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Railroads and Points

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The Days Ahead:
Earnings and China and Germany updates

Sometimes market and economic data looks like this:

Painting 1 detail.jpg

 

Not really a pattern or system but a lot of noise. So, you have to wait, stand back and see what the big picture is, which in this case is this (the above is the black rectangle) and of course, well known to Ferris Bueller fans.

Painting 2 full size.jpg

 

In the last week we had some very odd payroll numbers, the first job losses since October 2010, an uptick in consumer confidence, some weak retail sales and FOMC minutes that revealed a very lively debate about whether inflation is dead, mostly dead or just sleeping. The CPI numbers on Friday came in at 1.7% which is well below what it was when the Fed started tightening in 2015 and 2016 when they were on hold. We know there’s a lot of hurricane noise in the data right now but recent trends don't seem that much different from trends before they hit.

Our view is that inflation will stay stuck at less than 2%, simply because wage pressure seems low and likely to remain so. The 10-Year Treasury market seems to think so as yields fell 10bps in the week. Meanwhile stocks pushed on ahead based on some early but strong earnings reports, the prospect of tax cuts and ongoing good economic reports out of Europe. Elsewhere:


1. People are talking about tax cuts:
More than that, it’s been the major driver of stocks for the last few weeks and one reason why small companies, with an average tax bill of 28%, have ripped ahead of large cap, with an average tax rate of 19%. A cut in corporate tax falls immediately to the bottom line, so there’s no waiting around for the benefits. Of course, we're short on details and whether the House version, which reduces tax revenues by $2.4 trillion over the next 10 years, will square with the Senate version, which limits deficit increases to $1.5 trillion, will square with the White House version, which cuts taxes by $1 trillion… remains to be seen. We'll hold off on opining but there is little doubt that changes are coming.

One item that seems certain to change is the treatment of overseas cash holdings. S&P 500 companies hold around $1.8 trillion in cash, or 8% of market cap and 27% of equity. Tech firms dominate, holding 40% of all cash, which makes sense for businesses that have very low needs for working capital or physical assets. We looked at seven of the biggest firms with high (over 20%) overseas cash as a percent of market cap. Here’s the chart:

We know there are many other factors at play here but the immediate benefit of a tax cut for companies repatriating cash should cause shareholders to bid these stocks up. Which they did for a while. The top line sloping up shows they outperformed the S&P 500 by around 12% for most of the year. But this changed in September and they began to underperform. Why?

Well one reason is that the market had already discounted the likelihood of a tax cut. But we think it’s also because that with stocks expensive (and they're in the 95th percentile of valuations like Price to Earnings Growth, EV/Sales, Forward PE etc), management won't only use the proceeds for share buybacks. That leaves special dividends, M&A, capex investment or just keep it for dry powder.

We'd prefer investment for organic growth. At least that would indicate confidence in future demand. But either way, we’re not convinced the tax cuts on repatriation will make a big difference to market returns despite the press attention and the market seems to have drawn the same conclusion.


2. Investing with Uncle Warren:
We're fans of Berkshire Hathaway (BRK) and, full disclosure, I own it. This is not the place for an exhaustive recount of the wonders of Warren Buffet. There are plenty of books about him here, by him and of course, the annual reports are always worth a read. We were surprised to hear that JP Morgan just initiated coverage on Berkshire, which seems odd for one of the largest sell-side firms to start looking at the country’s sixth largest company by value and second largest by sales. Anyway, here's how we think of BRK:

  1. It’s four businesses i) insurance (personal and corporate) ii) rail iii) manufacturing and iv) utilities. Those account for 84% of sales. There’s other stuff like real estate, candy, furniture, Duracell, a motorcycle apparel company and a mobile home builder. Fine businesses but the big four drive the stock.
     
  2. It has a fortress balance sheet, with $86bn of cash. Most of the big four fund their operations internally or with debt not guaranteed by BRK.
     
  3. The well-known investment portfolio is around 30% of the company’s value or $137bn. To us, they're a sort of gimee. If they do well, they throw off more equity value and cash and if they fall, say 30%, in a stock market crash, they only reduce book value by 9%.
     
  4. There’s a sort of floor on the price at 1.2x book value, which would be around 20% below what it sells at today. Buffet goes into some detail about what this means but to us it just means he’s not going to stand by and let the company become a value trap.
     
  5. Finally, BRK uses an “intrinsic” value method, which to us, is the cash that can be taken out of the business for their remaining life and the value of the businesses over recorded book value. Sometimes, this is just the difference between a goodwill write-down and market value but in some cases it’s the value of the business after accounting for big but initial underwriting losses on its insurance businesses.

Basically, GAAP and Statutory accounting must expense the pure loss of an insurance contract and so ignores the deferred benefit of the float. So say, BRK writes an insurance contract for $10bn. They receive $10bn in premiums but must recognize that eventually they will pay $16bn in claims. So that’s a loss on the income statement in year one. But the claims come in over many years so BRK gets the famous “float” or investment returns from excess cash. This is way above the claims cost (e.g. $10bn at 5% for 25 years returns $34bn) and eventually flows back through the income statement and to shareholders.

Anyway, it’s all part of conservative financial management.

Finally, the ROE number looks pretty meager, right? I mean 8%. That's the bottom third of S&P 500 companies. But that incudes the $137 bn equity portfolio, which has a zero return on an ROE basis because it's just stock holdings. Exclude that and the number is more like 12%, which is pretty good for a financial and manufacturing company. And look at the two smaller charts. The growth in book value and earnings  (the green lines in the second and third chart) is poised to grow by around 10% for the next two years, mainly because rail, insurance and businesses like Precision Castparts are rebounding.

JP Morgan figure the book value of BRK is at least around $210 in 2018 (price today is $187) at a 2% growth and up to $266 at 4% growth. We'd look at it more simply. It’s a collection of superb businesses that operate independently and probably worth a lot more if they were ever sold. At this time of highly appreciated stocks, that’s somewhat comforting.


3. Spain:
We're not big experts on Catalan independence but given the Scottish referendum and the history of separatist moves in Spain, it seemed bound to happen. The Spanish constitution allows for some pretty drastic intervention if the region tries to break away. For now, tensions have lowered and we saw spreads on Spanish bonds lower this week. This does not change our view on European stocks, which we increased some six months ago, but is a reminder that political risk can come from very unlikely sources.


Bottom Line:
Stocks are at or near all-time highs and the S&P 500 continues to trade at around 17.5x earnings. Expensive but not at nose bleed level by any means. It’s an earnings week with inevitable Washington stop/go progress on taxes.  

 

Please check out our 118 Years of the Dow chart  

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Other:

We need to talk about Kevin Marsh

Tax cuts not good for rich…no scratch that

Google to buy Apple

 

--Christian Thwaites, Brouwer & Janachowski, LLC


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

How to Create an Investment Program for Retirement

Whether you have had an investment portfolio for years or are just starting out, this podcast episode is guaranteed to give you clarity on the best strategies for creating a strong investing program for retirement. A few topics covered in this discussion are:

  • How to automate savings and investments
  • 3 areas of risk
  • Importance of compounding


Is my Fed hawkish?


