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Weekly Issue: September Looks Like a Repeat of August

Weekly Issue: September Looks Like a Repeat of August

Key points inside this issue

  • We are establishing a buy-stop level at 9.50 for shares of Veeco Instruments (VECO), which will lock in a profit of at least 13% on this short position.
  • The Hershey Company: Tapping into Cleaner Living with M&A


We ended a volatile August… 

Stocks rebounded from some of their recent losses last week as trade tensions between the U.S. and China appear to have cooled off a bit. For the month of August in total, during which there seemed to be one market crisis after another, most of the major stock market indices finished down slightly. The outlier was the small-cap heavy Russell 2000, which shed around 5% during the month.

Looking back over the last few weeks, the market was grappling with a number of uncertainties, the most prominent of which was the announced tariff escalation in the U.S- China trade war. There were other uncertainties brewing, including the growing number of signs that outside of consumer spending, the economy continues to soften. We saw that consumer strength in Friday’s July Personal Income & Spending data, but also in the second June-quarter GDP revision that ticked down to 2.0% from 2.1%, even though estimates for consumer spending during the quarter rose to 4.7% from 4.3%. I would note that 4.7% marked the strongest level of consumer spending since the December 2014 quarter. We are, however, seeing a continued shift in where consumers are spending — moving from restaurants and department stores to quick-service restaurants and discount retailers as well as online. This raises the question as to whether the economy is prepared to meet head-on our Middle Class Squeeze investing theme?

Another issue investors grappled with as we closed out August was the yield curve inversion. While historically this does raise a red flag, it’s not a foregone conclusion that a recession is around the corner. Rather it can be several quarters away, and there are several stimulative measures that could be invoked to keep the economy growing. In other words, we should continue to mind the data and any potential monetary policy tweaking to be had.

Closing out August, more than 99% of the S&P 500 have reported earnings for the June-quarter season. EPS for that group rose just under 1%, which was far better than the contraction that was lining up just a few weeks ago. Based on corporate guidance and other factors, however, EPS expectations for both the September and December quarters have been revised lower. Some of this no doubt has to do with the next round of tariffs that took effect on Sept. 1 on Chinese imports, but we can’t dismiss the slowing speed of the global economy either.

That overall backdrop of uncertainty helps explain why the three best-performing sectors during August were Utilities, Real Estate and Consumer Staples. But as we saw in the second half of last week, a softer tone on the trade war led investors back into the market as China said it wished to resolve the trade dispute with a “calm” attitude.

Without question, investors and Corporate America are eager for forward progress on the trade war to materialize. While there have been several head fakes in recent months, we should remain optimistic. That said, we here at Tematica continue to believe the devil will be in the details when it comes to a potential trade agreement, and much like deciphering economic data, it will mean digging into that agreement to fully understand its ramifications. Those findings and their implications as well as what we hear on the monetary policy front will set the stage for what comes next. 


… and it looks like more ahead for September

This week kicks off the last month of the third quarter of 2019. For many, it will be back to work following the seasonally slow, but volatile last few weeks of summer. The question to be pondered is how volatile will September be? Historically speaking it is the worst calendar month for stocks and based on yesterday’s performance it is adhering to its reputation.

As a reminder, on Sept. 1 President Trump authorized a tariff increase to 15% from 10% on $300 billion in Chinese imports, many of which are consumer goods such as clothing, footwear and electronics.  As we saw, that line in the sand came and went over the holiday weekend and now Trump is once again rattling his trade saber, suggesting China should make a deal soon as it will only get worse if he wins the 2020 presidential election.

In addition to that, yesterday morning we received the one-two punch that was the August reading on the manufacturing economy — from both IHS Markit and the Institute of Supply Management. The revelation that manufacturing continued to slow weighed on stocks yesterday. The direction of Tuesday’s official data, however, was not a surprise to us given other data we monitor such as weekly rail car loadings, truck tonnage and the Cass Freight Index.  But as I have seen many a time, just because we are aware of something in the data doesn’t mean everyone is. 

What I suspect has rattled the market as we kick off September is the August ISM Manufacturing Survey, which showed the U.S. manufacturing sector declined to 49.1 in August. That is the lowest reading in about three years, and as a reminder, any reading below 50 signals a contraction. Data from IHS Markit also released yesterday showed the U.S. manufacturing PMI slowed to 50.3 in August, its lowest level since September 2009. Slightly better than the ISM headline print, but still down. Digging into both reports, we see new orders stalled, which suggests businesses are not only growing wary of the trade uncertainty, but that we should not expect a pickup in the month of September.

