GoPro (GPRO) and the mood of the market

a concept stock

I’ve watched GPRO from the sidelines since it went public in mid-2014 at $24 a share.  It’s the maker of the HERO line of wearable cameras for self-recording sports action.

The stock peaked at close to $100 a share in October 2014, amid discussion that the real value of GPRO was not in the devices themselves but in the potential for creating a YouTube-like video sharing network that could, Wall Street proponents thought (and wrote), add billions of dollars to the company’s market cap.

a long fall

The stock closed regular trading yesterday at $14.61 (!), up a penny from the day before.  According to Reuters, of the 20 analysts that cover the company ten are still bullish and eight neutral.

last night’s bad news

After the close, GPRO announced that the seasonally most important fourth quarter sales would fall 14% below the company’s prior guidance.  As I’m writing this trading in New York has just begun and GPRO shares are down about 19% at around $11.70 and are trading at a little less than 10x trailing earnings.

What has changed since GPRO was a $100 stock?

It’s not the company, although one might quibble that management must have known that 4Q15 would be problematic at least a month ago.

No, GPRO is still the same one-product niche firm whose chief protections from the predatory urges of much larger consumer products firms are:

–its first-mover advantage and

–the presumption that its target market is too small for the big boys to be interested in.

Yet that relatively thin story was worth 80-90x anticipated 2015 earnings in late 2014 and only 10x actual earnings now.

How so?

What’s changed is the tone of the stock market.  It was bullish/speculative in late 2014, meaning that market participants factored good news into stock prices and ignored bad–at times concentrating on the lipstick and ignoring the pig.  Today, buyers and sellers are much more alert to possible bad news and less interested in dreaming about how profitable the long-term future may be.

I don’t think the the more sober tone has much to do either with oil or China.  I think it’s all about preparing for a higher interest rate world.  Yes, to my mind, the market has now gone a little bit overboard on the negative side.  Still, I don’t expect a change in mood any time soon, maybe not until we’ve had one or two more interest rate hikes.

The lesson I take from GPRO, and the main reason I’m writing about it today, is that we should look long and hard at any stocks we hold where the main virtue is the long-term concept/story.   For a while at least, the market’s driving force will be PE, not the dream.

 

 

 

entering 2016…

Three thoughts:

–taxable investors sell losers in December, winners in January

This has something to do with strategy, as investors reshape their portfolios for the new year.  But it’s more about recognizing losses to count against this year’s income while nursing gains into the new year for sale so income tax on them is delayed.

As a result of tax-selling distortions, the first couple of weeks in January march to their own drummer.  Losers beaten down by tax selling rebound (more about this and the “January effect” in a few days); last year’s winners swoon for a short time.

Early January often presents an opportunity to buy interesting stocks a bit cheaper than otherwise.

–dividend stocks

If I’m correct that 2016 will be another so-so year for stocks–let’s say up 5% or so–then stocks with an above-average dividend yield should remain attractive.  Since they’re typically mature firms with more reliable income streams, they also provide some downside protection.

The current dividend yield on the S&P 500 is 2.04%.  I think anything 50 basis points or more above that is worth a second look.  This is one reason I’m holding on to Intel (-2.3% ytd in 2015) and Microsoft (+21.7%).

–sector rotation?

The year to date returns on the S&P sectors are something like this:

Consumer discretionary     +10.5%

Healthcare          +7.5%

IT          +7%

Utilities          -4%

Materials          -7%

Energy          -19%.

One could easily argue, purely on mechanical grounds, that the 30% difference in performance between Consumer discretionary and Energy merits at least some rebalancing away from the first toward the second in an active portfolio.

I’m not ready to to this quite yet.  I’d like to see yearend financials first.  But the numbers argue that we’re getting close to the time to act.

