thinking about the US stock market

tactics

There’s a struggle going on in the market between secular growth stocks and business-cycle sensitives. This contest has two parts: valuation and concept.

valuation

If we look at the performance of NASDAQ vs. the Russell 2000 over the past 2 1/2 years, the former has outperformed the latter by an almost unheard of amount for a developed country. Relative valuation alone argues that the R2000 should have its day in the sun.

One would expect balance to be restored by some combination of NASDAQ losing relative ground and R2000 going up. The immense money and fiscal stimulus coming out of Washington suggests the central tendency of stocks will be up, so NASDAQ could conceivably do its part to restore valuation balance by simply standing still.

concept

On the other hand, this performance differential is arguably justified. Thanks to Trump’s epic incompetence, the domestic economy has been increasingly weak–both vs our own history and results in most other places (not the UK) since the effects of the 2017 tax cut have warn off. And the R2000 is much more closely tied to the US than the more global NASDAQ. Every recent rally attempt by the R2000 has petered out in short order–although the one now underway may have more legs than its predecessors.

Then there’s the pandemic. Washington has spent trillions of dollars, correctly so in my view, to prop up a country being ravaged by a deadly disease. Unfortunately for us, with his usual blend of insight and judgment, Trump has armtwisted states like Florida, Texas, Arizona et al into lifting quarantine restrictions much too soon. The result has been that while Canada and the EU have Covid under control and are revving up their economies, we’re seeing the virus flare up again with huge increases in new cases and red-state hospitals and funeral homes overwhelmed. He’s now, in inexplicable fashion, compounding his error by pressuring schools to reopen shortly, amplifying the risk of disease to both students and teachers.

All this implies both that another round of aid from Washington may be necessary to offset Trump’s gaffe and that the domestic economy will be relatively weak for longer than hoped–and longer than any other OECD country. (The financial press has begun to link Trump’s handling of the coronavirus with his disastrous foray into Atlantic City gambling, even though the fact that he’s done this sort of thing before isn’t a great explanation for why he should be doing it again.)

Other worries: the national debt is now higher as a percentage of GDP than it was at the end of WWII, and the budget deficit is already approaching $4 trillion.

Concept, then, argues that investors should continue to do what they’ve been doing for the past couple of years–stay as far away from the domestic economy as possible.

strategy: i.e., what happens next?

I think we muddle along for a while. But the two big questions that I see eventually coming to the forefront of the market’s consciousness are:

–in November, will the US reelect a white racist economic illiterate who has crushed GDP growth, who’s a fanboy of corrupt dictators, who seems to revel in the suffering of others and who appears to be unraveling mentally before our eyes? It says something about the parlous state of domestic politics that the answer is not clear.

–how/when/at what cost does the country begin to clean up the gigantic mess Trump, his administration and his enablers in Congress have created?

musings (iii)–the presidential election

If the US is to retain a leading position in world commerce today we need better infrastructure, better schools and the ability to harness the efforts of all Americans in support of economic growth. Washington has fallen down badly on all three fronts for a very long time. Discontent with the status quo has resulted in the election of Donald Trump as president, as I see it, on the idea that things couldn’t be worse.

Whoops!

Though a Barnum-like showman, Trump is, unfortunately, a popular former reality show host but not much else. He’s an incompetent businessman and a white racist who appears to relish the suffering of others. His economic “vision” is for a return to the TV sitcom world of the 1960s, to be achieved by creating a Depression-era tariff wall that will prevent better-made or cheaper products from reaching the US.

In my view, this is suicidally crazy. As far as I can tell, mine is the consensus view in the rest of the world, which is appalled by the severe turn for the worse in the US. Even now, though, my sense is that Americans in general have been surprisingly complacent the damage Trump is doing.

So far, the stock market reaction has been to shun stocks tied closely to the US economy and bid up shares of companies with global franchises or with intellectual property that could just as easily be held in, say, Canada. Over the past month or so, foreign stocks have also begun to outpace US equities for the first time in years.

What if Trump is reelected?

Let’s ignore the messy possibility the Financial Times, for one, is now beginning to discuss–that Trump will “steal” a close election, again losing the popular vote, in a contest marred by voter suppression in red states. Without that complication, the results of a Trump victory would be pretty straightforward.

First and foremost, it would be read worldwide as a national endorsement of his loony-tunes economics, as well as his racism, sadism and eagerness to use the military to violently suppress civil dissent. Not a pretty picture.

