The Days Ahead: Inflation and the Fed meeting.
Lighter week on the U.S. economic front but what there was, was soft. The big slowdown in consumer credit and zero productivity growth both suggest lack of consumer confidence and margin pressure. We’ll wait to see if they reverse any in coming months. On the good news side, the ECB recommitted to its brand of QE and revised down inflation expectations. This, along with better growth, confirms the background we like about Eurozone equities.
Stocks were flat and could not decide if some of the tech valuations are getting out of hand (they are). Or if the first stab at breaking down Dodd-Frank was good for financials (they were up marginally but are the same level as last December and still 20% off their peak). The 10-Year Treasury hovered around 2.15% to 2.21% with a mid-week rally as the ECB announced lower inflation.
Markets remain inured to the political risk. And we don't just mean the theatrics in Washington, but also the Qatari diplomatic shutdown and the bizarre U.K. election. We think this is for a number of reasons starting with
i) U.S. institutions are strong and trouble in one branch does not spell disaster for business and the economy
ii) Even major political outrages don't worry markets much; as we’ve mentioned before, it took years for the Clinton and Nixon scandals to unfold and…
iii) There are just fewer active managers around to make big, outsize bets that must later be unwound.
But there were a few things for the market to think about.
1. Meh, again on U.S. Jobs. We watch the JOLTS numbers closely, even though they lag the New Farm Payroll numbers by a month. On the one hand, the number of job openings reached a record high (the series only goes back to 2000) so, yay, for the bulls. Here's the chart:
But, think about the typical “Job Opening” these days. Employers don't want to train new employees. They want them to be productive day one. That means if you don't have the exact plug and play skills, you're not likely to be hired. So, the job remains open and unfilled.
The NFIB and others have said for years that they cannot find qualified applicants. And that shows up in the green line on the chart. The number of “Hires” has been flat for three years. So, open jobs but no hiring. “Quit rates”, which are a good confidence indicator because, hey, you don't quit unless you think you can afford it or find another job, are also the same level as 2006. If there were a real labor shortage, employers would pay or train more. So far, there is little evidence that they are so we simply don't buy the narrative that there is a tight labor market.
2. Rough Winds for May: The U.K. election was a disaster. There was no need to call it. The campaign was a shambles. The debates laughable. We have been mostly out of the U.K. market and this week confirmed our thinking. Here’s the U.K. stock market:
The upper line is an impressive 20% gain for the U.K. broad index in the last year, with the S&P 500 5% below. But it’s the bottom line we want, which is the U.K. market for a dollar investor and which is only up 5%. And, no, a hedge would not have worked, as the rapid downturn in sterling would have made any hedge uneconomical. The one hedged ETF we know managed to lose money over the year. So what’s next?
- The Conservative government will ally with the DUP, an odd bunch of Ulster unionists
- But they will be a very weak, minority government
- A weaker hand with Brexit negotiations
- And maybe EEA membership (a sort of EU without agriculture and some laws) which would fall far short of a "hard” Brexit
- Anyway, from our perspective, it’s no change in investment outlook and there may be a challenge to May’s leadership within weeks.
3. Are FAANGs expensive? Yes. Here’s the chart.
Performance is impressive. They have outperformed the S&P 500 (itself up 17%) by 27% in the last two years. But the bottom two charts show the five stocks are 44% more expensive than the S&P 500 and pay a dividend of only 0.3%, compared to the S&P 500 of 2.1%. The numbers would be more extreme if we exclude Apple, which is actually quite cheap and an honorary member of the FAANG club. We put this chart out mid-week before a 3.5% correction of the NASDAQ on Friday. You can see the downturn over there on the right-hand corner. What’s going on?
- In a world of slow growth, growth stocks will trade at a premium
- These businesses don't require capital. They mostly have sky high ROEs and will return capital
- They're mostly natural monopolies given the network effect
- They generate a lot of cash and hold lots of cash
- They have avoided, so far, regulatory pushback.
Now, we’re not overly worried because, unlike 1999, these companies make money and show up in a lot of screens: momentum, realized volatility, balance sheet quality, Price/Earnings growth etc. But best not to go overboard.
Bottom Line: We ran our quick screen on SPX stocks trading at over 30 times earnings or roughly 75% above the market average. It’s up to 126 compared to a few weeks ago. The #1 spot is now Salesforce on a PE of 456x. And on our other quick price screen, we see 153 companies that trade 25% off their 10 year high. So this has not been a market with a lot of breadth.
Please check out our 118 Years of the Dow chart.
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--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.