 

 

strategy: 2016 vs. 2015

This time last year, my picture of 2015 was that:

–world economies in the aggregate were bottoming,

–early in 2015 the Fed would kick off the long journey of raising short-term interest rates from emergency-low levels toward normal (meaning 2%+)

–the first half of the year would be flat to down as world markets adjusted to the new interest rate regime and confirmed that global economic activity was no longer deteriorating, but

–late in the year there was a chance for a stock market rally as investors began to factor into stock prices their chance of better news coming in 2016.

My biggest worry last December was that stocks normally don’t go sideways for a long period.  They either go up or down.  If the market works out that the up direction is impossible–which I thought would be the case in early 2015–then short-term traders will invariably try to push the market down to see how low it goes before meeting resistance.  What I found most surprising was that the S&P 500 tread water for over seven months before beginning its August-September swoon.

As events turned out, the Fed delayed raising rates until December and emerging markets were hit by a deeper fall in mining commodity prices than I’d anticipated.

One result of that is that stocks are flat for the year vs. my expectation of a positive, but sub-10% gain.

Another is that I think we’re basically in the same position today as I envisioned we were a year ago–and should anticipate a flattish first half for 2016 followed by an uptick sometime in the second.

While this view placed me in the relatively cautious camp last December it places me among the bulls today.

 

More tomorrow.

 

 

 

 

 

a reply to a reader comment

I spent a lot of time over the weekend thinking about how to reply to a comment from an astute regular reader about my post on Friday.

Here it is (edited slightly):

Thanks for your comment, Chris.

I agree completely with most of what you say. I think the US stayed with easy money for far too long.  As you point out, we’ll find out how damaging the speculative excess this has spawned has been as rates begin to rise. At the same time, the internet has changed the dynamics of ownership of physical assets. The aging of the population plus the unwillingness/inability of homeowners to use the equity in their houses to fund current spending will also be drags on consumption in the US. And, despite our warts, we’ve come out of the big recession in better shape than the rest of the developed world. So we now face a complex, slow-growth world with lots of challenges for stock and bond markets.

As to mining commodities, though, I continue to think that they exist in their own boom-bust worlds whose main feature is that participants will add capacity, even though history has shown that this will destroy pricing, so long as they have positive cash flow and can get bank loans. Oil and gas are a little more complicated, but let’s ignore that. The ensuing slumps can last a decade or more. It’s the odd nature of these industries that they produce more when prices decline rather than less. I regard the current weakness in the prices of mining commodities as resulting from industry weirdness rather than a recession-induced falloff in demand.

Of course, this is an optimistic viewpoint and I’m an optimist, so I could easily be wrong.

Does it make a difference whether oil and iron ore price declines are harbingers of general economic weakness or are just playing out a new day in their Groundhog Day existences?

I think it does.

If I’m correct, then mining weakness–and the “lost decade” it seems to predict for countries radically dependent on mineral production, although important, is one of many entries to the list of transformational issues facing today’s world. That list includes:

–Millennials vs. Baby Boomers
–China’s emergence as the world’s biggest economy
–the disruptive power of the internet
–political reaction to the failure of the governments of the US, EU and Japan to enact appropriate fiscal policy, defending entrenched special interests (many of them on the wrong side of change) instead.

In the world I envision for 2016, stocks will go basically sideways.  It will be hard to make money by owning them, but with careful selection it’s possible.

If, on the other hand, if you’re right that mining commodity price weakness foreshadows global economic contraction that just hasn’t hit mainstream indicators yet, then my take is much too positive. Cash will be the best place to be.

Shaping a Portfolio for 2016: dealing with oil

Energy stocks now make up about 7% of the market capitalization of the S&P 500.  That’s not much.  They make up about 14% of the junk bond universe, however.  And they’re a huge chunk of emerging markets.  To my mind, it’s the spillover effect from these latter two areas where the price of energy may have an effect on the stock market.

forecasting earnings

I think it’s impossible to know what the earnings of oil and gas stocks will be for 2016.

If an exploration company spends $10 million to find 1 million barrels of oil, oil and gas accounting rules call for it to expense $10 of finding costs every time it produces a barrel.  On top of that, it expenses the out of pocket costs of extraction.

