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.
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.
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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.As noted, the commentator owns ADRs in Nestle SA (NSRGY).
All charts from Factset unless otherwise noted.