Print Friendly and PDF

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


Listen to the Latest Market Chat Podcast Episode:


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.

Please check out our 118 Years of the Dow chart  

Subscribe here for our investment updates

 

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. 

Subscribe here for our investment updates

Take me to Investment Blog

Take me to Attorney Briefs

Aww... Snap

Listen to our Market Chat podcast


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  

Subscribe here for our investment updates

 

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. 

Want to guess the right Ten-Year rate?

Listen to our 'Market Chat' Podcast:


The Days Ahead: Big earnings week and Fed meeting.

Volumes were quiet this week. Some of that is seasonal, some because of the communication blackout ahead of the Fed meeting next week…but above all it’s the lack of a theme. We all know i) the weakness of the hard data ii) two big central banks in Europe and Japan saying “no change” to monetary policy iii) strong bond markets and iv) still no change on the inflation front. ECB President Draghi sounded bored as he said for the umpteenth time that inflation was well below what they want.

How low are volumes? Well, the S&P 500 trades around 3bn shares a day and last week it was about 2bn. We look at SPY, which is the biggest ETF tracking the S&P 500. It has massive turnover, as much as 25% a day (yes!). It regularly accounts for 11% of all market volume, even though it's around 1% of the market cap. Right now it’s trading about half its normal volume. So the thing to remember about these markets is that it doesn't take much to knock it back 3% or more if someone wants to make a bearish trade. We haven’t seen a meaningful correction for a while but our guess is that it would little to cause a classic summer tantrum.

On the politics, we’ll leave it to more knowledgeable and seasoned commentators. We’re reminded of the old Prussian definitions of officer class. We'll leave it to you to fill in the quadrant but we suspect we’re not in the top right corner.


1. So what’s the correct 10-Year Treasury rate?
What answer do you want? We can take inflation, add a bit, and send it back for 10, 20, 50 or 70 years. That will give five very different answers. We can take the Fed Funds rate and add a normal curve steepening. That will give another dozen or so answers. We can take the yield on stocks and subtract an average ten year rate and run that back too. And so on. Even the rules based approaches (here’s the most famous one) throw up inconsistent numbers because there are two huge guesses in the formulas: the neutral interest rate and the output gap.

One proxy is the change in the Nominal GDP and the spread over 10-Year Treasuries. Here it is:

So, lots of high nominal growth in the 1970s but that was in a time of 11% inflation. Rates were thus high and well above the rate of nominal GDP growth. The average gap over nearly 60 years is 30bps suggesting the 10-Year Treasuries should be 3.8% not 2.23%. But wait, the average 30 years would mean 3.6% and over five years it should be 2.6%. But if we use high inflation periods it should be negative 4%. See the problem? (h/t David Ader at Informa)

Anyway, we’d start by stating the obvious that we’re in a slow growth world of around 4% Nominal GDP and that a spread of around 70bps puts you at 3%. But then again we’re digging out of a deep recession. So make it 120bps and we’re about right at current levels. Next time someone pundits on the “normalization” of rates, feel free to show them this and let us know.


2. Is the debt ceiling going to be a problem?
Mark your calendars because around September, the Treasury will not have further authority to issue new bonds. Treasury receipts in the last quarter were around $1,033bn or $42bn greater than this time last year. That puts them in a slightly better position to pay bondholders, especially if the momentum on receipts continues through the summer. One Treasury official admitted that they're “brushing up on options in the crazy drawer”, which includes things like writing IOUs to other government agencies (which are the biggest holders of Treasury securities). This year the debt ceiling collides with the expiry of the current budget resolution so we’ll be looking at a very cautious period for bonds.