In my view, the more official data is catching up to the “other data” cited earlier and that more than likely means downward gross domestic product expectations ahead. It will also lead the market to focus increasingly on what the Fed will do and say later this month. I also think the official data is now capturing the weariness of the continued trade war. The combination of the slowing economy as well as the continued if not arguably heightened trade uncertainty will more than likely lead to restrain spending and investment in Corporate America, which will only add to the headwinds hitting the economy. 

Taking those August manufacturing reports, along with the data yet to come this week – the ISM Non-Manufacturing readings for August, and job creation data for August furnished by ADP and the Bureau of Labor Statistics — we’ll be able to zero in on the GDP taking shape in the current quarter. I would note that exiting last week, the NY Fed’s Nowcast reading for the September quarter was 1.76%, below the 2.0% second revision for June-quarter GDP. There is little question that given yesterday’s data the next adjustment to those forecasts will be lower. 

Adding to that view, we’ll also get the next iteration of the Fed’s Beige Book, which will provide anecdotal economic commentary gathered from the Fed’s member banks. And following the latest data, we can expect investors and economists alike will indeed be pouring over the next Beige Book.

No doubt, all of this global macro data and the trade war will be on the minds of central bankers ahead of their September meetings. Those dates are Sept. 12 for the European Central Bank (ECB) followed by the Fed’s next monetary policy meeting and press conference on Sept. 16-17. Given the declines in the eurozone, the ECB is widely expected to announce a stimulus package exiting that meeting, and currently the CBOE FedWatch Tool pegs a 96% chance of a rate cut by the Fed. With those consensus views in mind, should the economic data paint a stronger picture than expected it could call into question those likelihoods. If central banker expectations fail to live up to Wall Street expectations, that would more than likely give the stock market yet another case of indigestion. 

All of this data will also factor into earnings expectations. Earlier I mentioned some of the more recent revisions to the downside for the back half of 2019 but as we know this is an evolving story. That means effectively “wash, rinse, repeat” when it comes to assessing EPS growth for the S&P 500 as well as individual companies. And lest we forget, companies will not only have to contend with the effect of the current trade war and slowing economy on their businesses, but also the dollar, which as we can see in the chart below has near fresh highs for 2019. 

The biggest risk I see over the next few weeks is one of economic, monetary policy and earnings reality not matching up with expectations. Gazing forward over the next few weeks, the growing likelihood is one that points more toward additional risk in the market. We will continue to trade carefully in the near-term and heed what we gather from the latest thematic signals.


The Thematic Leaders and Select List

Over the last several weeks, the market turbulence led several positions, including those in Netflix (NFLX), Dycom (DY) and International Flavors & Fragrances (IFF) — on both the Tematica Leader board and the Select List to be stopped out. On the other hand, even though the overall markets took a bit of a nosedive during August, several of our thematic holdings, such as USA Technologies (USAT), AT&T (T), Costco Wholesale (COST), McCormick & Co. (MKC) and Applied Materials (AMAT) to name a few outperformed on both an absolute and relative basis.

Even the short position in Veeco Instruments (VECO) has returned nearly 18% since we added that to the Select List last March. That has been a particularly nice move, but also one that is playing out as expected. Currently, we have do not have a buy-stop order to protect us on our VECO position, and we are going to rectify that today. We are establishing a buy-stop level at 9.50 for shares of Veeco Instruments (VECO), which will lock in a profit of at least 13% on this short position. 

  • We are establishing a buy-stop level at 9.50 for shares of Veeco Instruments (VECO), which will lock in a profit of at least 13% on this short position.


The Hershey Company: Tapping into Cleaner Living with M&A

When we think of The Hershey Company (HSY) there is little question that its candy, gum and mints business that garnered it just over 30% of the US candy market lands its squarely in our Guilty Pleasure investing theme. Even the company itself refers to itself as the “undisputed leader in US confection” and we look at its thematic scorecard rankings, its business warrants a “5”, which means nearly all of its sales and profits are derived from our Guilty Pleasure theme. 

Not exactly a shock to even a casual observer. 

But as we’ve discussed more than a few times, consumers are shifting their preferences for food, beverages and snacks to “healthier for you” alternatives. These could be offerings made from organic or all-natural ingredients, or even ingredients that are considered to promote better health, such as protein over sugar. Recognizing this changing preference among its core constituents, Hershey hasn’t been asleep at the switch, but rather it has been making a number of nip and tuck acquisitions to improve its snacking portfolio, which aligns well with our Cleaner Living investing theme. 

