the market is rotating…

…away from secular growth and toward business-cycle sensitives.

Over the past five trading days, including today (I’m writing just after noon), the Russell 2000 is +6.8% and the NASDAQ is up +2.4%.  Half of the relative gain has come so far today.

Unless/until we get bad coronavirus news, I think this movement will continue.

What to do?

The safest thing to do is to stick to your long-term strategy.  Use this as an occasion to adjust holdings, not a cause.  I think the primary reason for the current move from secular growth to cyclical is the huge performance differential that has built up between the two indices, not a fundamental change in trend.  Sort of like the losing team getting a turn at bat.

On the other hand, for someone willing to put in the time and effort, I think this could be a counter-trend rally that goes on for a couple of months before reversing itself.  To pluck a number out of the air, it could mean a 10% relative gain from here for the Russell over NASDAQ.

As for me, about a month ago I bought a small amount of an R2000 ETF and a smaller amount of MAR.  That lost me a tiny amount of performance.  I added to both two weeks ago.  That has worked out better so far. I added more R2000 today, bringing my total shift to just under 10% of my portfolio.

If what I said two paragraphs up turns out to be correct–and if I reverse what I’m doing at the right time–I’ll have gained around 100 basis points in performance.  The figure would be much higher if we could see an end to Trump’s highly damaging economic policies, or if his election opponent weren’t a septuagenarian whose fastball appears to have lost a lot of zip.

is this enough reward to justify taking the risk of being wrong?   Unless you’re involved with your portfolio every day–and I am now that art school is  over (graduation tomorrow)–probably not.  But it keeps my hand in.

 

 

 

Trump and TSMC (ii)

Over the weekend The Economist published an article about the administration’s attack on Huawei, denying Taiwan Semiconductor Manufacturing Company (TSMC) the use of US intellectual property in making chips for the Chinese telecom firm. The article basically paralleled my post from the 18th.  And it concluded that the ban could easily end up hurting the US far more than China.  In other words, it’s vintage Trump.

Although I didn’t mention it a week ago, I think it’s interesting to observe the behavior of the US companies affected by the initial order, which prevented them from supplying US-made chips to Huawei.

A basic fact about chip manufacturing is that although the output comes from gigantic, multi-billion dollar factories, the chips themselves are tiny and weigh next to nothing.  Output can easily and cheaply be shipped anywhere.  So plants don’t need to be located near customers.  They are highly automated, so no need for a large nearby workforce, either.  The key variables in locating a fab: areas where there are no earthquakes and where government tax breaks and subsidies are the highest.

Anyway, US firms continued to supply Huawei as usual after the initial directive, just from non-US facilities.

 

My point isn’t about administration ineptitude in taking months to realize this elementary workaround.  It’s that the chipmakers acted as businessmen.  They did what they thought was best for the long-term survival and prosperity of their firms.  Logically, it’s what they should have done as stewards of other peoples money.  More important, it’s what they did do.  That is, we have a reason to think that they will continue in this manner–to at least plan to put their operations out of the reach of Washington.  In addition, they will presumably pressure their suppliers of capital equipment–the semiconductor production equipment makers, some of which are heavily concentrated in the US–to do likewise.

 

 

 

 

 

 

 

Monday’s trading

 

I think yesterday could turn out to mark an important shift for US stock trading.

 

First, some performance figures:

year-to date       from the March low       yesterday          2 years     3 years

NASDAQ                   +2%                    +34%                           +2.4%           +22.6%       +48.2%

Russell 2000           –20%                    +33%                           +6.1%            -18.0%          -2.5%

S&P 500                    -9%                     +20%                           +3.2%             +8.9%        +20.2%

 

The S&P is just there for reference–and because it’s the key US equity benchmark.  The comparison I want to draw is between tech-heavy global-reach NASDAQ and the made-and-sold-in-the-USA Russell 2000 mid-cap index.

The difference year to date, 22%, in favor of NASDAQ, is huge.  Even more dramatic, the spread over the past two years, again for NASDAQ, is a whisker over 40%.  Over three years, it’s +50%+.  For the R2000, it’s like DJT (Trump Hotels and Casino Resorts) all over again.

Unfortunately for all of us Americans I think this will remain the primary trend for at least as long as the current administration is in office.

However, fear of the economic damage created by Trump’s pandemic denial has caused investors to stretch NASDAQ/R2000 valuation differences to the breaking point.  Yes, we’re considerably off the lows.  But economically sensitive stocks (R 2000) are still being priced, relative to NASDAQ, as if we were still at the worst level of panic.

But the market seems to be coming to believe that the relative rubber band has been stretched too far.

Evidence?

