I’ve just updated my Keeping Score page for a surprisingly strong (to me, anyway) July. Sector rotation is the main message.
As far as US stock are concerned, I don’t know.
As/when the correction is over, however, it’s very important to look for signs of a leadership change. At a minimum, one former hot industry/sector typically grows ice cold; at least one former laggard heats up. Figuring this out and tweaking/reorienting your portfolio can make a big difference in this year’s returns.
There are two factors involved:
—behavior of bank managements: To a considerable degree, commercial banks are able to use changes in interest rates to their money-making advantage. When rates are declining, banks immediately lower the interest they pay for deposits but they keep the rates they charge to borrowers high for as long as they can.
When rates are rising, as is the case in the current economic environment, banks do the opposite. To the degree they can, and given that most loans are variable-rate that is considerable, they raise rates to borrowers immediately. But they keep the interest rate they pay for deposits low for as long as they can.
A generation ago, banks had a much greater ability than they do now to maneuver the interest rate spread. That’s because money market funds were in their infancy. There were no junk bonds to serve as substitutes for commercial loans. There was even a Federal Reserve rule, Regulation Q, that prevented banks from paying interest on checking accounts and put a (low) cap on what they could pay to holders of savings accounts.
Nevertheless, especially as rates are rising, spreads still can widen a lot.
—economic circumstances: bank lending business tends to tail off in recession, since most companies don’t want to take the risk of increasing their debt burden during bad times–even if the potential rewards seem enticing. The credit quality of existing loans also worsens as demand for capital and consumer goods flags.
The opposite happens during recovery. The quality of the loan book improves and customers begin to take on new loans.
stock market effects
The market tends to begin to favor banks as soon as it senses that interest rates are about to rise. Wall Street was helped along this time around when perma-bear bank analyst Mike Mayo turned positive on the group for the first time in ages last summer.
After the anticipatory move, banks have a second leg up when the extent of their actual earnings gains becomes clear. It seems to me the first move has already come to an end …but the second is still ahead of us.
Investment companies are required to file lists of their holdings with the SEC at the end of each quarter. The latest such 13-F form for Berkshire Hathaway shows a buildup in Apple and airlines …and the sale of virtually all of Buffett’s long-term holding in WMT.
WMT as icon
A powerhouse in the 1970s and 1980s, WMT has been a bad stock for a long time. It had a moment in the sun during the market meltdown from mid-2007 through early 2009, when it rose by about 1% while the S&P 500 was almost cut in half. Since the bottom, however, WMT has gained 40% while the S&P is up by 219%.
Wal-Mart isn’t an obviously badly run company. It isn’t, say, Sears, or the Ackman-run J C Penney. But it does have a number of impediments to achieving significant growth in earnings. One is its already gigantic size. A second is its focus on less affluent rural customers who were disproportionately hard-hit by recession and who have in many instances yet to recover. There’s increased competition from the dollar stores. And there’s Amazon, whose competitive threat WMT itself admits it played down for far too long.
—old habits die hard. Mr. Buffett built his career from the 1950s onward on the observation, novel at that time, that traditional Graham/Dodd portfolio investing techniques glossed over the considerable value of investment in intangible assets–brand names, distribution networks, superior business practices. However, by the time I entered the business in the late 1970s, other people–me included–were beginning to adopt his methods. So thinking about intangibles became part of the toolkit, rather than something special. Then, of course, the internet began to erode the power of intangibles to stop newcomers from entering a business. Mr. Buffett, like any successful incumbent (including WMT), has been slow to adapt.
—WMT as metaphor for today. WMT could become more profitable quickly if its heartland lower-income customer base could earn more money. One way to do that would be to bar imported goods from the country, with an eye to creating manufacturing jobs in the US. Of course, that would also destroy the WMT value proposition in the process. So rolling the clock back to 1950 isn’t the answer, either for the health of WMT or for its customers.
Yesterday, TSLA shares touched $260 early in the day. That’s the latest high for a stock that has gained 30% since mid-December, a period during which the S&P advanced by 1.8%.
What does this mean?
–On a personal note, it means I don’t own any more TSLA. Regular readers might reall that one of my sons and I have been trading TSLA between $180-$200 and $250-$260 for the past couple of years. I had sold some at $250 this time around and placed a limit order for the remainder at $260 about a week ago. Yesterday, the stock touched $260.00 for a brief period before falling back to close at $257.48. (An aside: I find it strange that the stock peaked at such a round number. I presume this means there’s a lot of stock on traders’ books waiting to be sold in mechanical fashion–meaning with no attempt to entice buyers higher–at $260.)
–The main message, though, is that there’s a lot more going on in the US stock market than the post-election Trump rally–which seems to me to have already exhausted itself anyway.
I’m driving a Kia Sorrento these days, after my Hyundai Veracruz gave up the ghost late last year. I can imagine my next car being a Tesla. Nevertheless, TSLA is to my mind the ultimate concept stock. Yes, the merger with SolarCity is behind it and the death of a driver using the Tesla self-driving feature seems to have been operator error rather than a flaw in the car. Those are plusses. On the other hand, the company is still struggling with cash flow breakeven. And the Wall Street consensus, for what that’s worth, is that it will lose $1 a share in 2017. So finances continue to be a serious risk. To my mind, the rally is all about the hoped-for success of the Gigafactory, Musk’s reimagining the car manufacturing process, and the triumph of software over hardware and batteries over fossil fuel. TSLA’s gains are a testimony to the rude health of the stock market, with or without a Trump tailwind.
–Areas of interest other than aspirational tech or hoped-for tax reform and infrastructure spending? What about Millennials worldwide? economic strength in the EU? regular old tech? Mexico?? (I haven’t held Mexican stocks for over twenty years, although I’ve had exposure from time to time to that economy through multinationals. I think it’s too early to make a major commitment, but not too soon to be fact-finding.)