starting out in 2020

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, ithe 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.









today’s discounting mechanism


Discounting is Wall Street jargon for new information being factored into stock prices.

Discounting isn’t a single thing.  In the 1920s, for instance, company managements issued unreliable financial statements while happily passing along inside information to their bankers.  Ordinary investors fended for themselves with the only tool they had back then–watching prices and stock charts.

When I entered the stock market in late 1978 there were already laws requiring publicly traded companies to file detailed financial statements with the SEC.  From the early 1970s cadres of well-paid analysts poring over them and creating the microeconomics of firm and industry behavior.  Yes, there were still throwbacks who expected analysts to be part of their public relations efforts…and there was pressure on analysts who worked for brokerage houses to make their ideas known to the proprietary trading  desk before anyone else.  Still, the playing field was a lot more level.  There were significant rewards for original research conclusions, particularly with traditional growth companies, where the game was, and still is, finding situation where the consensus was too pessimistic about the rate of profit growth and/or the length of time unusually high earnings gains could be sustained.  Typically, stocks would start to rise a year or more in advance of confirming earnings.  In over-bullish markets investors might discount as much a three years into the future; in the depths of bear markets investors would stick to actual earnings and not discount the future at all.

In the 1990s this dynamic began to change, as investment managers began to lay off their in-house analysts on the idea that relying on brokerage research was a lot cheaper and a lot less effort.  In 2000, the SEC passed Regulation FD, which required publicly-traded companies not to make selective disclosure of corporate information (the presumed recipients were investment bankers and institutional shareholders).  Replying to an analyst’s novel question or inadvertently revealing information through body language became worrisome enough that companies either stopped having meetings or developed canned presentations and pretended they were news.  In the wake of the financial crisis, brokers laid off virtually all their experienced analysts.  Since academics are totally clueless about finance, this left no place for newcomers to learn how to do traditional analysis.

Enter AI–whose specialty is reacting to newly released information with lightning speed rather than anticipation of yet-to-be-announced developments.

What is a fundamental analyst to do?

Strategically, fundamentals-based investing remains the same, I think–figuring out potentially market-moving information before the average market participant does.  Today’s tactics are different, though.  Fifteen years ago, the best strategy would have been to amass a large position in a given stock and wait for the market to work out what you already knew.  Price action would tell you when/if that was happening.  There would likely be bumps in the road, but these would offer opportunities to add.

I think the better course of action now is to start with a smaller position and use AI-induced volatility to add and subtract.






thinking about 2020

where we are

The S&P 500 is trading at around 25x current earnings, up from a PE of 20x a year ago.  Multiple expansion, not earnings growth, is the key factor behind the S&P rise last year.In fact, earnings per share growth, now at about +10%/year, has been decelerating since the one-time boost from the domestic corporate income tax cut cycled through income statements in 2018.  Typically earnings deceleration is a red flag.  Not so in 2019.

EPS growth in 2020 will probably be around +10% again.

About half the earnings of the S&P come from the US, a quarter from Europe and the rest from emerging economies.  The US will likely be the weakest of the three areas this year, as ongoing tariff wars take a further toll on agriculture and manufacturing, as population growth continues to wane given the administration’s hostility toward foreigners, and as multinationals continue to shift operations elsewhere to escape these policies.  On the other hand, Europe ex the UK should perk up a bit, emerging markets arguably can’t get much worse, and multinationals will likely invest more abroad.


interest rates:  the biggest question 

What motivated investors to bid up the S&P by 30% last year despite pedestrian eps growth and Washington dysfunction?

Investors don’t buy stocks in a vacuum.  We’re constantly comparing stocks with bonds and cash as alternative liquid investments.  And in 2019 bonds and cash were distinctly unattractive.   The yield on cash is close to zero here (elsewhere in the world bank depositors have been charged for holding cash).  The 10-year Treasury started 2019 yielding 2.66%.  The yield dipped to 1.52% during the summer and has risen to 1.92% now.  In contrast, the earnings yield (1/PE, the academic point of comparison of stocks vs. bonds)) on the S&P was 5% last January and is 4% now.

The dividend yield on the S&P is now about 1.9%.  That’s higher than the 10-year yield, a situation that has occurred in our lifetimes only after a bear market has crushed stock valuations.  In my working career, this has happened mostly outside the US and has always been a clear buy signal for stocks.  Not now, though–in my view–unless we’re willing to believe that the current situation is permanent.

The situation is even stranger outside the US, where the yield on many government bonds is actually negative.