These acquisitions have played out over a number of years, starting with the acquisition of the Krave jerky business (2015);  SkinnyPop parent Amplify Snacks (2017), Pirate Brands, including the Pirate’s Booty, Smart Puffs and Original Tings brands (2018). Then, just last month, Hershey acquired ONE Brands, LLC, the maker of a line of low-sugar, high-protein nutrition bars. August 2019 turned out to be a busy month for the executives of Hershey, as also in that month, the company announced minority investments in emerging snacking businesses FULFIL Holdings Limited and Blue Stripes LLC. FULFIL is a one of the leading makers of vitamin–fortified, high protein nutrition bars in the UK and Ireland, while Blue Stripes offers cacao-based snacks and treats instead of chocolate ones. 

Clearly the Hershey Company is improving its position relative to our Cleaner Living investing theme. The outstanding question is to what degree are these aggregated businesses contributing to the company’s overall sales and profits? While it is safe to say Hershey has some exposure to the Cleaner Living theme, the answers to those questions will determine Hershey’s overall theme ranking. That level of detail could emerge during the company’s September quarter earnings call, but it may not until it files its 2019 10-K. 

As we wait for that October conference call, I’ll continue to do some additional work on HSY shares, including what the potential EPS impact is from not only falling sugar prices but also the pickup in cocoa prices over the last six months. In a surprise that should come to no one, given the size and influence of the company’s chocolate and confectionary business to its sales and profits, cocoa and sugar are two key inputs that can hold sway over the Hershey cost structure. 

In my mind, the long-term question with Hershey is whether it can replicate the nip and tuck transformative success Walmart (WMT) had when it used a similar strategy to reposition itself to better capture the tailwinds of our Digital Lifestyle investing theme? No doubt transformation takes time, but now is the time to see if a better business balance between our Guilty Pleasure and Cleaner Living themes emerges at Hershey.

Weekly Issue: As Global Economy Slows, Investors Switch into Fear Mode

Weekly Issue: As Global Economy Slows, Investors Switch into Fear Mode


Key points inside this issue

  • The global economy continued to slow in August
  • Uncertainty has investors in Extreme Fear mode
  • Trade remains the focus of the stock market
  • Boosting our Disney (DIS) price target following D23’s Disney+ focus
  • Items to watch this week


The stock market has been a more volatile than usual over the last few weeks as investors:

  • Contend with the latest global economic data
  • Eye the yield curve
  • Question what the Fed will do next
  • Brace for the next round of trade talks

As if that wasn’t enough, we’ve also witnessed mixed June quarter retail earnings, which are now getting factored into second half of 2019 earnings-per-share expectations for the S&P 500. At the same time, the velocity of corporate buybacks has slowed, Washington is scrutinizing tech companies, and consumer confidence is waning. 

All in all, these issues weighing on investors minds have led to swings in the market based on the most recent headlines, and that can make for a challenging time in the market and for investors.


The global economy continued to slow in August

Last Thursday morning, we received the first meaningful piece of August economic data in the form of the IHS Markit Flash PMI data for the month, and in aggregate, it confirms the global economic slowdown. To date, the U.S. has been the best house on the slowing economic block, but Thursday’s data, which showed the domestic manufacturing sector contracting for the first time in a decade means the trade war and uncertain environment are weighing on the economy. 

During periods of uncertainty, whether we’re talking about companies or people, the natural instinct is to pull back, wait and assess the situation. For both people and companies, dialing back spending is an arguable course of action when faced with uncertainty, but from an economic perspective that translates into a headwind for growth. We’re seeing that headwind in the day’s Flash PMI data.

Aside from the headline, U.S. Flash Manufacturing PMI hit 49.9, marking a 119-month low; the index’s new orders component put in its weakest reading since 2009. Per the report, “Survey respondents often cited subdued corporate spending in response to softer business conditions and concerns about the global economic outlook.” 

But as we saw with the July Retail Sales report, consumers continue to spend, despite rising debt levels and banks are starting to report a pick-up in delinquency rates. The question that is coming to the forefront of investor minds is whether consumers will be able to spend and keep the economy chugging along during the all- important holiday shopping season that will soon be upon us? Given the continued increase in consumer debt levels and news that Citibank (C), JPMorgan Chase (JPM), Bank of America (BAC) and other banks are reporting rising credit card delinquency rates we could be starting to see the consumer spending breaking point. 