The current trend toward stocks with substantial non-US businesses, innovative technology and/or the ability to transfer operations elsewhere would likely continue. Presumably, we’d also begin to see downward pressure on the dollar for both economic and ethical reasons, as fixed income investors as well as equity holders sought to reduce their US exposure.

US brands would likely begin to lose their aspirational appeal, if they have not already. Tourism, both to the US and to US-operated attractions, would wane, even if the coronavirus is brought under control. Global businesses would feel pressure from customers and from employees to relocate. The working population of the US would begin to shrink, as a result and as 1930s Germany became a more plausible analogue for the US. Even Japan might start to look good.

US self-destructive impulses would also open the door wide to China to supplant the US as a cultural and economic world leader. At the very least, capital and portfolio investment diverted from the US would have to find a home somewhere.

more on Monday

the Trump economy

Recent election polling seems to show that potential voters don’t approve of anything in the Trump administration except its handling of the economy. One might argue that in comparison with supporting white racism, subverting the Justice Department, causing tens of thousands of Americans to die needlessly from the coronavirus and trying to corrupt the military, blunting economic growth is the least bad thing Trump has done.

It appears, however, the common belief is that Trump has actually done good things for US economic growth during his time in office and that on economic grounds he would be a better presidential choice than Joe Biden. (Personally, I think it’s a sign of the extreme poverty of domestic politics that the Democrats can’t come up with a better candidate than Biden but that’s another issue.) My opinion is that Trump is worse than economically clueless; I think he has been doing potentially incalculable damage to the long-term economic prospects of the country. If so, why don’t people realize this?

I think the explanation is in the financial results of Walmart (WMT), the largest retailer in the US. WMT’s target market is Americans of average and somewhat below average income. The company started in the midwest. Political action by incumbent retailers in California and the Northeast have limited its exposure to those areas. So it’s a reasonable thermometer for economic health in the rest of the country.

EPS growth for WMT over the past seven years is as follows:

year yoy eps growth

2019 +6.3%

2018 +11.1%

2017 +2.3%

2016 -5.5%

2015 -9.9%

2014 -0.8%

2013 +1.8%.

Note: Like many retailers, WMT’s fiscal year runs from February through January of the following calendar year. So, for example, what I’ve labeled as 2019 is actually 2/19 – 1/20.

What I read from these numbers is that recovery from the financial crisis of 2007-09 didn’t reach the large chunks of America that WMT services until almost eight years after the overall economy bottomed. This coincided with Trump’s election.

Did Trump cause this pickup or is it simply the “trickle down” of recovery to a a part of the country neither major party cared that much about? I don’t see anything in Trump’s past or present performance record to make me think it’s the former.

autos, emissions and Trumponomics

I’ve followed the auto industry since the early 1980s, but have rarely owned an auto stock—brief forays into Toyota, later Peugeot (1986) and Porsche (2003?) are the only names that come to mind.

 

The basic reasons I see to avoid the auto manufacturers in the developed world:

–chronic overcapacity

–continuing shift of intellectual property creation, innovation, brand differentiation—and better-than-commodity profits–from manufacturers to component suppliers

–the tendency of national politics to influence company operations and prospects.

 

In addition, the traditional industry is very capital intensive, with a high capacity utilization required (80%?) to reach breakeven.  The facts that unit selling prices are high and new purchases easy to put off for a year or two mean that the new car industry is highly cyclical.

More than that, today’s industry is in the early stages of a transformation away from units that burn fossil fuels, and are therefore a major source of air pollution, to electric vehicles.  The speed at which this change is happening has accelerated over the past decade outside the US because pollution has become a very serious problem in China and because automakers in the EU have been shown to have falsified performance data for their diesel-driven offerings in a poorly thought out effort to meet anti-pollution rules.

California, which had a nineteenth-century-like city pollution problem around Los Angeles as late at the mid-1970s, has led the US charge for clean air.  It helps its clout that CA is the country’s largest car market (urban legend:  thanks in part to GM’s aggressive lobbying against public transport in southern CA in the mid-20th century).  CA has also been joined by about a dozen other states who go along with whatever it decides.  The auto manufacturers have done the same, because the high capital intensity of the car industry means building cars to two sets of fuel usage specifications makes no sense.