In short, wild distortions in sovereign bond markets, a product of unconventional central bank measures aimed at rescuing the world economy after the 2008-09 collapse, have migrated into stocks.

How long will this situation last and how will it unwind?


more on Monday





end of the year

Virtually all professional investors have long since taken their hands off the money and left their offices–either in triumph or despair.  The anecdotal evidence I’m gathering suggests there’s more of the latter than usual.  Since I have a growth temperament, this strikes me as weird.  But apparently the consensus view was that the sharp decline of stocks in December 2018 was a harbinger of further bad times to come.  Again, this strikes me as odd, but then professional money managers tend to live in gated communities with other well-off people rather than in the real world, so the information they get is highly filtered (another oddity–the gated community part, I mean).

In any event, it’s only the accountants rushing to close the books who remain in front of their computers during the last two weeks of December.

Who’s left to trade?

–retail investors doing tax planning by selling their losers

–the odd manager planning to “window dress” his portfolio by giving his large holding a(n illegal) nudge up on the final day of trading (this happens mostly in smaller foreign markets)

–people like me who are looking for interesting names being beaten down by the combination of few buyers + the need to realize tax losses.

three closing thoughts:

–4Q19 was a lot better than I thought it would be, given that there was no September-mid-October swoon driven by mutual fund/ETF yearend selling

–pundits who crow about stock strength in 2019 typically forget to mention how deep the decline in December 2018 was

–the most notable stars of recent trading have been the banks.  This is a group that’s hurt by falling rates and coins money when rates are rising.  This phenomenon plus the end to the bond buying panic of the summer suggest to me that securities markets have begun to believe that rates have passed their cyclical lows.  What remains to be figured out is when and how fast rates will rise from here.  But for equity investors stocks whose main characteristic is the dream of future profits will have a hard time in 2020.


Happy New Year!!!


Hong Kong riots

a brief-ish history

During the first part of the 19th century the UK’s stores of gold and silver were being depleted (in effect contracting the country’s money supply) to pay for tea imported from China.  London suggested to Beijing that they barter opium from the British colony India instead.  Beijing sensibly refused.  So in 1841 the British army invaded China to force the change.  The UK seized Hong Kong to use as a staging area and kept it once China submitted to its demands.  During a second Opium War (1856-60), launched when China again balked at the mass shipment of narcotics into its territory, the UK seized more land.

In 1898, China granted the UK a 99-year lease over the area it occupied.  This legalized the status of Hong Kong, which remained under the practical control of the “hongs,” a newer form of the old British opium companies, for much of the 20th century.

In the late 1970s Deng Xiaoping made it clear that the lease would not be renewed but that Hong Kong would remain a Special Administrative Region, with substantial autonomy, for fifty years after its return to China on June 30, 1997.  (For its part, the UK parliament decided Hong Kongers would find the climate of the British Isles inhospitable.  So these soon-to-be-former British subjects would be issued identity cards but no other legal protections–citizenship, for example–within the Commonwealth on the handover.  This is a whole other story.)

Hong Kong’s importance today…

The conventional wisdom at that time was that while Hong Kong China’s main goal in triggering the return was to set the stage for the eventual reintegration of (much larger) Taiwan, where the armies of Chiang Kaishek fled after their defeat by Mao.

Today Hong Kong is much more important, in my view, than it was in the 1980s.  Due, ironically, to the sound, and well-understood worldwide, legal framework imposed by the UK, Hong Kong has become the main jumping-off point for multinationals investing in China.  It’s also an international banking center, a transportation hub and a major tourist destination.  Most important for investors, however, is that its equity market not only has greater integrity than Wall Street but is also the easiest venue to buy and sell Chinese stocks (Fidelity’s international brokerage service is the best in the US for online access, I think, even though the prices in my account are invariably a day–sometimes three–old).

…and tomorrow

Mr. Trump has begun to weaponize US-based finance by denying Chinese companies access to US capital markets, US portfolio investors and, ultimately, the dollar-based financial system.  China’s obvious response is accelerate its build up of Hong Kong as a viable alternative in all three areas.  As with the tariff wars, Trump’s ill thought out strategy will most likely galvanize these efforts.

the riots…

Hong Kong has 27 years left to go as an SAR.  For some reason, however, Xi seems to have decided earlier in 2019 to begin to exert mainland control today rather than adhering to the return agreement.  His trial balloon was legislation under which political protesters in Hong Kong whose statements/actions are legal there, but crimes elsewhere in China, could be arrested and extradited to the mainland for prosecution.  This sparked the rioting.  These protests do have deeper underlying causes which are similar to those affecting many areas in the US.

