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The Days Ahead: Slow week. ECB minutes.
Some good earnings last week and not just from the tech, search, disrupt stocks. First out was Wal-Mart (WMT), which beat on sales and earnings. We view that as very important because i) it's the tenth largest company in the S&P 500 and fifth in the Dow Jones ii) it has the largest sales of any company in the U.S. at $485bn or 2.5% of GDP and more than twice as big as Apple, the next biggest by sales and iii) it employs 2.3m people or more than the next eight largest companies. The stock is up 37% this year.
Then Home Depot (HD), which is up 25% this year and raised sales by 6% excluding the one-off gains from the hurricanes. HD is a classic housing play but also a good indicator of confidence around large ticket items. It’s also very well managed. It’s up 780% since the recession.
On the other side, GE became the latest victim of “conglomeratism.” The recent CEO had to clean up an almighty mess of financial services. The new one has to work on the differing subsidiaries and get back to core businesses, which could be healthcare, aviation, transportation or energy. He’s cut the dividend. GE’s market cap peaked at $580bn in 2000 when it was on a P/E of 41. Today the price is down 70% (down 40% this year) and it has slipped from first in the S&P 500 to 33rd.
1. How’s Japan going?
Fine. It just completed seven quarters of growth for the first time in 30 years. This is not quite a vindication of the “Three Arrows” approach of newly re-elected Shinzo Abe, which is some heavy QE, promoting inflation and domestic reform, but exports performed well. We're looking for increasing household expenditure and for the 3% wage growth, both of which are heavily promoted by the government.
It’s a slow road. Meanwhile Japanese stocks have risen 17% for the large caps and 28% for small caps, which translate into 21% and 34% for a U.S. investor. The market is now at a 26 year high and has been the best performing developed market since 2013. We continue to like the market, not least because of this:
Earnings are growing and stocks trade at a 20% discount to the U.S. market (see the middle chart). The broad themes are i) domestic demand ii) easy monetary policy iii) profit growth and iv) foreign demand. We're not usually fans of the “weight of money” argument, which states investors are standing in the wings ready to buy. But in Japan’s case, foreign investors have underweighted Japan’s 25% share of the EAFE index for years. Two of the largest active international funds, for example, hold 10% and 14% in Japan. Eventually that gap will close.
2. Update on the yield curve.
We talked about flattening last week. We mentioned that an inverted yield curve is bad news and has been since around the early 1980s.
The arrows mark the time when the 2-year Treasury yielded more than the 10-Year Treasury. They seem to appear some six months before a recession. But we’d make a couple of points. One, the spread can get very close to zero and not mean anything more than the economy is doing well and inflation is low. Second, the full inversion happens when short-term rates increase as the economy speeds up but long-term rates think that a recession and easing are just around the corner. Third, short-term rates are policy driven. Long-term rates are market driven and right now, there is a lot of demand for long-term bonds.
We had good news last week about the growth of the economy and inflation. Industrial production was up 2.5%, with mining up 6%, and core inflation was up 1.8%, which is well down on what it was a few months ago. The low inflation puzzle is ongoing from Chair Yellen’s speech a few years ago and some regional governors (here’s our own John Williams at the San Francisco Fed) arguing for raising the target to 3% from 2%. Count me as favoring that because the Fed can't seem to forecast inflation to save its life and without some inflation, we’re not going to see meaningful real or nominal wage growth.
Anyway, for now we have low inflation, growth and strong earnings. Which is good enough.
We're at about the end of earnings season. Earnings and revenues are up 6%. Next week will be quiet and there is not much on the calendar. We're keeping an eye on Europe given its recent weakness around Brexit (again). Oil is on the move but we think it’s a geo-political short squeeze. Energy stocks haven’t moved.
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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.
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