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The Days Ahead: Consumer confidence for September

Stocks reached an all time high this week. It’s been pretty much a straight line all year. The biggest correction was less than 2% in August. We've not had a correction of more than 10% in over five years. That's not great but all market cycles are different and any “exuberance” is taking place away from public markets...in our view it's in the VC, privates and Bitcoin…see below. The narrative was the Fed, renewed healthcare legislation and some stocks hit for missing earnings. We’ll discount the latter because it’s unusual for companies to report an end-August Q3 number.


1. The Fed, no change though you lie under:
The Fed held rates but left open the possibility of a December increase. The full release is here. They don't feel the hurricanes will leave much impact on the economy, which sounds right. Rebuilding and new auto purchases are likely to be balanced by wage loss, some price increases and supply disruption. They announced the start of the balance sheet “normalization” which means smaller but we’re not sure how much smaller. The way they'll do it was announced back in June but is basically:

i) Treasuries: stop reinvesting maturities at a rate of $6bn a month up to a cap of $30bn in 12 months

ii) Mortgages: stop reinvesting maturities at a rate of $4bn a month up to a cap of $20bn in 12 months

Given they hold $2.4 trillion of Treasuries and $1.8 trillion of mortgages, this could take a while. But we think it’s absolutely the right approach and the market regards it as a “nothing to see” event. The 10-Year Treasury rose from its 2017 low of two weeks ago to 2.25%, which was where it was in August. 

Here’s the Fed projections at the time they started the rate hikes in December 2015 and now. Back then, they expected rates to be 3.5% going into 2018. Now it's 2.1%. We realize estimating inflation and growth has become trickier lately. Productivity growth has stumbled and the core PCE inflation seems to have a series of one-offs depressing it but it has only broken the 2% target in 16 of the last 120 months and 13 of those were prior to 2009. 

The Fed’s inflation debate is around two camps.

One, those who believe there are temporary forces at work and that inflation will stabilize at around 2%. The Cleveland Fed Governor even said that it’s going to be 2% because that’s been the most accurate forecast for the last 30 years, which to us smacks of some very lazy thinking.

Two, that post-crisis trend inflation has fallen permanently and deflation is a constant threat. Governor Lael Brainard takes the lead on this view.

We'd side with the latter because wages (here, Europe and Japan) have absolutely failed to move and without wage inflation, there is slime chance of broad inflation. Also, we’re always paranoid about deflation, which tends to kill an economy dead in its tracks.

It could be taken that the Fed is overtly predicting more volatility to come with rates increasing 200bps in two years. But back in 2015 it was 275bps and it just didn't happen. You’ll read plenty of forecasts about increasing volatility (if you're a hedge fund or running a bank FICC desk, you dream nightly of higher volatility) but we believe it will be slow, gradual and ultimately all a bit disappointing on the rate front.


2. Bitcoin everywhere:
We don't pretend to be experts on Bitcoin but we think we know a thing or two about bubbles. There’s lots of information on it. Some of the better sites we've seen are with the BIS here,  here and here.  Here’s an interactive map showing the number of active nodes (nodes are people running Bitcoin software and actively trading) exploding and here’s some instructions on how to trade it you're in North Korea or New York. Apparently, the computing power needed to run Bitcoin takes up 90% of your computer’s processing power so you may want to get a burner phone if you want to explore (definitely not investment advice).

We lived through 1987, the Asian Crisis, the tech crash and of course 2008 so looked back to the Nasdaq boom in the late 1990s and overlaid it with the price of Bitcoin today. We know Bitcoin is just one of the group of crypto-currencies, but we’ll use Bitcoin for now. But anyway, guess what? They match.

So, if you’d bought Bitcoin two years ago, you’d have made 20 times your money and three times since May. At its heart, Bitcoin is a ledger system allowing transactions across multiple users. Its benefits include encryption, anonymity, fixed unit amounts and peer-to-peer management. Which suits well if you want to transact stuff anonymously and cheaply or you believe that having a fixed supply of a currency prevents devaluation (which is why gold bugs like it).

But…but, it's still a bit all wild west out there and we’re seeing multiple copycats and free riders. Here’s one for dentists using Bitcoin called, wait for it, Dentacoin, which, I don’t know, sounds like a solution in search of a problem. Anyway, we put together a mini checklist of what our concerns are here. But if you get approached with a deal that has a spanking new team with a lot of dodgy Phds, a spiffy big font website, a whitepaper attached, security system that you can't quite understand (what is “offline multisig wallet”??) and pitched by a B-list celeb (not this one, he’s A-list), just, you know, don't. The SEC says it best here.


3. How’s International doing?
Depends where you're sitting. If you're in the U.S., then very nicely, thank you. We looked at the returns of the S&P 500, Japanese and Eurozone markets for a U.S. investor and a local investor. Here’s the chart:

The top three lines are for the U.S. investor, with Europe up 20% and the U.S. and Japan tied at around 12%. But for European investors stocks are up around 6% and for their S&P 500 investment, it's negative.

Most of the story this year has been the decline in the dollar, down some 11% this year. Some stock markets are highly dependent on the exchange rate. A strong Yen has not typically done well for Japanese stocks and vice versa. With some markets, a strong currency has just done just fine for stocks. The Aussie dollar strengthened in 2001 and again in 2009 and stocks were up 143% and 46% (ignoring the 2008 crash). It has to do with exporting of U.S. dollar priced commodities and importing secondary goods (we’re over simplifying, we know).

In the U.S., it's a bit of a mix because a weaker dollar flatters many S&P 500 companies that collectively derive 37% of their sales from overseas. For some companies like PM, WLTW, and AVGO it’s well over 90% and they're on a tear this year. It’s one reason why we're quite optimistic about the upcoming earnings season, which we don't think has adequately compensated for the 12% depreciation against the Euro the last three months.


Bottom Line: Stocks remain within a whisper of their all time high. Rates have taken the Fed in their stride and essentially round tripped from the early September low. Watch for politics because if there’s a deal on healthcare, tax reform may come soon after.

Please check out our 118 Years of the Dow chart  

Subscribe here for our investment updates
 

Other:

Google and Amazon new age fascists” says Peter Thiel

Corgis coming down stairs

Vermont’s Montpelier just got free jerseys from Montpellier

 

--Christian Thwaites, Brouwer & Janachowski, LLC

(Note I own PM personally)


 

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

Bitcoin Bubble

Bitcoin Bubble

The Bitcoin bubble is well and truly underway. It reminds us of the Nasdaq in the late 1990s so we overlaid the tech stocks then with Bitcoin now. Is Bitcoin a bubble? Well, you may want to check here. We think it is.

