’ve looked into Nicola a little bit–emphasis on little–more. Founder Trevor Milton’s resignation from the company’s board isn’t exactly a confidence builder. Even more telling for me, however, is his that his endgame for Nicola is not to make money from building hydrogen-powered vehicles but rather by supplying them the hydrogen they will consume when running.

This model is a familiar one. Copier makers, for example, are willing to sell machines at a loss; their profits come from selling ink, paper and maintenance contracts . But it’s also a very tough way to make a living, and not the kind of thing investors are willing to pay an above-average earnings multiple to own.

The revelation that Nicola’s master plan is more or less to run a chain of gas stations–even were, say, convenience stores come with them–has landed with a thud. To my mind, bare-cupboard Nicola is a clear signal that the wild speculation accompanying anything labeled tech is over.

What comes next isn’t clear. What I’m thinking, so far:

–tech itself isn’t over. But the sizzle of being the next, newest, best thing ever probably won’t be enough to drive a stock higher from now on. I think the key distinction investors will begin to draw will be between firms that have a good chance to become successful stand-alone businesses (i.e., the winners) and ones where they’ll at best be a feature on someone else’s product (i.e., the losers). The market may well spend the next few months sorting the former from the latter. This would echo what happened after the Internet bubble burst in early 2000.

–but the market will also begin to look at non-tech sectors/companies in a more serious way. The big question is in what way.

More tomorrow

mutual funds and this September

NASDAQ is down by about 10% so far in September, the S&P is off by about half that. The Dow, a primitive measure that used to be a good yardstick for the health of smokestack America but is pretty pointless today, is down by somewhat less than the S&P.

Despite all the drama about the valuation extremes separating tech from heavy industry–drama I’ll confess I’ve found myself caught up in–this has been a normal September so far. That is to say, I don’t think the market decline is about anything other than the internal workings of the mutual fund industry.

Mutual funds are exempt from income tax on their profits. In return for this privilege, they are required to distribute virtually all dividend income and realized capital gains to shareholders, where they become taxable income to the owners.

For reasons I don’t really get, mutual fund shareholders like to receive distributions, provided they’re not too large. (An aside: I once turned over a small-cap fund I’d been running successfully for a few years to an office-politics virtuoso who had risen to a high position despite having a mental cupboard bare of any trace of equity investment skill. He bemoaned my maladroitness in, for example, holding a large position in QCOM (which rose 10x over the following two years), dumped out most of “my” stocks and remade the the entire portfolio in his own image. The result: in year one, he was down, by 7% (?), in an up market and had created taxable gains equal to about 35% of NAV. Investors were not happy in this case. Hard to believe, but this guy is still working in the business, which is part of the reason people don’t trust investment companies.)

Anyway, the tax year for funds ends in October. So managers tend to sell–both to create gains for distribution and to recognize offsetting losses–from early September through mid-October.

That’s what I think is going on now.

There are much bigger issues in play, unfortunately. But I don’t think Wall Street has yet begun to factor the election results (which I think will be crucially important) into stock prices. My reading is that today’s prices are saying things will pretty much go on as they have been over the past four years. I think that’s the least likely outcome.

How so?

As the Bloomberg news service points out, Trump has been “outthought and outplayed” at every turn by China. He has brought the US economy to a standstill; the country continues to be deeply wounded by his coronavirus bungling, while China is already well into recovery; foreign students, tourists, scientists (those who are not turned away at the border) no longer find the US attractive because of civil unrest caused by Trump’s white racism, plus the high risk of coronavirus infection; tariff wars have left the farm economy in a shambles; despite his rhetoric, the trade deficit with China is significantly larger today than when Trump took office; government debt is ballooning into dangerous territory; his brainstorm of denying US tech firms access to the world’s largest market for their products has given renewed energy to China’s domestic tech research. All in all, an economic train wreck. This is basically Trump’s business career, only writ large–the sole reason to believe he’s not more than a “useful idiot”.

His re-election would mean Americans are ok with becoming a white supremacist banana republic. Emigration of the best and the brightest–something I could never have dreamed of seeing–might surge, except that Trump’s coronavirus mess means other countries will hesitate to accept us.

A Biden victory would mean beginning the painful process of repairing the epic economic damage Trump has done. The “flight capital” market would probably be over (with GM-Nicola possibly being the new AOL-Time Warner). I’m not sure what would replace it, though, other than that air would likely start to come out of tech stocks. (“Concept” or early-stage stocks would be the the worst casualties, but their decline would tend to pull down stalwarts like MSFT along with them.