Currently, the market seems unfazed. Here's the Ten-Year Treasuries and 3-month T-bill spread:

We would expect that line to head down more if there is a fear of any technical default. Investors would bid up short rates to compensate for a late or (heaven forbid) missed coupon on a longer-dated bond. Anyway, watch this space. In other games of chance, let’s play catch with a beaker of nitroglycerine…


3. The dollar’s getting hit:
Good for international investments, at least in the short-term and possibly good for large-cap stocks with their overseas earnings. Most of the recent move is because of renewed confidence in the euro. But it also seems to be a sign of concern for the dollar and some technical market shortages. Big move though:

Bottom Line:
A good earnings week. Some 20% of companies reported earnings up 7.2% and 77% of those have beaten revenue expectations. So the S&P 500 and NASDAQ both reached record highs. Emerging Markets are up around 22% this year and had another good week. To a euro investor, they’re up 11%, which gives some idea of the currency effect.

Please check out our 118 Years of the Dow chart  

Subscribe here for our investment updates

 

Other:

California housing (warning)

Suicidal robots

Jane Austen on bank notes

 

--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.

What if I told you…?

Listen to our 'Market Chat' podcast:


The Days Ahead: ECB and BoJ meet. No change expected.

We had a run of good earnings last week. On Friday, the big three banks (JPM, WFC and C) reported solid numbers. We were glad to see that they all reported decent loan growth and lower loss provisions. In recent years, earnings have come more from FICC (basically trading), which is a lower quality of earnings. So, these reports are in line with the recent successful stress tests that the Fed announced and clear the way for returning capital to shareholders. In a classic reminder of “buy the rumor, sell the fact” all three sold off on Friday.


1. What if I told you...?
In January this year, that we would have relentless political instability, stocks at the top end of their valuation range and a Fed raising rates? High volatility, no? But take a look at this:

It shows monthly change of the S&P 500 for the last 20 years. The smaller the columns around the 0% line, the lower the volatility. The recent clustering of the bars around the zero line shows just how quiet the market has been. We haven’t seen a correction of 5% since July 2016 or one of 10% since January 2016, and that lasted less than a month. So, investors have had an easy time over the last couple of years. It could change quickly and there are always reasons for why the market should fall. Ten minutes on CNBC will probably have you rushing to gold and tinned food. But to us, it's an absence of bad news for the corporate sector, low rates and a decent earnings recovery (h/t The irrelevant investor).


2. Oh dear… hard data:
It was another week of explaining away the weak hard data numbers. Producer prices and services costs were weak. So too was the NFIB, or small business survey, albeit from quite high levels. Industrial production was up 2% with strong showing from mining. Here it is:

Mind you, a lot of this was simply recovering from the string of declines over nearly two years. This is not any sort of return to big mining as the sector includes not just ores, coal and metals but also oil and gas. Finally, retail sales were flat, so won't be helping Q2 GDP growth much and consumer sentiment fell to pre-election levels. Which is what you would expect given the legislative gridlock and concern that health spending is about to drop 35%.


3. Yellen and Congress.
You can read the talk here. Our takeaway is that she has no real answer as to why inflation and wages remain low. Yes, there are lots of temporary factors like wireless programs, energy and airlines prices, but core sustained, long term inflation remains well below expectations. She’s certainly not alone in this so full credit to keeping it honest. She’s also worried about what the government may do which sounds sensible. There were no hints on timing of the next move but Friday’s inflation numbers suggest to us that December may be more likely than September. It won't be July.

Here’s inflation rolling over again with all the core numbers down and special items like wireless costs (down 13% YOY), used cars (down 9% annualized) and airline fares (down 37% annualized but that won't last). Ten-Year Treasury yields fell but overall there was very real new news.


4. There is low volatility but this is ridiculous:
The trading ranges for major asset classes have been historically very quiet. Consider:

  • Ten-Year Treasuries have traded between 1.5% and 3% for six years
  • German government bonds have traded between 0.2% and 0.6% for two years
  • The U.S. dollar index has traded between 95 and 100 for two years
  • VIX has traded between 10 and 25 for five years
  • Yen-U.S. Dollar has traded between 100 and 120 for four years

It's all to do with the economic cycle locked into lowish growth with no real momentum to any major story. Still, could be worse (h/t BAML).