–during the rebound from the late March lows, the Russell 2000 has kept pace with the NASDAQ for the first time in a long while–despite the much greater damage from the pandemic domestically than abroad

–post their initial large upward leap, there has been a duel for maybe a month within NASDAQ between tech like Shopify, Zoom and Beyond Meat that’s perceived to benefit from the pandemic, and more traditional tech firms.  On fear days, the former go up, both in absolute terms and relative to the market; on more optimistic days, they go down.

–the epic underperformance of the Russell 2000.

In other words, the market is back to analyzing and pricing risk again, instead of just panicking.

To my mind, yesterday suggests the market is starting to expand its horizons and sort through the rubble of economy-sensitive stocks in a more serious way.  I think this will continue.  For how long?   I don’t know.  My guess is at least a month.  But maybe much longer.

 

same conclusion, different thought process

Coming at this from a different direction (the one that actually started me down this track):

A competent growth stock manager should easily be 500 basis points ahead of his/her benchmark, year-to-date.  Could be a lot more.

This is gigantic.  It’s like being up 15 – 0 in the fourth inning of a baseball game.

Strategy has got to shift from trying to score more runs to protecting the lead.  Unlike baseball, this is straightforward for a portfolio manager to do.  Become more like the index.  You won’t gain more outperformance ( which you don’t need) but you won’t lose any either.  You do this by buying the domestic cyclicals that have been market laggards for so long.  An added plus, they’re still in the bargain basement.

 

 

 

 

 

 

time for market rotation?

market rotation

We all understand what the winning formula for the pandemic stock market looks like:  overweight NASDAQ, underweight the Russell 2000;  overweight secular growth stocks with worldwide sales, underweight US-centric business cycle sensitives.

At some point, however, at least one of two things happens:

–evidence starts to build that the worst of the pandemic-induced slump in economic activity is past us.  Companies start hiring again; credit card sales start to pick up; houses begin to be sold…   or,

–the valuation difference between safe havens and pandemic losers becomes so great that contrarians begin to sell the former to buy the latter.

In either case, the market rotates away from what has been successful so far into something else.

Two questions:  when and toward what.

On the valuation front, year to date NASDAQ is down by 3% (among heavyweights, MSFT is +12%), the Russell 2000 is -27%.  Yes, this is the trend we’ve seen through most of the economically toxic Trump administration.  But the magnitude is different.  This is a huge gap in a short amount of time.

Nevertheless, despite the fact I would really like to shift my holdings away from recent winners, price action isn’t giving me the slightest encouragement to do so.

For me, the “toward what” isn’t really clear either.  So it may be that professional investors will take the very unusual step of simply raising cash and waiting.

As for me, I’m staying on the sidelines with the same tech/cloud-heavy portfolio.

 

a third factor 

A cardinal rule for investment success during my 40+ year involvement with stocks has been to avoid worrying too much about politics.  Think calmly and objectively instead.  It’s becoming difficult to ignore the increasingly bizarre and worrisome actions of the Trump administration, though, which are also taking on more and more of a 1984 tone.

Lack of attention to education, retraining workers and aging infrastructure–failings of both major political parties–are bad enough.

But now there’s Trump’s doubling down on his worst-in-the-world response to COVID-19, which has so far cost the US more deaths than all our armed conflicts since WWII.  (According to the Financial Times, 90% of these deaths were preventable had Trump not continually asserted the pandemic was not real.)

Then there are his recent threats to bar Chinese students from US universities and to deny Chinese-made goods entry to the US–more signature shoot-yourself-in-the-foot moves.  Perhaps more important in a pragmatic sense, Trump threatens a lot but does nothing.  To me, this is the worst of all possible worlds because it exposes his underlying weakness.

Finally, as an Army veteran I’m particularly disturbed that Trump is destroying the career of the Navy captain who rescued his crew when he found his aircraft carrier a coronavirus hotspot.  At the same time he’s pardoned a convicted war criminal and is now trying to have charges dropped against former General Flynn, who confessed to lying to the FBI to conceal his work as an agent of the Russian government.  In other words, Duty, Honor, Country and the content of one’s character mean nothing.

 

A rant, yes.  But there is a point.  The Hitler vibe is certainly not a positive for potential buyers of US goods and services in foreign markets.  Nor are indifference to human life and race hatred a big draw for foreign investment or tourism here.

 

 

 

 

 

 

 

 

 

 

 

 

the current market: apps vs. features

sizing up the market

In some ways, current trading in tech stocks reminds me of the internet boom of 1999.  To be clear, I don’t think we are at anything near the crazy valuation levels we reached back twenty+ years ago.  On the other hand, I’m not willing to believe we’ll reach last-century crazy, mostly because nothing in the stock market is ever exactly the same.

On the (sort-of) plus side, three-month Treasury bills back then were just below to 5% vs. 1.5% today and 10-year Treasury notes were 4.7% vs 1.9% now.  If we were to assume that the note yield and the earnings yield on stocks should be roughly equivalent (old school would have been the 30-year bond), the current PE supported by Treasuries is 50+, the 1999 equivalent was 21 or so.   This is another way of saying that today’s market is being buoyed far more than in 1999 by accomodative government policy.

