Tag Archives: economy

cyclical growth vs. secular: which to choose now?

May 14, 2015 By in bond market, currency markets, securities markets, stock market, Strategy Tags: , , , , , Leave a comment

cyclical and secular

The rhythmic cyclical economic progression from recession to expansion and back again affects everything the global economy.  Yes, there are sectors like Materials that go through their own long boom and bust cycles that can last decades.  There are also public Utilities that supply water or electricity that are well-insulated from cyclical fluctuations.

Despite these (relatively minor, in my view) complications, it’s useful for stock market investors to distinguish between companies whose profits are linked mostly to the business cycle–say,  a cement plant, or a supermarket or a department store–and those whose success is more a product of their own innovation or of being positioned in the slipstream of structural change–like Apple, or Amazon or Facebook are/have been.

How so?

In the simplest terms, the first group does particularly well as economic recovery springs out of recession. The latter typically begin to come into their own a year or two into an economic/stock market upswing, when demand pent up by recessionary fears is satisfied and economies settle into a slower, more sustainable growth pace.  In the case of the Great Recession, this process has taken a much longer time.

At some point, central banks step in to raise interest rates, reining in growth a bit further, and tipping the scales a bit more toward secular growth.

Yes, but…

By these last few keystrokes, the “yes, but”s have begun screaming loudly enough in my head to interrupt my train of thought.

They see where this post is going–how should we structure our portfolios to deal with the coming rise in interest rates in the US?–and the answer is going to be to go with structural growth over cyclical growth.

It isn’t necessarily that simple…

…what if the current slowdown in the US is all about the cold weather and port congestion, and we’ll get catchup in the summer?

–what about the weakening dollar, which is giving more evidence of having peaked against the euro?

–what about the EU picking itself up off the economic floor for the first time in years?

–what if the anti-corruption drive in China is past its worst and growth will pick up there?

–what about the bounceback in oil prices?

–how much do valuations matter?

…or is it?

What I think:

Rising interest rates always have a sobering effect on investors.  It’s a change to a more conservative mindset, rather than a precise calculation of the effect on profits of higher rates.

Valuations matter more than before, especially for smaller, non-mainstream companies.  Investors will take a harsher look at highly indebted companies that are struggling.  The same for startups with little more than a business plan and a prayer–it will be much harder than it is today for them to go public.  PE multiples generally don’t expand; if anything, they contract.  At the very least, investors will take pruning shears to the highest numbers.

To the degree that the US economy remains in low gear, interest in secular growth names will intensify.  However, I also think investors will lose their taste for “me too” smaller stocks.

More tomorrow.

 

 

 

 

 

 

a surprising reaction to a so-so jobs report …trading computers at work?

May 11, 2015 By in Constructing a Portfolio, Current Market Thoughts, economics, Employment Situation report, Strategy Tags: , , , , , , 1 Comment

Last Friday, the Bureau of Labor Statistics released, as usual, its monthly employment report for April.  The numbers were good, but not surprisingly so.  The Employment Situation said the economy added 223,000 new positions in April– +213,000 in the private sector and +10,000 in government.

The revisions to prior months’ data were strongly negative, though–+2,000 jobs for February and -41,000 for an already weak March.

Wage gains remained in the +2%/year range;  the unemployment rate was stable at 5.4%.

My reaction was that the figures were about what the market had expected.  The headline figure, ex revisions, was exactly in line with economists’ estimates.  Nothing else changed much.

Nevertheless,

…the S&P rose steadily during the day end ended up by 1.3%.

Yea, I’ve been retired for some time.  But I can’t imagine any of the portfolio managers I knew/know buying stocks on this report (because it contained no new information).

Yet the market didn’t just shrug the report off.  Instead, it went up a lot.  Assuming the market went up on the Employment Situation–and I think it did–the market reacted to a just-as-expected report rather than discounting it in advance, as usually happens.

Why did the market behave this way?  I don’t know.  All I can come up with is that computers, not people, are the main actors, and that the decision rules they’re using aren’t very good.

Something to think about …and keep an eye on, since this behavior runs so counter to prior experience.

Whole Foods (WFM) and Millennials

May 11, 2015 By in earnings conference calls, Recent Market Action, Retail, Stock ideas, supermarkets Tags: , , , , , , , 1 Comment

What should we make of the announcement by WFM that it’s launching a new chain of supermarkets–smaller stores, selling less expensive merchandise, targeted to Millennials?

preliminaries

I was an early investor in WFM.  My family shops there on occasion.  But I haven’t followed the company for years.

Over almost any period during the past decade, the traditional supermarket chain Kroger (KR) would have been a better investment.

The stock’s strong performance from the depths of the recession comes in part from its starting point–a loss of over 3/4 of its stock market value and the need for a $425 million cash injection from private equity firm Green Equity Investors.

my thoughts

new brand–As I once heard a hotel marketing executive say, “You don’t start selling chocolate ice cream until the market for vanilla is saturated.”  Put a different way, if there’s still growth in the tried and true, it’s a waste of time to segment the market.  Therefore, the move to a second brand signals, at least in the minds of the managers who are doing this (and who presumably know their company the best), the end to growth in the first.

less expensive food–Pricing and brand image are intertwined.  Paying a high price for goods can confer status both on the product and the buyer.  Lowering prices can do the opposite.  It seems to me that WFM judges it can’t lower prices further in its Whole Foods stores without risking the brand’s premium image.  It may also be that WFM thinks it needs the pricing to pay for the big stores/prime locations it already has.  That would be worse.

smaller stores–This is less obvious.  The straightforward conclusion is that WFM has exhausted all the US locations where the demographics justify a big store.  My impression is that this happened years ago, however, when WFM began to decrease the square footage of its new stores.  On the other hand, it may also be that in their search for “authenticity,” Millennials react badly to big stores.