Bottom Line:
Major earnings in U.S. and Europe. Housing starts is the only major news data. So we’re on the sidelines.

Please check out our 118 Years of the Dow chart  

Subscribe here for our investment updates

 

Other:

Umbrella sharing company loses 300,000 umbrellas

Number of estate taxes at lowest ever level

Australian checks single beer in luggage – and it makes it

The reason Larsen C is melting

 

--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.

Audio: "Summer Lull or Summer Panic?"

Here's a recording of our recent conference call. Please feel free to email us with comments or suggestions. cthwaites@bandjadvisors.com

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. 

 

Subscribe here for our investment updates

Take me to Investment Blog

Take me to Attorney Briefs

Need a JOLT?

What's the JOLT report?

It's the Job Openings and Labor Turnover repot, published by the BLS on a one month lag. It came out today, July 11, 2017. 

What happened? 

Job Openings were down but...

Quit rates were up. Now quit rates are important because people don't leave jobs voluntarily....only if they feel they can get another or better job. 

So, it's a measure of confidence and a welcome one in an otherwise very slow week. 

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. 

Subscribe here for our investment updates

Take me to Investment Blog

Take me to Attorney Briefs

Bond Tremors & some ETFs to avoid


The Days Ahead:
Yellen in front of Congress. Inflation report. Start to earnings season.

Apart from the job numbers, this was a slow week for trading and hard news. We think there’s a lot of profit taking and positioning going on. On Thursday we saw a 1.1% sell off with 90% of the S&P 500 stocks down. But, as we've noted before, this is not a market where all boats float. Since January, the S&P 500 is up 6.5% but 161 companies have seen their share prices fall and 37 by over 20%. We would expect the occasional sell-off. It is summer, after all, and traders often vacate their desks by lunchtime. So much of what we see is more noise than news.


1. Jobs: What do you do if you're running the Fed? You have two things to do: one, stabilize prices at around 2% and, two, keep unemployment around 4% to 5%. You're doing fine on one but the other refuses to budge from well below 2%.  Well, you can change the subject to asset price inflation, declare victory on one target and say the other is just around the corner or just keep the market guessing. And that's pretty much what it’s doing.

Anyway, the jobs report is one of the real “hard” numbers we have and this one is the last before the July meeting. June’s report had a little for everyone:

The headline number was good, some 222,000 and a revision up for April and May. But average hourly earning gains were soft, the underemployment rate rose and 15% of the new jobs were government. Nothing wrong with that but many of those are seasonal jobs.

U.S. Treasuries have been weak recently with yields up from 2.2% to 2.4% in the last 10 days. Some of that is down to the ECB last week hinting at rate rises but then saying they didn't mean it. And some is from the Fed June minutes where they said “…equity prices were high when judged against standard valuation measures.” Now, there’s nothing in their job description about asset prices but they have mentioned it a few times, here and here. So, there is a noticeable hawkish lean.

But one simple explanation for bond weakness here and in Europe is sentiment. Bond prices rose rapidly between March and June, the charts looked overbought and investors took profits. But they didn't move on Friday’s news, which suggests the bond market is struggling with the hawkish sounds from the Fed and the weaker numbers coming through in the economy and can't quite decide which is right.


2. What does it mean for equities if bonds are weak? We'll rely on the “it depends” answer. If we look at the chart below, we can see stocks in the blue line and bonds in green.

Back in 1994, we saw rapid tightening from the Fed, raising rates from 5% to 8%, yet stocks picked up and headed for one of their best performance runs ever. Every other shaded area shows stocks growing despite a weak or flat bond market. So, it can happen. It just depends on the cycle and levels.