A complication:  suppose the extraction costs exceed the selling price of the oil.  If so, the oil company won’t produce any.  It won’t have revenue, but it won’t have a loss on its income statement, either.

If, however, the oil company decides the field is permanently impaired, it could write part of all of the cost of the field off at the end of this year.  That would allow it to show an accounting profit on output from that field in 2016.

This kind of housecleaning has already begun with Royal Dutch Shell, which has written off a number of high cost projects.

To the extent that the industry as a whole has large, non-recurring writeoffs this December, 2016 earnings will look better than we now think.  We won’t know this for a while, however.

reported earnings probably don’t matter that much

It seems to me that the stocks are no longer trading on reported earnings, but on the spot price of oil and gas instead.

It strikes me, too, that we’re now entering some sort of capitulation phase with oil and gas stocks, where panicky investors tend to throw the baby out with the bathwater.  This phase could last a considerable amount of time, especially if energy prices continue to slide during what is supposed to be the strongest season for demand.  So there’s plenty of scope for near-term bad news.

We’ll know that the capitulation is over only when the stocks stop reacting negatively to oil/gas price declines.

the energy sector is now a small part of the S&P 500

At today’s size, it would take a 15% fall in the Energy sector to clip one percentage point off the return on the S&P 500.  One could argue that in this sense, oil and gas no longer have a large bearing on the fate of the index.

one worry

It seems very clear to me that the current decline in energy prices is similar to what happened during 1982-86.  That is, a period of very high prices leads to the creation of supply overcapacity that causes the price to subsequently plunge.

I don’t think there are wider macroeconomic implications.   It’s all about the microeconomics of benefit to oil consumers and hurt to oil producers.  For the S&P 500, that ends up being a net plus.  For emerging markets, especially for OPEC, it’s a net minus.

I find it hard to follow the logic of the argument that if very high oil prices are bad for the world economy, then low ones are also bad.  Yet that’s what I’m beginning to read and hear in the financial media.  It’s taking the form of a claim that the price decline is not being caused by oversupply–which it clearly is–but by a recessionary falloff in demand.  The low oil price, these commentators say, is the first evidence that the world is entering a business cycle decline.

If investors in general begin to believe this, we could talk ourselves into a period of stock market weakness.

For long-term investors, this shouldn’t have any effect on investment strategy.  For more trading oriented, a stock market selloff based on false premises could provide a buying opportunity.  When?  My guess is as we enter the seasonal energy lull early next year.

 

 

 

 

 

 

 

Shaping a Portfolio for 2016: summing things up

Today I’ll try to put numbers to my guesses about growth around the world next year.  I think the best way to do this is in two steps, first without trying to factor in what I think will be a negative influence from natural resources industries, and then making both economic and stock market adjustments for them in a second round of analysis.

the US

We’re likely to have trend growth in the US next year, meaning a total of +4% expansion, consisting of +2% real and + 2% inflation.  Because publicly traded companies are typically the best and the brightest, this will probably translate into +8% growth in earnings.

Let’s say that Fed interest rate rises have little net effect on growth and that the dollar has peaked (meaning that headwind is gone).  This may be a bit too optimistic.

I’m guessing that, unlike the past couple of years of aggressive share buybacks, we won’t companies retire more shares than to offset the issuance of new ones to employees through stock option plans. Therefore, 8% earnings growth will translate into +8% growth in earnings per share.

Given that half the earnings of the S&P 500 come from the US, this means the domestic contribution to S&P 500 earnings growth will be +4%.

the EU

The EU is maybe two years behind the US in recovery from recession.  But it has clearly turned the corner and will grow in 2016.  It also has the tailwind of substantial currency depreciation behind it, and the strength of Greater China and the US, major export customers.

Europe is also a substantial beneficiary of the fall in energy prices, although that plus is tempered a bit by the weakness of the euro against the dollar.