Looking at the August Flash PMI data for the eurozone, the slowdown continued as well, but the report also registered a “sizeable drop in confidence regarding the 12-month outlook” with sentiment down to its lowest level since May 2013. Digging into that report we find new order growth in Germany, the largest economy in the eurozone, falling to its weakest levels since early 2013. The August data for the region confirms current forecasts the region is likely to hit just 0.1%-0.2% Gross Domestic Product in the current quarter. Another round of weak data, and odds are we’ll soon see recession fears rising ahead of the European Central Banks upcoming mid-September monetary policy meeting.


Uncertainty has investors in Extreme Fear mode

If we were to step back and look at the data, what we are seeing is data that points to a continued slowdown with some bright spots. Granted those bright spots are also somewhat mixed and there are reasons to be concerned over the sustainability of those bright spots. Is it any wonder then that the CNN Money Fear & Greed Index has been firmly in “Extreme Fear” for the last week? In a word, no.

During periods of Extreme Fear, the jittery market is bound to overreact. Add in the fact that we are in one of the seasonally slowest times of the year for trading volumes means market reactions will be even more extreme one way or another. The danger for investors is to get caught up in the turbulence, and it can be rather easy to do, especially if one is looking to pile onto a money-making trade, be it a long or short one. This makes headline-grabbing, bold assertions increasingly digestible, like the one from hedge fund hired-gun Harry Markopolos on General Electric (GE) or rumor–mongering like the recent one that drove the recent pop in shares of Tesla Motors (TSLA).

Rumors and assertions are tricky things, and while some may turn out to be true, others may only have a whisper of truth, if any at all. In the case of Markopolos, he’s working with an unnamed hedge fund partner, and while it would be wrong to cast wide dispersion on the industry, the reality is it is hurting. In 2018, eVestment hedge fund performance data showed the overall hedge fund industry returned negative 5.08%. While the industry is in positive territory on a year-to-date basis this year, it still meaningfully lags the major market indexes.

The bottom line is that in a market environment that is teaming with uncertainty on several sides, it is even more important that investors continue to focus on the data rather than be led astray by rumors and conjecture. Whether it is digging into a company’s financial filings; cross referencing conference call transcripts across a company’s competitors, customers and suppliers; or wading deep into the economic data, now more than ever it is important to do the homework rather than simply piling onto an idea that could simply be one person talking his or her trade book.  In our case, we’ll continue to assess and revisit the tailwinds that powers each of our investing themes each week through Thematic Signals and our Thematic Reading as well as our Thematic Signals podcast. 

Along the way, we may find something that helps put some of those potentially over-the- top assertions into perspective. One such example is found in the work by Bronte Capital that took Markopolos’ assertion that GE’s industrial margins near 15% are “too good to be true” to task by comparing them with similar margins at Honeywell (HON), Emerson Electric (EMR) and others. Once again, digging into the data adds that layer of context and perspective that is both helpful and insightful to investors.

In my experience, making a trade without doing the homework first and getting conviction on the thesis rarely yields the hopium expected. If the homework checks out, it offers confidence and conviction in the position. Periodically checking the data to determine if that thesis remains on track can either keep one’s conviction running high or alert to a potential issue. Not doing the homework leaves one vulnerable to a change they might not even known was coming.


Trade remains the focus on the stock market

As we approached the end of last week, the stock market was poised to move higher week over week, but as we saw it finished up on a very different note given all of Friday’s news. That news spanned from China threatening countermeasures on tariffs set to be instilled on Sept. 1, to the Fed being ready to extend the current recovery even though it remains upbeat about the domestic economy, to President Trump “ordering” U.S. companies to look for “alternative to China” and then raising tariffs on China after the market close. 

There was little question, we were once again seeing U.S.-China trade tensions escalate, raising questions as to what it could mean for the next round of trade talks. In other words, as we headed into one of the last summer weekends, U.S.-China trade uncertainty continued. While the market absorbed China’s escalation and Fed Chair Powell’s “at the ready when needed” comment, it was Trump’s latest trade salvo that reversed the market’s direction for the week leading all the major stock indices to finish down for the week. Trump said he would raise existing duties on $250 billion in Chinese products to 30% from 25% on October 1 and increase the 10% tariff on another $300 billion of Chinese goods set to take effect on September 1 to 15%.