3. Dopey ETFs: About a year ago, we wrote briefly about some dopey ETFs out there. Sadly, it seems Accushares VIX down/up (VXDN and VXUP) are no longer with us. Both managed to lose 99% over 12 months ending in October 2016. Here are some recent ones from the Financial Times. And here charted:

The thing to remember about investments like these is i) they're usually based on short-run themes ii) they're very concentrated with the top 10 holdings somewhere between 35% and 60% of the fund and iii) they tend not to stick around.

The ETF field is all about innovation and in funds like these, they’re active funds in all but name. Anyway, if you're thinking about investing in funds like these, you know…don’t.


Bottom Line: Low-level M&A action, some sector rotation and some profit-taking in bonds. There is a lot of background information but nothing with a strong direction. It's fine to wait.

Please check out our 118 Years of the Dow chart

Subscribe here for our investment updates

 

Other:

How bank filing worked in 1750s

Environmental footprint from electric cars

Financial Stability Board says all things are now “simpler, fairer and safer”

 

--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.

Milky Bar Kid is Strong and Tough


Milky Bar Kid is Strong and Tough  

The Days Ahead: Short week. Jobs number on Friday.

The major news was the eight-month low of the dollar, a sell-off in European bonds and equities following some comments from the ECB, which suggested policy stimulus may ease up. The core PCE number (the inflation number the Fed watches) was weak at 1.4% against the target of 2.0%. Look at this chart and you can see the Fed missing its inflation target repeatedly:

Personal income up 0.4% MoM but April’s number was revised downward, so not much to see. Personal spending was in line with expectations at 0.1% MoM. U.S. Treasuries were weaker at the end of the week but trading, we suspect, on short-term positioning. Here's some other stuff going on:


1. Nestle (NSRGY):
So here you are. The biggest company on the Swiss exchange with your stock outperforming the local index and the S&P 500 by a country mile. Your shares have returned 11% a year for 10 years and 24% this year. Then a letter from a stock activist drops on your desk. He’s been a shareholder, for, oh, about a week but he gives you a list of things to do because, well, he knows better. Welcome to the world of activism in the form of surfer and hedge fund manager Dan Loeb of Third Point.

Now we don't normally talk much about individual securities but i) Nestle is the largest company in the MSCI-EAFE index, so widely held by investment managers and our clients and ii) activism on poor performing companies is one thing but on well-respected companies is another. And full disclosure, I have owned NSRGY for years.

The playbook comes right out of a first-year MBA course with Third Point asking for improved productivity, share buy-backs, increased debt and offloading some brands. Nestle is a conservative company and, if you've been at the top of your game since 1866, you might think that’s not a bad way to run a global business. Their debt is very low at around 0.2x debt to EBITDA. Third Point wants to increase that to 2.0x. And they want the company to spend $40bn on stock buy-backs. We could be petty and point out that Third Point’s quoted reinsurance company (TPRE) has returned 2.3% annualized in the last three years and Nestle 11.8%. Adding insult to injury, he charges 2/20. So, you know, who’s schooling who?

Now it appears that Nestle was in the middle of doing much of this already (except the debt part because that seems, well, rash) and told shareholders as much. The stock rose but S&P promptly downgraded its credit rating. Here's what it looks like when debt spreads widen.

Why does all this matter? Because i) activists demanding companies to take on debt at this point of the cycle seems plain reckless and ii) share buybacks are short-term measures that don't work. Just ask IBM which spent $100bn buying shares, or 70% of its market cap, and saw its stock fall 20% in five years. We don't think Nestle is going to take the bait but this sort of M&A can be an indication of late cycle desperation.


2. Corporate Profits:
Q1 GDP was revised up a bit, mostly from better consumption. But we liked the corporate profits numbers which look like this:

So, while we’re still below levels from a few years ago, we seem to have recovered from the full-on collapse in profits from the energy and related capital good sectors. Profit growth, which was running negative for 18 months up to mid-2016, is now growing at 11%. This will edge down a bit in coming months not least because of the base effect. But this is a firm underpinning for stocks and supports our belief that fundamentals support the market, not the Trump reflation hopes.