For all these reasons, the EU will likely enjoy above-trend growth next year.

Let’s say that the EU will expand by +2.5% real, with +1.5% inflation, for a total of +4%.  That probably also translates into +8% growth in profits for S&P subsidiaries located there, and a +8% advance in eps.

Given that 25% of the profits of the S&P 500 come from the EU, this means that region’s contribution to index earnings will be +2%.

emerging markets

Let’s separate emerging markets into Greater China and everyone else.  In broad strokes, the everyone else are natural resources producers, who are in recession and who will make a negative contribution to S&P 500 growth.  The question is how negative the situation will be.  -3%?

On the other hand, I think that mainland China and its direct sphere of economic influence will have a better 2016 than the consensus now expects.  Let’s say +6%.

If we figure that China and the rest are both roughly equal in size, this implies that emerging markets, which account for 25% of the profits of the S&P, will make a positive contribution to growth in earnings, but a negligible one.  Let’s say +0.5%.

the total

My back of the envelope analysis suggests that the growth in S&P 500 profits will come in at +6% – +7%.  next year.  Not a banner result, but still enough to nudge the index ahead.

the price earnings multiple

In what will be a period of rising interest rates, it seems that there can be no cogent argument for PE multiple expansion in 2016.  If anything, multiple contraction should be the order of the day.

On the other hand, the Fed’s intentions have been widely telegraphed for an extremely long time, so it’s equally hard to argue that the market hasn’t already factored into today’s prices a large portion of any negative effect.  In fact, it seems to me that the market PE already incorporates in it all the tightening the Fed is likely to do.  Nevertheless, there’s always someone who hasn’t gotten the memo, so there will be some negative effect, at least initially.

The most prudent assumption, I think, is that Fed tightening will make little difference to the PE.  The contrarian in me says the money-making stance to take is that the PE will rise once the market sees that Fed tightening will only occur very slowly.  But I’m not willing to take that risk.

a market of stocks

If I’m correct, 2016 will be a mildly positive year, where outperformance will come from astute stock selection rather than playing macro trends.

On Monday:  adjusting for natural resources, especially oil.

 

 

 

 

 

Shaping a Portfolio for 2016: petrodollars

Petrodollars is the term coined in the 1970s to describe the money flow from oil consuming nations to oil producers–meaning by and large OPEC–during a decade when the crude oil price skyrocketed from around $3 a barrel in 1970 to $25+ in 1979.

Some economists of the day feared that this massive increase in money paid for fuel would be, in effect, withdrawn from circulation in the global money supply, and that the resulting money supply contraction could cause a worldwide recession.  (I have no idea where this notion came from, but it was seriously discussed.  Another strange idea being floated then was of the “backward-bending demand curve,” i.e., that there was something magical about oil so that the higher the price went, the more demand increased.)

What happened instead was that these funds were quickly recycled into the world money supply through increased spending by OPEC and through gigantic purchases of financial and other assets, from Treasury bonds to real estate to large stakes in publicly listed companies in Europe and the US.

Economic growth in the OECD did slow markedly during the 1970s and inflation rose sharply in places like the US, as industry heavily reliant on ultra-cheap oil struggled to adjust.  One might also argue that the fact that money was going from the pockets of avid consumers to those of wealthy savers also retarded economic expansion.

What I’ve just written is only interesting, other than to me, because the reverse of that 1970s flow is now happening.  More money is remaining in the hands of consumers.  According to the Financial Times, during the September quarter alone, Middle Eastern sovereign wealth funds cashed in at least $19 billion of their investments to underpin current government spending. Since not all asset manager report withdrawals, the true figure could easily be twice that.

It’s clear that a large shift of wealth away from OPEC and to oil consumers is under way.  But, in addition, as OPEC liquidates financial investments to fund current spending–Saudi Arabia is actually talking about issuing international bonds to fund its budget deficit–it will provide another monetary (and consumption) tailwind for economic growth in 2016.