1. Are cypto-currencies easy to understand?

2. Is the lack of regulation a concern? 

3. What recourse do you have if they're sold fraudulently? 

4. Bitcoins will put banks out of business. 

5. The high level of ICOs (Initial Currency Offerings) is not a problem. 

6. Do Bitcoins have an intrinsic value? 

7. Is the market in Bitcoins driven by FOMO (Fear of Missing Out) or is there a fundamental economic reality behind them?

8. Do your neighbors talk about Bitcoin? 

 

nasdaq bitcoin_COMP-USA.jpg

Subscribe here for our investment updates

 

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Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

Back to '99


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The Days Ahead: Fed meeting and presser.

Slower retail sales, slow growth in job openings and better claims. Something for the bulls and bears. Oh, and Apple announced new stuff which left the stock price unchanged. Nestle bought Blue Bottle coffee, a local company for us. The price values the company at $700m against a total of only $115m in raised capital over five years. Google, Jared Leto and Bono were all investors. It’s a sign that big companies are desperate for new and innovative ideas and will get growth where they can find it. Full disclosure, I own NSRGY. But back to work.


1. Well that took long enough.

We passed a rather dismal milestone last week. The Census Bureau announced that median household income returned to the same level it was in 1999. That's right. It took 17 years to make it back to where we were. Here's the chart:

Median household income is $59,039 and up from $58,665 in 1999, a laughable compound growth rate of 0.03%. That's the median so it would have been pulled up a bit by inequality at the top end. The 95th percentile out earned the median by 3.8x against 2.7x 50 years ago. Other fun facts show that male head of households earned 40% more than female head of households. And the poverty rate fell to 12.7% or 41m Americans.

What the household income doesn't tell us is how the earners got there. So, yes, $59,000 is a new high but did it take more earners working longer hours to get there? Our guess is yes, given the green line of real hourly earnings growth has pretty much stalled out for the last 10 years. And, while we’re at it, if prices go down 5% and your earnings stay the same, the above Census Bureau methodology, says “Congratulations, your real income just rose 5%.” It did. But did it? We talked about this a few weeks ago here. And while, we’re still at it, they don't adjust for size of household. Same income with three people at home isn’t the same as with four. Now, we admit, that cuts both ways and our guess is that the average household size has dropped.

Why are we going on about this? Because consumers are stretched and real incomes are barely moving, despite known labor shortages. It's tough to see the economy moving to a 3% growth rate with household income at these levels. It’s just possible that a tax cut may help but as most of the talk is about corporate, not personal tax rates, it seems unlikely.


2. Low inflation again.

The CPI came out and, while up on the monthly rate, is still only 1.9%, and for the core (so less energy and food) up 1.7%. So, no worries there. Here’s the chart:

Gasoline costs skyrocketed, up 10%. That was mostly due to Havey but as you can see, it’s a wildly volatile price point, which is why the Fed ignores it for monetary policy. Still, it’s 7% of the CPI weighting so people will feel it. Housing costs (OER) were also up 3.3% and they're the biggest slice of the CPI by far at 24%.

Finally, wireless costs fell by 13% YOY mainly because of Verizon’s unlimited plan. This brings us into the world of “hedonic adjustments.” Here’s the full explanation but we don't think the BLS goes far enough. So, which of these is a price increase?

1. Your wireless bill is $75 a month. You get 1GB of data. It goes to $100.
2. Your wireless bill is $75 a month. You get unlimited data. It goes to $100.

Your pocket says both but the BLS says only the first because you get so much more quality in the second. They'll go further and say it’s a price decrease, which is exactly what’s going on in that lower graph. But for us, the fact that households end up paying more for a basic good means they have less for other things. And if the adjustment is plain wrong, then inflation is over or understated. There are plenty of conspiracy theories that inflation is deliberately understated and here's one of the calmer ones.

We won't go that far except to say that inflation is on a low and steady path. We don't expect big increases and the Fed may stay its hand even beyond December if we continue to see inflation below 1.5%.


3. Cash Overflow.

An interesting article came up with Microsoft last week. Microsoft has a balance sheet of $240bn of which $133bn is in U.S. Treasuries. Some of that is non-repatriated earnings that build-up because bringing them back to the U.S. triggers a tax liability. But man, that’s a lot and makes them a bigger Treasury holder than all but 12 countries. Apple, Cisco and Google (all right, Alphabet) have another $280bn.

We looked at the market numbers and here they are:

That's the market cap of the S&P 500, around $23 trillion, and the cash percent. It climbed rapidly after the crash and seems to have plateaued at 8% of market cap. It’s around 25% of the S&P 500 equity (the bit that's left over in the balance sheet once all liabilities are paid).

So what? Well i) if the corporation tax cuts comes, that potentially frees a lot of money for shareholders or capex ii) it’s some buffer against a downturn or rising rates (although about 10 tech companies account for 25% of the cash) and iii) it provides a lot of support for Treasuries.


Bottom Line:

We expect stocks to stay well bid… again. Talk of tax cuts help and the dollar will help earnings. The Fed will probably sound dovish which will keep Treasuries in their 2.15% to 2.25% very tight range.

 

Please check out our 118 Years of the Dow chart  

Subscribe here for our investment updates

 

Other:

Tech lobbying (they're good)

Day in the life of a backpack corgi

Electric vehicles “unaffordable and unachievable

 

--Christian Thwaites, Brouwer & Janachowski, LLC

(again, I hold NSRGY)


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

 

Quick Read: Claims and Hurricanes

Expect jobless claims to jump a lot in coming weeks.

That blip on the right is only one week of Harvey. Katrina pushed up claims by 100,000 back in 2005 and Houston and Florida have twenty times the population of New Orleans. 

Claimsbasic storms_SP50-USA.jpg

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Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

Hitting the Ceiling

The Days Ahead: More fallout from Irma and Harvey

Markets were keyed into the Florida hurricane. We already saw a big jump in jobless claims last week from 236,000 to 298,000. That’s only one week of Harvey. Katrina pushed up claims by 100,000 back in 2005 and Houston and Florida have twenty times the population of New Orleans. It will be difficult, in the next few months, to get a read on the data and the underlying trends.

Elsewhere, the ECB left rates unchanged. They're on a different track from the Fed. They are still buying bonds at the rate of Euro 60bn a month but beginning to run out of eligible bonds. It’s likely they'll follow the path of i) tapering ii) reducing the balance sheet and then iii) raise rates. The Fed went i) taper ii) raise rates and is about to iii) reduce the balance sheet. President Draghi also mentioned some concerns in commercial real estate. Which we’re watching.

And the Fed lost its Vice Chair: Stanley Fischer This is a very big deal. For a start, it means there will be three board members and four vacancies, which is probably a record. It also means the Regional Presidents are now in the majority of the FOMC and the size of the FOMC, which should be 12, is now eight. We still have no read on the next Fed Chair. We’re hopeful Yellen will re-up or at least stay on as a non-Chair. But precedent is against us.