3. Bank Stress Tests:
The Fed released its stress test results. This exposes banks to several tough economic and financial scenarios, counterparty problems and some global shocks. Basically, the Fed OK’s the dividend and share buy-backs proposed by management. So, it's more of a derivative approval of banks’ health. Not before time. Banks used to pay out around 4%-5% yields or nearly twice the S&P 500 back in the early 2000s. They were the steady and reliable dividend payers for many investors. It's now closer to 1.8% and share buy-backs were cut dramatically. The test result clears the path for more capital distributions to shareholders, which in turn could attract yield seekers.

Financials are rarely the most exciting sector of the market but they became exciting for the wrong reasons a decade ago and subsequently underperformed the S&P 500 by a whopping 65%. So, this is a real turning point and marks the (probably temporary) end of highly supervised oversight and control of capital.


Bottom Line:
The tech correction is pretty minor. Stock volatility is low. But so is fixed income and economic volatility. There is no storm brewing. Just ennui.  

Please check out our 118 Years of the Dow chart.  

Subscribe here for our investment updates

 

Other:

100,000 bees in your house

Why you should use checks (cheques?)

Life at the back of the plane

 

--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.As noted, the commentator owns ADRs in Nestle SA (NSRGY).

All charts from Factset unless otherwise noted.

Trade Balance: drag on growth

Trade Balance: drag on growth

  • Trade deficit fell but Q2 averages are worse than Q1
  • Consumer good imports rose
  • Cap goods exports rose
  • All in all modest drag on GDP 

Subscribe here for our investment updates

Take me to Investment Blog

Take me to Attorney Briefs

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. 

All you need to know about Durable Good Orders

All you need to know about Durable Good Orders

 

Not the most exciting series but a very good indicator of future manufacturing activity.

Orders fell 1.08%. Total orders have fallen for the second consecutive month.

All in all, not inspiring. No market reaction.

Subscribe here for our investment updates

Take me to Investment Blog

Take me to Attorney Briefs

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. 

Index Flexing


The Days Ahead:
Look for consumer sentiment. It’s been weak.

The market remains resilient hovering around its year to date and all-time highs. Mind you, there’s no visible difference between resilience and torpor. They both don't move but for different reasons. The market is not being tested and holding up, it’s just not moving, as in, there’s no place to go. The NASDAQ and tech corrections look like they were plain old profit taking, so no concerns there. None of our “fear” indicators (Yen, gold, U.S. Treasuries and VIX) are flashing. Put it all down to short-staffed summer trading desks and the absence of a strong narrative.

The healthcare sector had a nice surprise on Thursday with the “Better Care Reconciliation Act of 2017”, which proposes reducing Medicaid coverage, subsidies and credits and repeals things like device excise taxes. Healthcare stocks were up 4% on the week and 16% this year. We would put the three major Trump reflation themes, (tax cuts, infrastructure and deregulation) as no longer driving the market. This bill is more about “no new regulation”, which is not quite the same thing. Healthcare is usually a solid outperforming sector of the market but for the last two years has underperformed by around 10%. This removes some of that uncertainty. We'll refrain from further comment.


1. Active Indexing:
We’re big supporters of the move to indexing. It’s cheaper, simpler and outperforms active management in efficient markets. There are millions (sic) of indexes calculated every day by the big six index providers, S&P, Russell, FTSE, Barclays, CRSP and MSCI. Keep in mind, the number of indices far outnumbers the number of listed stocks, bonds and commodities so there’s an index for any investment theme you can think of.

MSCI made the news last week because it runs the most widely followed Emerging Markets index. So any change they make to the index means that $4.3 trillion must follow suit. And the change was to include more China stocks in the index from 2018 on. Right now China is about 28% of the index. The bulk of that is Hong Kong-listed China shares. The change will be gradual with perhaps only another 2% going into China (MSCI is pretty coy about how they will do this) but this will still understate the importance of China’s market which is the second largest in the world and five times bigger than India, the next largest Emerging Market.