The trade drama at the G-7 meeting continued over the weekend, and it appeared the market was going to start this week off with more than a whimper given that last night US stock market futures were down more than 1%. However, like any good drama that has a number of twists, this morning President Trump shared that China wants to make a trade deal, which served to walk back last week’s jump in trade tensions. 

My stance on the trade war has been a combination of hope, patience and details. Hope for a trade deal, patience realizing it would take time to come together and that the details of any trade agreement matter. Despite the purported trade related developments today, my stance remains unchanged. 


Boosting our Disney price target following D23’s Disney+ focus

While many were watching the political and trade events unfold at the G-7 meeting over the weekend, there was another gathering of note – D23 2019 at which Walt Disney (DIS) shared quite a bit about its upcoming Disney+ service that is set to launch on November 12. As I’ve said before, that service not only grows Disney’s exposure to our Digital Lifestyle investing theme, it’s also going to change how Wall Street values both DIS shares as well as those for Netflix (NFLX). 

On its own Disney+ will cost users $6.99 a month, or $69.99 for a full year, but together with ESPN+ and ad-supported Hulu the bundle will run customers $12.99 per month, which is on par with the standard plan offered by Netflix that allows for two screens to be watching at the same time. The starter price for Disney+ allows for up to support for four simultaneous streams with 4K included. That’s quite a difference, and one that runs the risk of eating into Netflix’s business, particularly at the margin as Middle-class Squeeze consumers tally up how much they are spending on all of their streaming video and music as well as other subscription services

During D23 Disney showcased a plethora of Disney+ exclusive content ranging from its Star Wars to Marvel universes. On the Marvel front, Disney+ will include seven live action programs that are expected to tie into the active Marvel Cinematic Universe (MCU) that span existing characters and introduce new ones as well. While some may be missing the original Marvel streaming content that was found on Netflix, the upcoming Marvel content on Disney+ will continue the interlocking nature of the box office films that culminated in this summer’s blockbuster Avengers: Endgame. 

The original programming will be dribbled out over the coming quarters, but at launch Disney+ is expected to contain approximately 7,000 episodes of television series and 400 to 500 movies. According to Disney CEO Bob Iger, almost every single movie in the Disney catalog will eventually be available on the service. That is expected to pale in comparison to the sheer volume of content found on Netflix, which according to Ampere Analysis will be roughly eight times bigger than Disney+’s launch lineup. That may help explain the initial price point for Disney+ but what the service has going for it is it will be the only place one can find some of the biggest franchises in entertainment. That’s very much a page out of the Disney park playbook, and the odds are certainly high that Disney will leverage the content found on Disney+ across its merchandising and park businesses. It was also revealed that Disney and Target (TGT) will partner to open Disney shops inside Target locations, which should only add to the Disney merchandizing business. 

The looming question is to what degree will Disney+ attract subscribers? A far better sense will be had once the service goes live, but that hasn’t stopped Wall Street for putting forth expectations. Wedbush expects Disney to add between 10 million and 15 million subscribers to its service each year until they reach around 45 million. For context, that compares to roughly 60 million Netflix US subscribers and other firms are calling for a faster sign-up rate at Disney+ given the combination of cost and content. 

  • With details surrounding Disney+ becoming clearer, we are boosting our price target on Walt Disney (DIS) shares to $150 from $125. As subscriber data for Disney+ is shared, we’ll continue to refine our price target. 


What to watch this week

On the corporate earnings front this week, the parade of retail earnings will continue with J.Jill (JILL), Chico’s FAS (CHS), Tiffany & Co. (TIF), Best Buy (BBY), Ulta Beauty (ULTA), and Dollar Tree (DLTR) on tap to report, among others. In each of those reports, I’ll be looking for signals relating to our Living the Life, Digital Lifestyle, Aging of the Population, and Middle-class Squeeze investing themes. 

Beyond that cohort, we also have Sanderson Farms (SAFM) reporting and it will be interesting to see what it says about the growing prevalence of meat alternatives that are part of our Cleaner Living investing theme. . Yesterday, Cleaner Living Index company Beyond Meat (BYND) announced it will start testing plant-based fried chicken with YUM Brand’s (YUM) KFC in Atlanta beginning today, August 27. In keeping with that theme, we’ll be comparing and contrasting results at Campbell Soup (CPG) and Hain Celestial (HAIN) given the shifting preference among consumers for healthier foods and snacks. 