1.     Growth and Value: It should be easy. Growth stocks have a record of, er, growth, high multiples and increasing sales. Value stocks are cheap relative to their book value, generate lots of cash and sell below market levels. So, a Value Index tilts towards Financials, Energy and some Health Care (the basic stuff like supplies and long term treatments). Those three sectors alone account for over 55% of the Value index. They should be attractive as core long-term holdings and a solid investment. But not so:

Blog 1 9-8-2017growthvalue2_.jpg

Over three years, Growth outperformed Value by 22%. Is this end point dependent? Well, for five years Growth was better by 25%, 10 years by 60% and by even larger amounts over 20 and 30 years. The time when Value really paid off was in the 2000s after the tech bust. In the five years to 2007, Value outperformed by 20%.

What’s going on? One problem is financials. They may trade at a discount to book value but determining the actual value of bank assets, as opposed to the published value, can be tricky. Are all those loans good? Should we discount the Deferred Tax Asset? After all tax rates may fall and is that really an “asset”? It certainly wouldn't be if you applied for a mortgage. Are those lease assets (say, putting your bank branches into a lease agreement), really worth what they say they are? Will regulatory change help or hurt earnings? If these are all uncertain, then the stocks may trade at a permanent discount to book value, and then you have a classic “Value Trap.”

On the other side, in a period of low growth, Growth stocks sell at a premium. This is especially true when many growth stocks are effectively monopoly platforms and there simply aren’t that many growth stories around. That seems to be the case today.

Should we give up on Value? No. We like companies that throw off a lot of free cash flow. This avoids i) highly leveraged companies (debt tends to do a number on cash flow) and ii) manipulated GAAP accounting that allows deferred sales or high warranty costs. Berkshire Hathaway is a great example of avoiding both. And it has the added benefit of some strong businesses that are valued at cost, sometimes from years ago, and with goodwill mostly written off. We also like companies with strong balance sheets and cash generation. But, in general, we’re not big fans of “pure value” and can't really see a catalyst for change (h/t John Authers.)

2.     Debt Ceiling (again): We posted this chart earlier in the week. But things changed. It shows the spread between 1-Month and 3-Month Treasury bills. It should be a spread of around 6bps but look at this:

Blog 2 9-8-17 3m 1m spread_TRYUS3M-FDS.jpg

For a while in the week, 1-Month bills yielded more than 3-Month bills and briefly yielded more than 2-Year Notes. The explanation is easy. The expiration of the debt ceiling fell smack in the middle of when the 1-Month bills matured. So, why take the risk? Investors went for longer dated maturities on the basis that those would be less likely to delay principal payments.

We know now that the debt ceiling problem has been well and truly kicked down the road until December. Which is good. Except that coincides with the FOMC meeting on December 12th, which is the probable time of a rate increase. It’s never good to see money markets twitchy. They’re the backbone of the payments system. So, last week was both a reprieve and a heightening of the problem.

3.     The Lucky Country: Meanwhile Australia has just recorded its 26th straight year without a recession. Australia is around 7% of the MSCI-EAFE index, the leading large cap tracker of non-U.S. stocks, and 20% of Pacific stock markets. One tends to think of Australia as a resource economy. They're about 5% of GDP. Exports are around 18% of GDP and GDP per capita around the same as the U.S. Here's the chart:

blog 3 9-8-17 Australia GDP pop_.jpg

The top part shows GDP growing consistently with only the occasional quarter of negative growth (it generally takes two consecutive quarters to record a recession). Even 2008-2009 barely dented growth. The line shows declining unemployment.

How do they do it? Well, part of it is immigration. The lower chart shows growth of the labor force overlaid with that of the U.S. As is clear, the number of workers entering the workforce has far exceeded that of the U.S. Average growth is 1.7% compared to the U.S. of 0.8%. At that rate the population doubles in 40 years, compared to the U.S. of 90 years. So, it would seem if you want to keep growth up, you need healthy population growth. Either by birth rate or immigration. Mmmm.

There are other factors contributing to the Australia success story. Low interest rates, a strong housing market and household debt growth. Sure, a drop in mining and metals will hurt but that seems not to be in the cards. The biggest industry in the stock market is financials, which tend to be solid GDP trackers and benefit from industrial and housing growth. There are other reasons we like Asia as an investment opportunity. But for now Australia’s winning streak looks set to continue.

Bottom Line: Stocks have gone sideways for most of the quarter. The 10-Year Treasury yield, on the other hand, has dropped from 2.4% to 2.06%, for a return of more than 3%. We expect stocks to stay well bid. If nothing else, the weak dollar (down 12% this year) and foreign growth path will help large companies.

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 Other:

Bad things at the Fed

Regulators and ICOs.

Moody’s on South Korea

Blankfein on Cohn: “He’s not that bright but should be OK for the Fed”

--Christian Thwaites, Brouwer & Janachowski, LLC

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

Debt ceiling fears just got real

When do one month bills yield more than three month bills? When your'e afraid you may not get paid back. 

3m 1m spread_TRYUS3M-FDS.jpg

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Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

Oh Brother, Where Art Thou?

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The Days Ahead: Congress back at work.

A big week for numbers. GDP was revised up for Q2 but that’s old news by now and we all expected a rebound after Q1. That pattern of a slow start to the year, a good two quarters and then slack towards the end of the year has run for years now. The commentary practically writes itself. The gap between soft data (“I’m feeling confident”) and hard data (“I’m doing stuff”) seems to continue. On the hard side, commercial construction was down 6% from May’s high and manufacturing construction was down 15% YOY. These two components are about a third of non-residential construction. Total construction of both residential and everything else is a $1.2 trillion industry or 6% of GDP. So, pretty important. Pending home sales fell too. On the soft side, consumer confidence improved and the ISM Manufacturing survey bounced.

The relentless news from Houston hung over markets. We discussed it earlier in the week and don't have a lot to add. Gas prices in Texas are, predictably, at about $3.00 compared to an average of $2.25 for the last three months. The hit to spending will follow. We expect weekly jobless claims to spike. Right now they're running at 236,000. But in the weeks after Katrina in 2005, claims jumped 33% to 424,000 and after Sandy in 2012, by 20% to 446,000. Even that will understate the economic loss, as only 1.5% of unemployed are eligible for employment insurance. And if they're not eligible they won't file.  

In all this, bonds rallied. The 10-Year Treasury at one point yielded 2.09%, its lowest level this year.


1. Personal Income
We’ve been banging on about weak wage and income numbers for a while. The Fed, of course, looks at the unemployment rate and core inflation, as defined by PCE (Personal Consumption Expenditure). The target is 2%, which they've missed for years, and came in at 1.4% for July… its lowest all year.