Why do we care? Well, investors want to run ahead of index changes because all the “forced” buyers of the index will have to commit more in coming months. This can distort markets and a good example is what happened on the same day, when MSCI said they may include Saudi Arabia in the Emerging Markets, a promotion from Frontier Markets.

So there you have it. There was no news from Saudi Arabia, whose stock market tends to follow, unsurprisingly, oil. Yet the market shot up 9%. And it was all due to a change in indexing methodology.

We expect more of these kind of changes because indexing has become such a force in investing. We're not sure index providers should have so much market impact but it's something with which we must live. And it’s something we pay a lot of attention to as we build portfolios.


2. Bond Spreads:
There has been some movement in bond spreads recently. Here’s the spread between 10-Year Treasuries and High Yield, CCC and Energy High Yield bonds. The last two (the two top lines in the upper chart) have risen rapidly.

Why? Some is i) concern about raising rates which will hit highly indebted companies first ii) more energy coming online at a time of weak oil prices and iii) some tightening of lending. We've thought for a while that high quality bonds are a better investment, which is another way of saying that we’re not paid enough to take the risk of low quality bonds. The recent retreat in spreads does not change our view.


3. No clear signals and we don't expect one:
Here’s a graph that we used about a year ago because it was signaling that stocks were cheap relative to bonds.

It simply measures stock yields, at about 2.2%, against Treasury yields at about 2.15%. It’s by no means foolproof because inflation and dividend growth can change the signals. But it suggests to us that both stocks and bonds are fairly well valued and there’s no major opportunity to overweight either. It'sanother reason why we would put our marginal dollar into Europe where, on the one-year anniversary of Brexit, indicators like Purchasing Managers’ surveys are hitting six-year highs.


Bottom Line:
One of our favorite stock market aphorisms is “prices change more often that facts.” Right now, neither are changing. Our screen on market breadth still shows one third of companies in the S&P 500 25% below their 10 year highs. So not much exuberance.

Please check out our 118 Years of the Dow chart.  

Subscribe here for our investment updates
 

Other:
Lyft invents buses
Why those Phoenix flights were cancelled (wonk)
Killer whales stalk fishing boats


--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.

Corporate Debt as % of GDP

Corporate debt as a percent of GDP is near record highs. Yes, we know rates are low and companies are often borrowing against cash collateral, but debt is debt. And if credit ratings are hit, then we'll have a problem. 

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. 

 

Subscribe here for our investment updates

Take me back to Investment Blog

Alexa, what can I buy?


The Days Ahead: Quiet data week. More M&A coming?   

Ouch. Don't let your kids grow up to be retailers. Over the last year, Macys, Target and Bed Bath & Beyond are all down 20% to 40% and even the analyst’s favorite, Costco, is barely above its 2015 level. This week it was Kroger’s turn in the cage...down almost 50%. I guess it’s all the themes of Amazon, ez-delivery, people moving back to the city, fewer car owners, less time, stricter zoning, more choice. I’ve always been hesitant on retailing as an investment. It’s brutally competitive. They seem to go through fashion cycles, margins are razor thin and companies are loaded with debt.

So, Amazon taking over Whole Foods for $13bn is either i) the inevitable rise of online retailing and general disruption ii) the merging of warehouses with stores iii) a canny play on highly desirable locations iv) premium pricing meets value discounter or iv) the result of an activist/founder face off. We're not sure if the friendly farmer’s market approach of Whole Foods will fit with Amazon’s high-efficiency brand. But we do know this: it's a symptom of finding growth in a low growth economy.

Amazon can of course afford it. It’s a $475bn market cap and so the price is less than 3% of its value. The deal increases Amazon’s sales by around 10%. Historically, failure rates of M&A are high. (Just a thought.)