Also this week, specialty contractor and one-time Digital Infrastructure Thematic Leader Dycom Industries (DY) will issue its quarterly results and guidance, both of which should offer a view on 5G network buildout for its key customers that include AT&T (T) and Verizon (VZ). Given that Nokia (NOK) shares on the Select List, this will be a report worth digging into.   

While the number of economic data release last week were relatively light, they did pack quite a punch and that continued today with the July Durable Orders Report. While its headline figure showed a better than expected increase, excluding transportation, aircraft and defense to focus on core capital goods the data revealed a 0.4% increase in July, which followed the 0.9% increase in June. Sucking some of the air out of that improvement, core capital goods shipments in July dropped 0.7%, which will weigh on September quarter GDP forecasts. Over the coming days, we’ll get several other pieces of economic July data including trade inventories and Personal Income & Spending reports. 

Coming off a better-than-expected July Retail Sales report, we expect investors will be closely watching the July Personal Income & Spending report to gauge the degree to which consumers can be counted on to power the economy in the second half of the year. In addition to the usual monthly economic data, this week will also bring us the second GDP estimate for the June quarter. As focused as some might be on that revision, we here at Tematica far more focused on what the continued slowdown in the current quarter means for the market and investors. 

The Magic 8-Ball Market

The Magic 8-Ball Market

Last week ended with equity markets taking another dive that accelerated into Friday’s close as the trade war with China intensified heading into its eighteenth month with China announcing that it will impose retaliatory tariffs on US goods. The S&P 500 closed down 2.5% for the third time this month. After the close President Trump launched a twitter storm to announce additional retaliatory tariffs in response to China’s. So that’s going well.

Investors face challenging times as the major market movers have simply been words (tweets) coming from politicians and bureaucrats, the prediction of which is akin to assessing the next missive from a Magic 8-Ball.

While many continue to talk about the ongoing bull market, the major US equity market indices have seen four consecutive weekly declines and are all in the red over the past year with the small cap Russell 2000 down well over 10%, sitting solidly in correction territory. On the other hand, this year has seen the strongest performance out of long-maturity Treasuries since at least 1987.


Source: Bespoke Investment Group

How many bull markets see the total return for the long bond outpace the S&P 500 by over 16%.

This comes at a time when the domestic economy is in it 121st month, the longest is post-war history, which means that many have not lived through a recession as an adult.


Yield Curve

As the adage goes, expansions don’t die of old age, but their footing becomes less sure over time and we are seeing signs of rockier terrain. One sign comes from the yield curve which has been flattening steadily since October 2018 with the spread between the 10-year and the 3-month falling from over 100 basis points to -39. The most widely watched part of the curve, between the 10-year and 2-year, has inverted four times in the past few weeks.


This 2-10 inversion is most closely watched as over the past 50 years it has preceded all seven recessions. Credit Suisse has found that on average a recession hit 22 months after the 2-10 inversion occurred.

The third of August’s four inversions came as Kansas City Federal Reserve President Esther George and Philadelphia Fed President Patrick Harker stated in a CNBC interview that they don’t see the case for additional interest rate cuts following the cut in July. Mr. Market was not looking to hear that.

This past week we also received the meeting minutes from the prior Fed meeting with led to July’s 25 basis point cut which gave the impression of a Fed far less inclined to cut than the market was expecting with most Fed participants seeing July’s cut as part of a recalibration but not part of a pre-set course for future cuts. Keep in mind that central bank rate cuts are a relative game and ECB officials have been signaling a high likelihood of significant accommodative measures at the September meeting, saying the ECB “will announce a package of stimulus measures at its next policy meeting in September that should overshoot investors’ expectations.”

Manufacturing

Another source of bumps on the economic road comes from the manufacturing sector, both domestic and international. A recent IHS Markit report found that the US manufacturing sector is in contraction for the first time in nearly a decade as the index fell from 50.4 in July to a 119-month low of 49.9 in August – readings below 50 indicate contraction.

According to the Institute for Supply Management, US manufacturing activity has slowed to a nearly three-year low in July. By August New Orders (a key leading indicator) had dropped by the most in 10 years with export sales falling to the lowest level since August 2009.

New business growth has slowed to its weakest rate in a decade, particularly across the service sector. Survey respondents mentioned headwinds from weak corporate spending based on slower growth expectations both domestically and internationally – likely caused by the ongoing trade war that got much, much worse this past week.

In a note to clients on August 11th, Goldman Sachs stated that fears of the US-China trade war leading to a recession are increasing and that the firm no longer expects a trade deal between the two before the 2020 US election. The firm also lowered its GDP forecast for the US in the fourth quarter by 20 basis points to 1.8%.