The reason we harp on this is that we simply don't see any meaningful increases in personal income. The problem is that income includes earned income (so wages and employer benefits) and unearned income (so rental, dividend, interest and inventory valuations). So, the headline number can look good but we think there is a world of difference between wage growth and whether a portfolio kicks off more income. In the jargon, the marginal propensity to spend is likely higher for wage earners than for investors and landlords.

As for income increases, which would you prefer?

A. Your employer gives you a pay increase of 2%
B. Your employer does not change your pay but inflation falls 2%
C. Your employer increases your hours by 2%

They all have the same real effect on your pocket book but our guess is that you’ll only be really happy with #1.

Anyway, here's private sector wages, adjusted for inflation, with annual growth of wages at 2.5% (nominal!). The wage numbers look good from 2010 to 2013 but that coincided with very low inflation. Nominal changes were minimal. It’s the #2 example.

It also shows the annual change in savings. The number is pretty volatile and was $510bn in July, down from nearly $800bn a year ago. Outlays, or spending, can of course get a boost from people running down savings and, if they feel confident about the future, then that is exactly what they'll do.

We don't think this a pretty picture. Slow private sector wage growth at a time of supposedly near inflationary levels of unemployment (if you're a NAIRU, Philips curve fan) seems, ya know, uninspiring.


2. Oh brother, where art thou?
The new job numbers came in and disappointed. Non-farm payrolls were 156,000, well below expectations. The survey was before Harvey. August is typically a tough month. Something to do with the seasonals. The circles show August for the last five years. 2017 was no exception.

The big industry winners were tech and the losers were hospitality and leisure. That's a nice change because the latter work 26 hours a week for $402 and the former 36 hours for $1,391. But overall hourly earnings (the bottom line) increased at a low 2.5%.

Earlier in the week the core inflation numbers came out and, yep, once again, well below target.

We'll stick with our position that the Fed will probably increase rates in December because they've more or less said they would and they like to follow through. The balance-sheet reduction will be a non-event. Some parts of the credit markets will bid up mortgages but the Treasury part will diminish slowly. There is no sense of urgency with PCE at 1.4%.


3. And the winners are…
Last month saw tech and utilities vied for best performing sector. Both were up nearly 3.5%, compared to the S&P 500 of 0.3%. Here's the chart for the last two years:

Together the two sectors account for 28% of the S&P 500, with tech the biggest sector by far at 25%. It’s really the story of growth at high price (the tech sector sells at a 30% premium to the rest of the market) and interest rates, which utilities broadly track. For us, it's a vindication of a mix of seemingly pedestrian investments with more exciting themes. Note the above chart shows utilities outperforming the S&P 500 in the last two years. It’s the same for the last 10, 15 and 20 years.

We've also mentioned that 2017 has not been the year for Small Caps, after a large outperformance in 2016. Part of this is tied to the promised tax changes and overseas economies. The first hasn't happened. The second has. The S&P 500 has a tax rate of 17% compared to the small cap S&P 600 of 28%. So any tax changes will benefit small companies much more than large. On the other side, S&P 500 companies have around 30% of their sales from overseas while small companies have around 18%, and even that is weighted by a small sample. So if either of these themes turn, we expect small companies to perform well. 


Bottom Line:
“It seems as if there is no president in the U.S.,” Risto Murto, chief executive officer of Varma Mutual Pension Insurance Co., said in an interview in Helsinki on Wednesday. “If I look at what is the moral and practical power, there is no longer a traditional president.”

That's a quote from someone who runs a Finnish $50bn pension fund. They're running down their U.S. stock position. We don't quite agree but it does show that U.S. capital markets are in an extended holding pattern. Something might break in the next month or two, probably to the upside.

 

Please check out our 118 Years of the Dow chart  

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Other:

Did astronauts go on strike?

Oh look, Google shuts down a critic of monopoly power.

Hummingbirds complain

 

--Christian Thwaites, Brouwer & Janachowski, LLC


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

The market does not have much to go on….be thankful.

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The Days Ahead:
Jobs report. Amazon will close Whole Foods on Monday.

It was a slow week for markets. No big economic news, reporting season over and no Fed speak. Most eyes were on the Jackson Hole speeches from Chairs Yellen and Draghi. Would they discuss monetary policy? They didn't. But they did move markets more by omitting any major policy changes. The Euro rallied hard and 10-Year Treasuries closed at their lowest level in over a month.

Yellen’s speech was interesting on another front. She compared the financial regulatory framework from pre-crisis to now. It's better and should make the system more secure. But the Fed still lacks many macroprudential tools that other financial regulators across the world use. These allow central banks to adjust things like loan-to-value, leverage and debt-to-income ratios on the fly and depending on the cycle. Meanwhile, there are moves afoot to pull back on many parts of the Dodd-Frank regulations. Call us worriers. But the mix of not enough tools and a deregulating financial services sector does not fill us with confidence.

Meanwhile, elsewhere:


1. Spanish Dancer:
We've talked a lot about the recovery in Europe. For years, investors had every reason to avoid the place. Europe suffered terribly in the economic crisis but, 10 years later, austerity policies and slow reforms are showing up in the numbers. Eurozone growth is now ahead of the U.S. German GDP is on track for around 2.3% growth this year. QE has certainly helped and the Euro’s strength has not yet hurt the German export machine.

Earlier in the week, we saw Q2 Spanish GDP. It looks like this:

Spain, along with Greece and the other painfully named PIIGS economies, lived through a disastrous real estate bubble compounded by a failure to address bank failures and bad loans. The shaded area shows the almost six-year recession where GDP fell over 10% and unemployment peaked at 27%. In the U.S., we had four quarters of decline and the worst year was a -2.8% decline in 2009. The latest numbers saw domestic consumption rise 2.2%. For us, this is a key number as ultimately it shows confidence returning. Spanish stocks are up 11% this year and up 25% for an unhedged U.S. investor. It’s a small market. You could buy the entire market for one Apple and a Facebook. It’s also heavily weighted to banks. But it's moving in the right direction and carries a yield of 3.7%. Patience should work.

In the U.K. meanwhile, the Brexit fallout is growing some teeth. Last week saw lower household spending, several profit warnings and higher import prices from weak sterling.


2. Debt Ceiling:
It’s a week closer and while we had some assuring words from Senate Majority Leader Mitch McConnell, other government branches seemed positively gleeful at the prospect of a shutdown. So far, the T-bill market has not reacted. But it’s worth recalling what happened in 2013, when there was a shutdown over Obamacare and 800,000 government employees furloughed. Here's how stocks and bonds reacted.

In the weeks up to the shutdown, the S&P 500 was down 4% and then recovered 9% in four weeks. Bonds both reacted and recovered earlier. In both cases, it was “risk on” once the impasse was over.

But that was then. This time, we’d argue that markets are taking one day at time. The news of tax cuts weighed more than the debt ceiling and Treasuries rallied on Friday after Janet Yellen’s speech. At this point, it seems nigh impossible to reconcile the House proposal to cut $200bn from Medicare with the Senate’s desire not to see any change in the deficit. Congress has only 12 working days to pass something when they return on September 5th. After that, the House and Senate swap weeks before they reconvene together on October 23rd. Expect a few weeks of wide swings in risk markets.


