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
--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.