Global manufacturing has also been slowing, with just two of the G7 nations, Canada and France, currently showing expansion in the sector. In July, China’s industrial output growth slowed to the weakest level in 17 years.

Germany is seeing the most pronounced contraction with its manufacturing PMI dropping from 63.3 in December 2017 to 43.6 this month. German car production has fallen to the levels last seen during the financial crisis.

Overall, we see no sign of stabilization in global manufacturing as global trade volumes look to be rolling over, leaving the economy heavily dependent on growth in the Consumer and the Service sectors. Keep in mind that the last time global trade volumes rolled over like this was back in 2008.

The Consumer

The consumer is yet another source of bumps on the economic road. Ms. Pomboy’s tweet is perfect.

As for that debt, Citigroup recently reported that its credit-card delinquency rate had risen to 2.91% in July from 2.56% in June versus its three-month average of just 1.54%. With all the positive stock moves we’ve seen in retail, keep in mind that the story for many has been more about earnings than actual growth.

For example, Nordstrom (JWN) shares rose 21% after it delivered stronger-than-expected earnings, but that was off of weaker than expected revenue of $3.87 billion versus expectations for $3.93 billion. Nordstrom also slashed net sales guidance for the fiscal year as well as earnings guidance. Management forecast net sales for the year to decrease by about 2%. It previously estimated sales would be flat to 2% down. It also slightly lowered guidance on earnings per share to a range of $3.25 to $3.50, compared with the prior guidance of between $3.25 to $3.65. Did I mention shares rose 21%?

US Consumer sentiment fell to 92.1 in August, the lowest reading for 2019, versus expectations for 97 and down from 98.4 in July. If sentiment continues to degrade, how long will the consumer continue to load up credit cards in order to spend?

Debt

It isn’t just the consumer that is taking on more debt – yet more economic bumps. The federal government deficit rose by $183 billion to $867 billion during just the first 10 months of this fiscal year as spending grew at more than twice the rate of tax collections. The Congressional Budget Office expects the annual budget deficit to be more than 1 TRILLION dollars a year starting in 2022. Total public debt, which includes federal, state and local has reached a record 121% of GDP in 2019, up from 69% in 2000 and 43% in 1980.

Keep in mind that debt is pulling resources out of the private sector and at such high levels, fiscal stimulus becomes more challenging in times of economic weakness. The only time debt to GDP has been higher was after WWII, but back then we had relatively young population and a rapidly growing labor force compared to today.

I’ve mentioned before that I am concerned with the strengthening dollar. Dollar denominated on balance sheet debt is over $12 trillion with roughly an additional $14 trillion in off-balance sheet dollar denominated debt – that’s a huge short USD position. The recent resolution of the debt ceiling issue means that the US Treasury now needs to rapidly rebuild its cash position as I had been funding the government through its reserves. This means that we will see a drain on global liquidity from the issue of over $200 billion in Treasury bills.

I’ve also written many times in the past concerning the dangers that lie in the enormous levels of corporate debt with negative yielding corporate debt rising from just $20 billion in January to pass the $1 trillion mark recently – more bumps on the road.

Bottom Line

As I said at the start of this piece, this expansion is the longest in post-war history which doesn’t itself mean a recession is imminent, but it does mean that the economy is likely to be more vulnerable. Looking next at the economic indicators we see quite a few that also imply a recession is increasingly likely.

The President’s twitter storm in response to China’s tariffs and the continually rising geopolitical uncertainties that create a strong headwind to any expansions in the private sector only increase risks further. Perhaps by the time you read this piece some part of the rapid escalation of the trade war will have been reversed, as foreign policy has become increasingly volatile day-to-day, but either way, the view from here is getting ugly.

Weekly Issue: Trade and geopolitical issues make for a less than sleepy August 2019

Weekly Issue: Trade and geopolitical issues make for a less than sleepy August 2019

Key points inside this issue

  • Trade and geopolitical issues make for a less than sleepy August 2019
  • What to watch this week
  • Earnings this week
  • Economic data this week
  • The Thematic Aristocrats?

Uncertainty continued to grip the stock market last week as the U.S.-Chinese trade dispute once again took center stage. After the return of tariff talk week prior, the battle expanded this week to include a war of words between Washington and Beijing over the Chinese yuan’s devaluation.

The market ultimately shook that off, in part due to the renewed thought that the Federal Reserve could accelerate interest-rate cuts. But then stocks closed lower week over week after President Trump suggested Friday that trade talks with China set for next week might be canceled.