Millennials–Millennials and Baby Boomers are each about a quarter of the population.  Boomers have about twice the income of Millennials.  But as Boomers fade into retirement, their incomes will drop.  Millennials, in contrast, are just entering their prime working years, when salaries will rise significantly.  So targeting Millennials makes sense.

 

It’s not surprising that WFM shares dropped on the news.   It signals the end of the road for the proven brand and a venture into the unknown for which no details have been provided.  Why announce this now in the first place?

worrying about productivity

May 8, 2015 By in economics, employment, wage gains Tags: , , , , , , , Leave a comment

getting GDP growth

Looking at GDP from a labor perspective, growth comes either from having more workers or from more productivity, that is, from workers creating more stuff per hour on the job.  (Yes, you can get more output by not letting workers go home and forcing them to work 100 hours a week.  But that’s not going to last long, so economists generally ignore this possibility.)

The trend growth rate of the population in the US is, depending on who we ask, somewhere between +.7% and +1.0% per year. For reasons best known to itself,  Congress spends an inordinately large amount of time, in my view, devising ways to keep a lid on this paltry number by prohibiting immigration.  So, as a practical matter, the only way to get GDP to expand in the US by more than 1% is through productivity growth.

 

The weird thing about productivity is that it’s a residual.  We don’t see it directly.  Productivity is a catchall term for the “extra” GDP that a country delivers above what can be explained by growth in the number of people employed.  Economists figure it’s the result of employers providing better machinery for workers to use, technological change, and improved education + on the job training.

Productivity peaked in the US shortly after the turn of the century at around +2% per year, accounting for the lion’s share of national GDP growth.  It has been falling steadily since.  Over the December 2014 and March 2015 quarters, productivity dipped into negative territory.  This is hopefully a statistical quirk and not the sudden onset of mass senior moments throughout the workplace.

why worry?

Over the long term, the disappearance of growth through productivity gains implies economic stagnation in the US.  (My personal view is that the productivity number are the aggregation of a highly productive tech-oriented sector and a low/no-productivity rest of us hobbled by a weak public education system   …but, as a practical matter, who knows?   By the way, productivity figures don’t include government.)

The more pressing issue is that no productivity gains means employers aren’t finding ways to make their employees create more output per hour worked.  That is, they have no way of offsetting  higher wages other than to try to pass costs on by raising prices.

the bottom line for investors

Conventional wisdom is that the Fed will take a long time to shift from extreme economic stimulation through emergency-low interest rates back to normality.  Both stock and bond prices also seem to me to have imbedded in them the idea that “normal” will be lower in nominal terms than it has been in the past.

A bout of inflation induced by rising wages could change that thinking in a heartbeat.

To be clear, dangerously accelerating inflation isn’t my base case for how the economy will play out.  And no one is thinking that the US will only grow at about 1% annually from now on.  All the more reason to keep a close eye on how productivity figures evolve.

inflation on the rise?

May 5, 2015 By in bond market, currency effects, currency markets, Current Market Thoughts, Dividends, inflation, securities markets, stock market, Strategy Tags: , , , , , , , Leave a comment

Regular readers know that I like the economic work done by Jim Paulsen of Wells Capital, the Wells Fargo investment management arm.  His May 1st “Economic and Market Perspective” piece argues that the US has turned the corner on inflation, which will –contrary to consensus beliefs–be on the rise from now on.

His argument:

–the first signs of upward wage pressure in the US are now becoming visible (in developed economies, inflation is all about wages)

–recently, a rising dollar has kept the price of imported goods from rising (in some cases, they’ve been falling) and suppressed demand for US goods abroad.  That’s changing, turning the currency from a deflationary force into in inflationary one

–productivity is low, meaning that companies will have no way of offsetting higher wages other than to raise prices

–in past economic cycles, the Fed has somehow invariably remained too loose for too long.

 

I’m not 100% convinced that Paulsen is correct, and to be clear, he expects only mild inflation, but I’ll add another point to the list:

–although it doesn’t talk much about this any more, the Fed has clearly in mind the lost quarter-century in Japan, where on three separate occasions the government cut off a budding recovery by being too tight too soon.  In other words, there’s little to gain–and a lot to lose–by being aggressive on the money tightening trigger.

 

Suppose Jim is right.  What are the implications for stocks?  This is something we should at least be tossing around in our heads , so we can have a plan in mind for how to adjust our portfolios for a more inflationary environment.

My thoughts:

–inflation is really bad for bonds.  As an asset class, stocks benefit by default.  But bond-like stocks–that is, those with little growth and whose main attraction is their dividend yield–will be hurt by this resemblance.

–if the dollar is at or past its peak, it’s time to look for domestic-oriented stocks in the EU and euro earners in the US (the basic rule here is that we want to have revenues in the strong currency and costs in the weak).

–companies that can raise their prices, firms whose labor costs are a small percentage of the total, and consumer-oriented firms that are able to expand unit volumes without much capital investment should all do well.

–I think that average workers, not the affluent, are the main beneficiaries of a general rise in wages.  So firms that cater to them may be the best performers.