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The Days Ahead:
Retail sales and NFIB. Surely small business will show better confidence?
More tech earnings but not the good kind. Snap, Priceline and Expedia all took big hits of 15% to 20%. Oil rallied but not energy stocks. The tax cut story lost momentum. Broadcom launched a bid for Qualcomm. They’re both $100bn companies so we’re talking some major M&A activity.
The tax discussions took a new turn. We're loath to comment on tax proposals. The proposed changes will look nothing like the end result and there’s no mileage in trying to trade the outcome. The original one-page tax manifesto back in April probably represented the optimistic high point. Now, even the corporate tax rate cut, which was the cornerstone of the entire proposal, looks like it's being delayed. Does it matter?
Yes to market sentiment. But not really to the economy. The blue bars are the corporate taxes paid. They stalled out more than a decade ago. The green line shows the amount paid as a percent of GDP. It’s a small and declining number. There is nothing to suggest that lower corporate taxes will lead to i) higher capex ii) investment iii) growth or iv) wage increases. Nothing. It is probably good for shareholders but the wealth effect of the stock market growth is dubious at best and charlatanism at worst. The sort of thing you’d draw on the back of a napkin and call it policy.
When the yield curve starts to look flat and long-term rates do not look substantially different from short-term rates. Last time they flattened 10 years ago, the then Fed Chair said "The evidence [of a flat curve] very clearly indicates that its efficacy as a forecasting tool has diminished very dramatically because of economic events.” Er, no. Six months later the economy slipped badly and dropped like a stone a year or so later.
So what do we have now? Well the spread between the 10-Year Treasury and the 2-Year Treasury is at a decade low.
What does it mean? Well, we’re in the camp that bond markets are better predictors of trouble than stock markets. Because i) they’re more liquid ii) they’re traded off-market so prices and sizes don't have to be disclosed iii) they represent more types of investors than stocks (e.g. Central Banks, corporate treasurers, collateral posts, repos) and iv) have fewer variables to work with (you don't really care about Apple’s iPhone sales if you hold the bond…you care about the ability to repay).
So, if you have a flat curve, it means that investors don't believe the economy is going to grow at a fast enough to require a rate increase. We would agree that QE and Central Bank buying may have distorted the signal. But there is nothing the Fed is doing with its balance sheet assets that we don't already know.
This flattening trade also means corporate credit spreads are at 12-year lows as investors hunt for anything to create income. And it means that the bond market remains skeptical about tax changes.
2. Whaaat? Top of the market stuff, surely?
When it comes in acronyms, it’s time to get the red flags out. A few years ago, it was BRICs (Brazil, Russia, India and China), which were the dominant Emerging Markets countries set to take over the world. The idea was backed by growth, large populations and a Goldman Sachs marketing campaign. The timing was awful. The ETF launched at the time unperformed the S&P 500 by 73% in the next 10 years and is still 27% below its offering price. Further back, there were a bunch of companies called, well, BUNCH or Burroughs, Univac, NCR, Control Data and Honeywell. They were the tech dream team of their day. And yes, all gone except Honeywell, which massively underperformed the S&P 500 for 20 years.
Now we have the NYSE FANG where you can trade 10 underlying stocks on the futures market. It’s actually more than the Facebook, Amazon, Netflix and Google original line up. It has the Chinese equivalents (Alibaba etc) and some others like Tesla thrown in for good measure. So tech all day every day, with leverage. And this in on top of the FANG ETF launched in July, which is up about 12%. Anyway, FANG Is catchy and so breaks one of our core rules about ETFs: if they have a cute name, just, you know, check it.
Here is how the FANGs have done:
So, from top to bottom, the six names have outperformed the S&P 500 by 48% in the last three years during which time you doubled your money. They're about 35% more expensive than the market and yield less than half the market average of 2.0%. They have delivered on growth with earnings up around 14% a year compared to the S&P 500 of 9.6%.
They're about 14% of the S&P 500 market cap, 5% of sales, 10% of the earnings and 2% of employees. Observant readers will have noticed three versions of FANGs: the original four, the NYSE of 10 and ours, which is the one currently in wide use, of six stocks. And that too is a problem. The NYSE reserves the right to change the components of the futures any time they want. So, you don't always get what you bought.
We're not about to call the top of the FANG market but we’d share that:
1. Cute names don't work
2. If something looks like it’s forever, it isn’t
3. We've never seen an investment fad work
4. Companies that look unassailable aren't and…
5. Beware CEOs with overzealous PR departments.
Stocks had little news to trade on. We'd like to see a consolidation period in this post-earnings pre-Congress period. Of course, it never happens that calmly. And we’re keeping a close eye on those very tight credit spreads.
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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.