 

Enter Donald Trump.  His administration has decided to roll back pollution reduction measures put in place by President Obama.  CA responded by agreeing with Ford, VW, Honda and BMW to establish Obama-like, but somewhat less strict, requirements for cars sold in that state.  Trump’s reposte has been to call the agreement an anti-trust violation, to claim the power to revoke the section of the law that permits CA to set state pollution standards and to threaten to withhold highway funds from CA because the air there is too polluted (?).

 

Other than pollical grandstanding, it’s hard to figure out what’s going on.

Who benefits from lower gas mileage cars?     …Russia and Saudi Arabia, whose economies are almost totally dependent on selling fossil fuels; and the giant multinational oil companies, whose exploration efforts until recently have been predicated on demand increasing strongly enough to push prices up to $100 a barrel.

Who gets hurt by the Trump move?     …to the degree that it prolongs widespread use of inefficient gasoline-powered cars, the biggest potential losers are US-based auto firms and the larger number of US residents who become ill in a more polluted environment.  Why the car companies?  Arguably, they will put less R&D effort into developing less-polluting cars, including electric vehicles.  The desertification of China + disenchantment with diesel will have Europe and Asia, on the other hand, making electric cars a very high priority.  It wouldn’t be surprising to find in a few years a replay of the situation the Detroit automakers were in during the 1970s—when cheap, well-built imports flooded the country without the Big Three having competitive products.

It’s one of the quirks of the US stock market that it has very little direct representation of the auto industry.  So the idea that profits there will be somewhat higher as the firms skimp on R&D will have little/no positive impact on the S&P.  Even the energy industry, the only possible beneficiary of this Trump policy, is a mere shadow of its former self.  Like Trump’s destruction of the American brand—Apple has dropped from #5 in China to #50 since his election—all I can see is damaging downside.

I think the Trump policy is intentional, like his trade wars and his income tax cut for the super-rich.  The most likely explanation for all these facets of Trumponomics is either he doesn’t realize the potentially grave economic damage he’s doing or it’s not a particularly high priority.

 

 

 

 

 

 

 

 

yield curve inversion, external shock and recession

Stock markets around the world sold off yesterday in wicked fashion after the yield on the 10-year Treasury “inverted,”  that is, fell below the yield on the 2-year.  This has very often been the signal of an upcoming recession.  Typically, though, the inversion happens because the Fed is raising short-term interest rates in an attempt to slow too-rapid economic growth.  So it’s first and foremost a signal of aggressive Fed tightening, which has in the past almost always gone too far, causing an economic contraction.

In the present case, this is not the situation.  The Fed is signalling ease, not tightening.  Arguably, arbitrage between long-dated US and EU government bonds is suppressing the 10-year.

While trading robots, unleashed by the inversion, may have been behind the negative stock market action yesterday, my sense is that this is not all that’s going on.  I think the market is beginning to step back and focus on the bigger economic picture.  It may not like what it sees, namely:

–worldwide, economies are now being hit by a significant negative external shock.  It’s not a tripling of the oil price, as was the case in the 1970s, nor a collapsing financial system, as in 2008.  Instead, this time it’s the Trump tariffs, which appear to be reducing growth in the US by more than expected (not that anyone had extremely precise thoughts)

–the 2017 tax bill is not paying for itself, as the administration claimed at the time, but is adding to the government deficit instead–implying that further fiscal stimulation is less likely.  Giving extra cash to the ultra-rich, who tend to save rather than spend, and keeping tax breaks for industries of the past hasn’t bought much oomph to growth, either

–channeling his inner Herbert Hoover, Mr. Trump is trying to export the weakness he has created by devaluing the dollar.

 

Stepping back a bit to view the larger picture,

–pushing interest rates near to zero, depreciating the currency and defending the politically powerful industries of the 1970s all seem to mirror the game plan that has produced thirty years of stagnation in Japan and similar results in large parts of the EU.  Not pretty.

–on a smaller scale, this brings to mind Mr. Trump’s fundamentally misguided and ultimately disastrous foray into Atlantic City gaming, a venture where he appears to have profited personally but where those who supported and trusted him by owning DJT stock and bonds were financially decimated.

 

It seems to me that Wall Street is starting to come to grips with two possibilities:  that there may be only impulsiveness, and no master plan or end game to the Trump trade wars; and that Congresspeople of all stripes realize this but are unwilling to do anything to thwart the president’s whims.  In other words, the real issue being pondered is not recession but Trump-induced secular stagnation.