…continue to be an issue

The recent change in Hong Kong’s stock listing rules (to allow companies whose owners have special, super voting power shares) and the subsequent fund raising by Alibaba seem to me to show that Beijing wants Hong Kong to become the center for international capital-raising by Chinese companies.  From this perspective, Xi’s failure to minimize disruptive protests by withdrawing the extradition legislation quickly is hard to understand.

One might argue that Xi, like Trump, is trying to reestablish an older order, purely for the political advantage it gives.  In China’s case it entails reviving the Communist Party’s traditional power base, the dysfunctional state-owned enterprises that Deng began to marginalize in the late 1970s with his move toward a market-based economy (i.e., “Socialism with Chinese Characteristics”).   I find it hard to believe that Beijing is as impractical and dysfunctional as Washington, but who knows.

My bottom line:  I think the Hong Kong situation is worth monitoring carefully as a gauge of how aggressively China is going to exploit the opening Trump policies have haplessly given it to replace the US as the center of world commerce–sooner than anyone might have dreamed in 2016.














the Huawei issue

Huawei is an integrated Chinese telecom company whose products range from handsets to large-scale transmission equipment.  It’s the leading provider of next generation, G-5, cellular infrastructure, a market where the US has no viable entry.  Washington has successfully put enormous pressure on the big US telecom companies not to buy Huawei products, arguing that its devices may contain hidden back doors that could allow Chinese intelligence operatives to spy on conversations and intercept data.

Despite this, Huawei has established a substantial foothold in small US communities because its offerings are much cheaper and better than competitors’.  American worries/threats appear to be met with shoulder shrugs in the EU as well, on the idea that conversations are already being intercepted by the US, so how much worse than Mr. Trump can China be.

In addition, the administration has:

–placed Huawei on the “Entity List,” thereby designating Hauwei a threat to national security and giving the government the ability to cut off the company’s access to American-made computer chips and other components

–floated the idea that Huawei–other Chinese companies as well–could be denied access to US financial markets–bond, stock and bank lending–as venues for raising capital.  Government-related investment pools may also be barred from owning Chinese securities, including Huawei

–had the Huawei CFO (the daughter of the Huawei chairman) arrested on charges of money-laundering and violating the embargo on Iran–effectively telling the company not to use the US banking system at all.  Ms. Meng is still under house arrest in Vancouver, 14 months after being detained at US request in Canada, fighting extradition.


practical implications, as I see them

–although chipmaking has been a Beijing priority for as long as I can remember, the industry has never really developed in China.  I don’t know why.  Washington’s action certainly underlines for Beijing the urgent need to do so.

–my strong impression is that US-based chip companies have continued to supply Huawei from fabs abroad during the on-again, off-again embargo.  Since high-end fabs can be located practically anywhere, the Trump ban on sales to Huawei has likely knocked the US way down the list of locations for new investment

–over the past few years China has slowly been opening its securities markets to foreigners.  The pace of creating an alternative to the US as a source of capital will doubtless pick up after the Trump threats.  Hong Kong, for example, has recently changed its rules to allow companies with multiple classes of shares to list.  And Alibaba has chosen Hong Kong over its prior home, New York, for its latest equity raising.  I think this is just the beginning of China’s move to decrease its reliance on the US

–by weaponizing the dollar-based payment system against national champion Huawei (Mr. Trump has suggested that the charges against Ms. Meng would disappear as part of a trade deal), practical support for the renminbi as a substitute for the dollar must be rising strongly in Beijing.  Implementation is a looong way off, but the seeds have been planted.

on a more conceptual level…

It seems to me that the recent rash of shoot-yourself-in-the-foot economic policy making in Washington makes the US much less desirable as a place for capital investment to anyone, foreign or domestic.  Yes, Mr. Trump is the catalyst, but Washington appears to meekly acquiesce to his economically damaging edicts.

Two saving graces:

–Xi Jinping’s embrace of backward-facing state-owned enterprises as a way of strengthening the grip of the Communist Party over that economy parallels Mr. Trump’s odd desire to relegate the US to the third world.  So China may not be able to exploit fully the huge opportunity Washington is presenting it.

–the obvious move for Beijing would be to ally with the EU against the US.  The easiest connecting link would have been the UK, which, however, is in the process of destroying itself through Brexit.  Is Germany an acceptable substitute?