On the other, the economic policy goal of the Trump administration, wittingly or not, seems to be to follow ever further down the trail blazed by Japan during the lost decades starting in the 1990s.  So the post-pandemic future is not as cheery as the turn of the century was.

what to do

I think valuations are high–not nosebleed high, but high.  I also know I’m bad at figuring out what’s too high.  I started edging into cyclicals a few weeks ago but have slowed down my pace because I’m now thinking that cyclicals might get weaker before they get stronger (I bought more MAR yesterday, though).

With that shift on the back burner, what else can I do to make my portfolio better?

features vs. apps

Another thing that’s also very reminiscent of 1999 is today’s proliferation of early-stage loss-making companies, particularly in software.

The 1999 favorites were online retailers (e.g., Cyberian Outpost, Pets.com, eToys) and internet infrastructure (Global Crossing) whose eventual nemesis, dense wave division multiplexing, was also a darling.

The software losers were by and large undone, I think, not because the ideas were so bad but because they weren’t important enough to be stand-alone businesses.  They were perfectly fine as features of someone else’s app.  A number were eventually bought for half-nothing after the mania ended, to become a part of larger entities.

 

One 2020 stock that comes to mind here is Zoom (ZOOM), a name I held for a while but have sold.  The video conferencing product is inexpensive and it’s easy to use.  It’s also now on center stage.  But there are plenty of alternatives that can be polished up and then offered for free by, say, Google or Microsoft.

 

Another group is makers of meat substitutes (I bought a tiny amount of Beyond Meat on  impulse after reading about 19th-century working conditions in meatpacking plants).  Same issue here, though.  Where’s the distribution?  Will BYND end up as a supplier, say, to McDonalds?  …in which case the PE multiple will be very low.  Or will it be able to develop a brand presence that separates it from other meat substitutes and allows it to price at a premium?  Who knows?  My reading is that the market is voting for the latter, although I think chances are greater for the former outcome  …which is why I’m in the process of selling.

 

 

 

 

 

 

serving more bleach: debt default

Two disturbing reports came out of Washington last week.  Both are linked to Donald Trump’s attempt to recast his failure in handling the coronavirus threat as being the result of a sinister plot by China to hurt the US.  I’m not sure that saying you’ve been tricked by China into ignoring world health officials is any better than just having ignored them, but…  Trump is, in his usual 1984 style, spewing disinformation and silencing civil servants who want to tell the truth.

As a human being, the key issue is the many thousands of Americans who have died because of his negligence.  From a near-term stock market point of view, though, what’s more important is the cover-up, being expressed in Trump’s desire to “punish” China for COVID-19.

Two actions are apparently being discussed by the White House.  Both are bad.  The second would be devastatingly so.  They are:

–placing new tariffs on goods imported from China, the main effect of which will be to negate some of the stimulus from Washington and slow economic growth

–defaulting on the national debt–specifically, ceasing either to pay interest on Treasury bonds held by China and/or to refusing to repay principal when Chinese bonds come due.

There has been no reaction so far in the Treasury bond market to leaks from the White House about the (to me) chilling prospect of possible default.  I presume this is because the market thinks no sane person would do something so financially damaging to the US …especially when the country needs to issue tons of new debt to finance the huge deficits the Trump administration is creating.  This, despite the fact that Trump did appear to favor a default strategy, as one he employed in his business dealings (btw, a reason no banks would lend him money), in statements he made during the 2016 election campaign.  

The most obvious consequence of default would be that borrowing costs would go up for the US. The dollar would probably decline. Default would also remove Treasuries from some (most?) clients’ list of permissible investments, putting more upward pressure on rates and downward pressure on the currency.  In theory, foreigners would be quicker to abandon the sovereign debt of a defaulting country than locals.  I’m not sure that would be true in this case.  In 1989, for example, a time of budget and trade deficits and an ineffective administration, domestic bond managers were the first to balk at buying Treasuries.

 

my bottom line:  It seems to me the trial balloons about default being floated by the White House are enough to have shifted the stock market away from the nascent “cyclical recovery” theme back to “flight capital.”

I’m reluctant to raise a large cash balance (hold in what currency?–probably not US$), which would be the right thing to do if I thought there were any chance Trump could carry out default plans.  But I can do some indirect things now. Dollar-denominated variable rate debt (i.e., bank debt instead of bonds) and business models where costs are in foreign currency and revenues in dollars would be toxic in a dollar default, so I’ll get rid of any I have.  I’ve been trimming tech positions recently and buying domestic recovery names.  I’ll stop that for now.  I should also have a list of what I would sell were Trump’s default idea to start to move forward.