3. Emerging Markets check in:
It's been a few weeks since we discussed Emerging Markets equities. They have been this year’s clear winner, up 25% compared to S&P 500 of 9.3%.

Nothing big has happened in the last week. The Emerging Markets (EM) story is underpinned by steady growth in Japan (Asia weighs heavily in the index and exports to Japan), a slow rate increase in the U.S., which means EM central banks can keep rates low, and robust export growth. The wrinkle, of course, is trade negotiations - particularly NAFTA and Mexico. But on balance, we think EMs will stay well bid.


Bottom Line:
Stock and bond markets remain range bound. The 10-Year Treasury is only 6bps away from its 50-day moving average. In January it was more like 25bps. It all makes sense. There is little to go on and the market judges most of the politics a sideshow.

 

Please check out our 118 Years of the Dow chart  

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Other:

Global warming and rodents

National Parks Service is 101

Things left behind at Dublin airport

Harvest moon

 

--Christian Thwaites, Brouwer & Janachowski, LLC


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

 

You're fired... and so are you, and you, etc.


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The Days Ahead: Jackson Hole symposium.  

Who could have imagined that last week, when we wered reminded of the specter of thermo-nuclear strikes in a casual throw­­away comment, that markets stayed strong? This week it was racism, violence and top CEOs abandoning the administration. Finally, the markets broke stride. The S&P 500 was down 2% and NASDAQ down 3%. Both bounced from their lows. Bonds did what they're meant to do. 10-Year Treasuries rallied from 2.28% to 2.16% or up about 1.5% in price.

What we saw in stocks up until a month ago was strikingly low single stock correlation. Basically, all stocks moved independently of each other. This is usually an example of investors running into stocks for multiple, different reasons and ignoring the overall direction of the market. This makes sense in an ETF world. A stock like Amazon can appear in momentum, retail, Internet, large cap, growth, market cap/debt and numerous other ETF factors. Lots of buyers for lots of reasons but not because they just “like” the market.

This changed last week. My colleague, Nick Prieto, ran some numbers on the top 20 stocks. Last month, for example, Facebook moved totally independently of the top 20 stocks (or -0.04 correlation for the CFAs out there). This month 20% of Facebook’s move is explained by other stocks. For the top-20 basket as a whole, correlations rose 20%. That's a big move in one month.

It appears that correlations moved up as investors took an overall view of the market and didn't like what they saw. The good news is that there is very little mileage in reacting to political events like last week. It's true that the hopes for healthcare, taxes or infrastructure faded fast. But the market gave up on those months ago. What we see now is economic numbers come stumbling in with a sort of “good enough for me” feel.

As far as market corrections go, last week barely registered. We've been used to low volatility in equities, bonds, economic numbers, rates…in just about everything this year. So, it felt bad. But it really wasn't a tough correction and we don't think it’s a canary, swallow, first leaf or anything else presaging a downturn.


1. What's up with Small Caps?
Large caps have made the running this year. The Dow is up 10%, the S&P 500 up 8.6% but all small caps (Russell 2000) are flat and quality small caps (S&P 600) down 2%. Partly it's because they had a blistering 2016, up around 20% and outperforming large caps by 11%.

But some is exposure to the dollar and overseas markets. The S&P 500 gets around 37% of its $10 trillion in sales from overseas. With small caps, it's around 20% on $740bn. This group benefits most from tax cuts and the least from a weak dollar. Throw in some disappointing consumer expenditure and the heavy weighting in financials (27% vs the S&P 500 of 15%) and low weighting in tech (13% vs the S&P 500 of 23%) and the underperformance, while disappointing, makes sense. So we looked at how small caps look against large caps:

Busy chart, sorry. But this shows the S&P 600 (small cap) PE relative to large caps. It's now about 90% of the S&P 500 PE and has been as high as 115% a few years ago. That seems cheap. There are other reasons to keep the exposure. Debt is generally lower and cash to market cap higher. So the opportunities for dividends and share buybacks seems better.


2. Over in Europe:
The ECB published the minutes from the July meeting. The strength of the Euro was high on its agenda given the 12% appreciation this year. We found lots to like in the minutes. Inflation is still low. So the QE will continue. Labor market slack was still considerable. So, again, on with QE. The concern with the Euro (“concerns were expressed about the risk of the exchange rate overshooting in the future”) means they want to keep economic prospects favorable. Which is good because we’re on a run. Here's the latest GDP numbers.

For most of the last 10 years, U.S. growth (the green line) has comfortably exceeded the EU (blue columns). But the rate of change in Europe has accelerated and is well above its 20-year average. Also, remember the basic math that a change from 1% to 2% growth is a 100% improvement. And that's what we’re seeing in Europe.


3. How’s the U.S. doing?
Quite well, thank you. Retail sales had a good month, up 0.6% on the month and with June’s numbers revised up. There are many shifts going on in retail. Here's one chart we put out earlier in the week.

It shows retail sales in stores, declining at an average rate of 6%, compared to sales in non-stores. Those “non-store” sales are everything from door-to-door sales to vending machines but are clearly mostly e-commerce. They're up 8%-10% every year for the last seven years. Industrial production was also well up on a year ago and has maintained a 2% growth rate for four months. The Fed minutes showed some splits between the “inflation too low” and “don't overshoot on inflation” camps. Given the Fed’s truly awful inflation prediction record, we think they’ll just start adjusting the balance sheet in the fall and hold off a rate hike until December.


Bottom Line:
We're surprised at how sanguine markets remain. I’m not sure how many ways we can define “dysfunctional.” We'll leave it to Washington to show us. Meanwhile, it's good to see bonds firm while risk assets falter.

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Other:

Carl Sagan: time traveler

Hilarious endorsement of Cohn for Fed job

Amazon borrows cheaper than most countries

Apparently there is a solar eclipse coming.

 

--Christian Thwaites, Brouwer & Janachowski, LLC


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice. We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security. The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended. Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data. Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

Changing face of retail

Brutal decline in store retail sales....

another YOY decline of 5%. Meanwhile, non-store retailers are powering ahead at 11% growth. Retail (ex autos) still accounts for nearly one job in 11 in America.

Christian Thwaites

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted. 

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Aww... Snap

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The Days Ahead:
China retail sales. German GDP Fed minutes.

Snap. It was always going to be the most over-hyped stock of the year and it lived up to its reputation. Before we pile in, this is a $16bn company that IPO’d at $17, went to $24 and traded at $11 late Friday. It’s essentially a venture stage company facing aggressive price competition from larger companies, high expenses and disenfranchised shareholders. In its first full quarter, it lost $192m. It’s lost $2.2bn this year. Cash is about 85% of its tangible assets. It will run out of cash some time later this year unless it can increase revenues by 100% every quarter. Which will be tough because they're also lowering ad prices. It spent about $3.60 per user to generate $1.05 per user (h/t Andy Swan). That's the sort of costs you’d expect for your first 100,000 users. But at 173m, it's ridiculous. Yeah, and I’m looking at you Blue Apron, as well. And Twitter. And GoPro.