Elsewhere, the Bank of England sounded a bit more hawkish, probably because sterling’s 15% drop against the dollar and Euro in the last year may have inflation consequences. U.S. economic numbers were weak. We’ve hammered this point for weeks now but when housing starts, retail sales, the NFIB small business survey and industrial production all reported lower than expected, then you have to ask “blip or trend”?  

The Bank of Japan kept rates low, despite calls to back off on QQE (the extra “Q” is for Qualitative, nice touch). The Nikkei index is running steady at a 10-year high.


1. The Fed: It was a mistake for the Fed to tighten. So why did they do it? First, they've talked about it and any climb down from three moves this year may be taken as, well, a climb down. Second, they're all trained on the Phillips curve model where low unemployment means tight labor markets means wage inflation. Third, they see ever-so-feint lights of spending and investment which, crossed fingers, may lead to the normalization of policy to which they would all like to return. Now, if we were in chess notation this would be either:

a.     ?  a bad move; a mistake
b.     ??  a blunder
c.     ?!  a dubious move or move that may turn out to be bad

And that’s it. They're the only choices. As we’ve noted before there is no inflation. Yes, it may come but there’s usually a lot of runway before inflation takes off. The Fed’s excuse would be, well, preemptive caution. Or it’s tilting at windmills.

For the windmill case, we’d look no further than the “dot plots” or Summary of Economic Projections. The Fed expects growth at 2.1%, inflation at 2%, unemployment at 4.6% and Federal Funds at 3%. These are essentially unchanged from March 2017 and a year ago except they revised growth down.

So, since the Fed embarked on its tightening cycle in December 2015, growth and inflation have been revised down. Granted, unemployment has also been revised down but by 0.3%, which is around 405,000 jobs. On a workforce of 160m. Speciously accurate, no?

The 10-year Treasury has rallied by about 40bps this year and the yield curve has flattened. Here’s the spread between 10 and 2-year Treasuries dropping like a stone:

What will happen from here? The market will test the Fed and keep rates well bid. The market sees i) low growth and inflation and ii) monetary policy as already too tight given the real Fed Funds rate, which has risen noticeably this year. If we see weak numbers over the summer, and last week’s industrial and manufacturing production were pretty bad, then the expected third rate hike won't happen. Our hopes are on Neel Kashkari.

So, we have to live with higher real rates and the prospect that some heat may come off risk assets for a while, especially after the S&P 500’s near 9% gain this year.


2. Japan: The Bank of Japan’s QQE is now around $3.9 trillion, which is a far bigger proportion of Japan’s GDP than the Fed’s program. And they own another $140bn of equities and corporate bonds. It seems to be working. Consumer confidence, employment, industrial production and chain store sales have all been strong in recent months. There have been many false dawns in Japan over the years. Not for nothing was the Japanese Government Bond known as the “widow’s trade.” But maybe this time is different.

We'd note that foreign investors' fund flows correlate strongly with the USD/JPY rate since the start of Abenomics, but that investors' Japanese equity positions up to the end of April were the lowest since mid-2012. They might be missing something:

Japanese large and mid-cap stocks have performed well against the S&P 500 and, in the bottom chart, the S&P 500 remains nearly 25% more expensive than Japanese equities using a simple EV/EBITDA measure. We like Japan and have noted some of our managers moving their allocations up.


Bottom Line: We're somewhat relieved to see the Nasdaq correction. It's off around 5% from its highs. As we discussed last week, it's not a bubble but simply profit-taking. We're reminded that the ETF tracking the Nasdaq was launched in 1999, promptly doubled, then fell 76% and took 17 years to recover. We're not seeing anything remotely like that. There’s more noise than signal in the market right now.

Please check out our 118 Years of the Dow chart.  

Subscribe here for our Investment Updates

Take me back to Investment Blog

Other:
Now there’s an Act for Covfefe
Maybe Janet Yellen does not want to be Chair
Vegetarian, Vegan, Breatharian

--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.