Anyway, we’re old fashioned and like companies with real balance sheets, experienced management, cash generative operations, equity. Ya, know. Real business. So Snap’s not really our thing. We wouldn't really mind about this sort of company but here’s the problem. For many millennials, this type of IPO, valuation, business model and disdain for shareholders are devastating. If the Snaps of the world shape their investment experience, they may be put off investing and the markets. For good.

The gap between the political headlines and financial reactions continues. The casual talk about hurling missiles around of course brings to mind Cuba in 1962. Back then discussions were tightly controlled, measured…and information kept at the highest security levels. The market had no details of the brinkmanship. Still, stocks fell 5% but recovered very quickly. History suggests that’s very normal. Our 118-year history of the Dow Chart (do check it out) shows that political events tend to have very little effect on markets. It’s earnings and inflation that push stocks.


1. Running out at NASDAQ:
The largest components of the NASDAQ index are the big five tech companies, which are up between 15% and 30% this year. The entire market is around 3,100 companies and market capitalization ranges from Apple at $800bn to Top Ships at $0.6m. (You can check out Top Ships here where the price fell 99.9999%. No, it’s not worth a punt. But, you know, not investment advice.)

The NASDAQ trades at half the yield of the S&P 500 and is 50% more expensive. The ROE for the S&P 500 is 14% and has dropped below that number only once in the last 20 years. NASDAQ’s ROE is 12% and it's never been higher than 14% in the last 20 years. It has 23% in tech, about the same as the S&P 500. But many investors use the QQQ ETF to track the NASDAQ, which is a mash-up of tech, large companies and growth. It’s over 50% in tech and explains this:

NASDAQ has been on a vertical climb for the last 18 months. Normally those two “moving average” (MA) lines are well below the blue line. In this case, we changed the scale for the MAs because they're sitting right on top of the price line. We've had no meaningful correction since the 7% decline in June 2016. Last week, we saw a 3% correction despite North Korea (stop me if you heard it) and some high profile poor results.

We get it that investors like growth in a low growth economy. And that low rates mean we can value stocks at a higher multiple. And company profitability has moved inexorably towards capital and away from labor. And that VIX is almost meaningless below 15. But markets need corrections to flush out the quick money and we would like to see one.


2. Inflation and Bonds:
Inflation is a killer for bonds. That's when the value of your fixed coupon erodes and current rates cannot keep pace with price changes. That's not happening now. In fact, the Fed has warned repeatedly that inflation is running too low, and some 50bps below the target rate. On Friday, we had the CPI report, which along with the employment report, is important to both the Fed and markets. Here's the chart:

The core number is bumping along at 1.7%. It hasn’t decisively broken above 2% since 2008. The weak components are lodging (down 3.6%), airfares (-6.8%), used cars (-4.1%) and wireless costs (-13%, that black line in the lower chart). These alone count for around 10% of the index. The big one, housing, is up around 3.2%.

On the wages side, real average weekly wages are up only 0.8%. We think that employers are still very reluctant to increase wages. They may reduce hours for the same pay or increase benefits both of which will show up as wage increases. But that’s not the same as putting extra discretionary spending in employees’ hands. We're in the minority in this view. Many people, including the Fed, think wage inflation is just around the corner.

Put all these together and we see core inflation running low at least until the end of the year. In our view, it won't force the Fed’s hand and we expect no rate increase until December. Meanwhile, they will tighten moderately by working on the balance sheet.

U.S. Treasuries rallied and are now at the bottom of the 2.2% to 2.4% range that we've seen since March. We think the debt-ceiling problem is real. We've already seen T-Bills maturing just this side of the debt ceiling deadline of early October rally more than those maturing afterwards.


Bottom Line:
There is no conviction in equity or fixed income markets right now. Even the South Korean Kospi index was off around 6% and it's still up 15% this year. We'll recreate a chart put out by the folk at Informa Global market, which shows the ratio of the Dow Jones Transportation stocks (i.e. cyclical growth) and utilities (defensive) overlaid with 10-Year Treasuries. If the line slopes down, we’re in a more defensive market, which seems to be the case right now.

Please check out our 118 Years of the Dow chart  

Subscribe here for our investment updates


Other:

Are index funds evil?

$300 for a yogurt maker.

High enthusiasm for dog surfers

 

--Christian Thwaites, Brouwer & Janachowski, LLC 


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

Flight of the Euro

The Days Ahead:
Earnings winding down. Quiet with some inflation numbers.

The biggest news last week was the Euro. It climbed again and is now up 13% against the dollar this year. Some of that is because investors expected rate increases in the U.S. to be quicker than they do now. All the infrastructure and tax cuts look pretty distant at this point. And some is because the Euro is a favored reserve currency and will almost always catch a bid, if only because central banks and sovereign funds do not want to overweight the dollar.

Other than that, it was another week of not-great economic numbers (ISM down, Loan Officers Survey and personal income growth weak), but good reporting from S&P 500 companies. Earnings are up 10%, much better than the 6% expected at the beginning of Q2. Revenues are up 5%, with only Telecom Services, in the midst of a price war, down. And the political front? Well, only 44 companies mentioned the President in their earnings calls, compared to 181 in January.


1. Jobs Numbers:
Came in at 209,000 on Friday. You can take this two ways.

  1. Yay, strong results from participation rate at 62.9% (vs. 62.8% prior) and the unemployment rate at 4.3% (unchanged). Revisions from the last two months were up. It’s quite typical for the headline number to change up to 30,000 in either direction in later months but we tend to forget that.
     
  2. Really? Average hourly earnings were unchanged at 2.5%. Over half the jobs were in food and health services and temporary work and all of those work 25 to 33 hours, compared to goods producing jobs at 41 hours. Only 35% of workers are full-time salaried. More than half are paid hourly. And the level of hourly work was unchanged.

The Amazon effect is showing too. Courier and messenger jobs (the guys who deliver the boxes) increased 24,000 in the last year. Retail service jobs (the guys who used to sell the stuff in those boxes) fell 40,000 (h/t John Authers at the FT).

Here it all is.

Let me know if you can see a recent trend. Anyway, the jobs recovery continues to be very uneven, in lower paid and temporary positions, with a lot of insecurity. And we’d add that there is not the remotest chance of wage pressure, and therefore cost-driven inflation around. The Fed won't quite own to this, except for James Bullard at St Louis and Neel Kashkari, but they're in the minority.  Meanwhile, even the Fed has given up trying to understand the labor market and on Friday discontinued the Labor Markets Conditions Index.


2. Let’s stop talking about the Dow:
Apple is the biggest stock in the S&P 500 at a 3.8% weighting and worth $805bn. It’s 25% bigger than the next company. Last week’s results, (basically more Ipad shipments) helped the stock climb 7%, which alone would increase the S&P 500 by 0.2%. Good stuff, and it's probably headed to be the word’s first $1 trillion dollar company until Aramco arrives next year.

Over at the Dow, which crossed another 1,000 threshold last week, it’s still the most valuable company. But because of the weird way the Dow is calculated (basically all the stock prices added up and divided by 0.146), it weights high priced stocks more than valuable stocks. So Apple is the eighth largest company in the Dow (with Goldman and Boeing the top two), even though it's 50% bigger than all the companies ahead of it.

Anyway, as one who remembers when the Dow hit 1,000 for the third time in 1982 (it had done it in 1972...ye gods the 70s were a bad time) and 2,000 in 1987, it is worth remembering that at current levels, it only takes a 4% move to hit another “thousand” mark. The Dow is a horrible index but it’s the only one we have going back to the 19th century. Meanwhile, Apple is a reasonable bellwether stock and it seems to pay off if you can buy below 12 times earnings.


3. S&P Announcement:
Perhaps the biggest news last week for investors was that S&P will no longer allow companies with multiple share classes to be part of the S&P 500. Companies already in, like Facebook, Alphabet, Viacom, UPS and about 20 others, are grandfathered. This is designed to keep Snap out, whose price has halved in the last four months. The announcement is a big deal.

 

  1. It means new IPOs will have to think carefully about what control they're willing to give up. If they're not in the index, they will lose about 35% of all potential shareholders. That's a good thing given what companies like Twitter and GoPro have done to investors.
     
  2. It’s a level of good corporate governance coming, not from activist investors, but index providers. The very same who control the indices used by passive investors. So let’s check that again. The biggest change in market governance in years has come from a company that does not manage money. Not the stock exchanges, who used to do it, not the SEC and not activists working for shareholders.
     
  3. It’s a good reminder that indexes are not all the same and that the choice of index matters in investing. Some indexes will put in any company. Some will carfully pick and vet the components. S&P are one of the best and have become an active managers of indexes. And that’s a good thing.

Bottom Line:
We're at the end of the earnings season. Only companies with something to bury report in mid-August, so we’re not expecting much. Volatility is unbelievably low but corrections do not disrupt trends. The trend is good.

Please check out our 118 Years of the Dow chart  

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Other:

Jim Cramer in full rant 10 years ago (he was right though).

How Boeing drew a picture over the entire U.S.

 

--Christian Thwaites, Brouwer & Janachowski, LLC


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

Flying High

The Days Ahead:
Big earnings week in Europe and U.S. jobs.

It was an earnings week. At both ends of the economy we saw Facebook and Boeing report very strong numbers. This is worth a moment. They're up 50% and 53% so far this year. Facebook is now the fourth largest company in the S&P 500, valued at $500bn or $29m per employee. It's worth more than Amazon. Boeing is the 33rd most valuable company, employs 150,000 or 10 times more than Facebook, is worth about one quarter of Facebook and valued at about $900,000 per employee. Boeing ranks 24th in sales in the S&P 500. Facebook is barely in the top 100.

Why all these fun facts? Well, it seems as if both the growth and industrial side of the stock market story is intact. On the growth side, the big leaders (I’m not going to say it…oh, all right FAAMNG) have delivered 20% to 80% earnings growth, er….except Amazon, which has a pact with the market not to make money until it eliminates all competitors, and, all right, ignores Google’s $2.8bn fine from the EU. Anyway, plenty of growth.

Boeing stunned every analyst on the street, generating twice the amount of free cash flow than what the street was expecting. But that's not all. They plan to increase their stock buyback program, return all its free cash flow to shareholders and pre-pay pension commitments that are due over the next four years. In a world of massively underfunded pension plans, that’s a stunner. Oh, and they're cutting 6,000 jobs.

So, at the risk of oversimplifying, we’d say this is what the stock market is about in 2017. It has nothing to do with politics, tax cuts, border adjustment taxes, infrastructure, the promise of 3% growth or any other midnight tweet. It's about steady growth and efficiency from blue-chip companies and spectacular growth from “winner-take-all” tech companies. And that's more than enough.


1. Happy Birthday Mr President:
No, not that one.  Five years ago, President Draghi of the ECB delivered the most memorable Central Banker speech (wait don't change the channel). You don't have to read it (here if you do) but it said that it would do “whatever it takes to preserve the Euro”. This was at the time when you could have made a small fortune if you had a dollar for pundits lining up to curse the Euro to oblivion, that you could not have “monetary union without fiscal union”, that Europe was bound to implode. All made the mistake that Europe is very well aware of its history and that an imperfect union was worth the effort. The ECB, indeed, saved the Euro.

It was a time when Portuguese and Spanish debt was selling at 8% to 15%. Now look. All but Greece borrow at cheaper rates than the U.S. Europe is not out of the woods. Its banks are mostly undercapitalized and recent bailouts in Italy repeated the mistake of preserving debt holders at the expense of taxpayers. Corporate earnings are better but can be improved. But, confidence is turning. Last week we had a barnstormer report from the German Business Survey.

This is what stocks have returned for the year to date and compared to the U.S.

For a U.S. investor, it'sthe top line that counts. Stocks are up 17% compared to the S&P 500 of 10%.


2. Back to U.S.:
We had the Fed meeting and the first estimate of Q2 GDP. On the first, the report only differed marginally from the June report, and the June 2016 report too. Weak inflation, near term risks (read Washington), modest household and business spending. The news was that they intend to start reducing the balance sheet in September. The Fed has done a masterful job at making this as boring as possible. The unwind is coming but we don't think it will be the slightest bit disruptive.

On the GDP, we all knew that Q2 would be better than Q1, coming in at 2.6% compared to 1.2%. Personal consumption (69% of GDP) was up 1.9% but that's down on a year ago and a good chunk of it was more spending on utilities, financial services and healthcare. Not exactly discretionary purchases. Employment costs rose but so did benefit costs so really not sure how much of that is going to feed into final demand.

Anyway, we’re bang in line with the long-term average, which is a ways off the 3% growth bandied around by those who should know better.


Bottom Line:
We're halfway through earnings season and it’s a barnstormer. The blended growth is 9% and even without the energy sectors (which is up more than 300%) the numbers are impressive. The market trades at 17x earnings. Which is exactly where it was last November. So the 13% performance since then is almost entirely earnings driven.

 

Please check out our 118 Years of the Dow chart  

Subscribe here for our investment updates

 

Other:

Bear chases 200 sheep over cliff

Bloke owns a Ferrari 430 Scuderia for an hour.

Thinking of investing in crypto currencies (Bitcoin et al) ? Don't.

 

--Christian Thwaites, Brouwer & Janachowski, LLC


Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.