There’s also renewed geopolitical uncertainty — not just Britain’s Brexit process, but also a looming no-confidence vote against Italian Prime Minister Giuseppe Conte that’s once again plunging Italy into political turmoil. And as if that wasn’t enough, over the weekend escalating tensions between Chinese authorities and protesters in Hong Kong were added to the mix, making for one big ball of uncertainty even bigger.

Meanwhile, global economic data continue to soften. This gives some credence to the notion that the Fed could become more dovish than Chairman Jerome Powell suggested during his July 31 press conference following the Federal Open Market Committee’s decision to cut rates. While I don’t expect anything near-term, down below we have a calendar date to mark even though I don’t think it will mean much in the way of monetary policy.

We’re seeing confirming signs for the economic data in oil and copper prices, both of which have been mostly declining of late. Not exactly signs of a vibrant and growing global economy.

Odds are that as we head into summer’s final weeks, stocks will be range-bound at best as they trade based on the latest geopolitical headlines. And odds are there won’t’ be any newfound hope to be had on the earnings front. With 90% of S&P 500 stocks already reporting second-quarter results, it looks like we’ll see another year-over-year decline in quarterly average earnings. For the full year 2019 those earnings are only growing at a 2.5% annual rate, but if President Trump goes forth with the latest round of announced tariffs, odds are those expectations could come down in the coming weeks – more on that below.

All in all, barring any meaningful progress on US-China trade, which seems rather unlikely in the near-term, at best the stock market is likely to be rangebound in the coming weeks. Even though much of Wall Street will be “at the beach” the next few weeks, odds are few will be enjoying their time away given the pins and needles discussed above and further below.

What to watch this week

We have three weeks until the Labor Day holiday weekend, which means we’re entering one of the market’s historically slowest times. There’s typically lower volume than usual, as well as low conviction and wishy-washy moves in the market.

Traditionally, a more-sobering look emerges once Wall Street is “back from the beach” following the Labor Day holiday. This tends to bring a sharper picture of the economy. There are also ample investor conferences where companies update their outlooks as we head into the year’s last few months.

But as we saw this past week, geopolitical and trade tensions could make the next few weeks much more volatile than we’ve seen in the past. As we navigate these waters, we’ll continue to assess what this means for earnings — particularly given that analysts don’t expect the S&P 500 companies to see year-over-year earnings-per- share growth again until the fourth quarter. In my view that puts a lot of hope on a seasonally strong quarter that could very well be dashed by President Trump’s potential next round of tariffs. I say this because retailers now face the 10% tariffs set to go into effect on September 1, which will hit apparel and footwear, among other consumer goods.

The risk is we could very well see 2019 turn into a year with little to no EPS growth for the S&P 500, and if factor out the impact of buybacks it likely means operating profit growth had at the S&P 500 is contracting year over year. We’ll know more on that in the coming weeks, but if it turns out to be the case I suspect it will lead many an investor to question the current market multiple of 17.6x let alone those market forecasters, like the ones at Goldman Sachs, that are calling for 3,100 even as their economists cut their GDP expectations.

Earnings this week

This week will have the slowest pace of earnings releases in about a month, with only some 330 companies issuing quarterly results. That’s a sharp drop from roughly 1,200 such reports that we got last week.

Among those firms reporting numbers next week, we’ll see a sector shift toward retail stocks, including Macy’s (M), J.C. Penney (JCP) and Walmart (WMT). Given what I touched on above, I’ll be listening for their comments on the potential tariff impact as well as comments surrounding our Digital Lifestyle and Middle-class Squeeze investing themes, and initial holiday shopping expectations.

This week’s earnings reports also bring the latest from Cisco Systems (CSCO), Nvidia (NVDA), and Deere (DE). Given how much of Deere’s customer base sells commodities like U.S. soybeans (which China has hit with tariffs), we’ll carefully listen to management’s comments on the trade war. There could be some tidbits for our New Global Middle-class theme from Deere as well. With Cisco, we could hear about the demand impact being generated by 5G network buildouts as well as the incremental cyber security needs that will be needed. These make the Cisco earnings conference call one to listen to for our Digital Infrastructure and Safety & Security investing themes.

 

Economic data this week

On the economic front, we’ll get July reports for retail sales, industrial production and housing starts, as well as the August Empire Manufacturing and Philly Fed surveys. Given the importance of the consumer, the July Retail Sales will be one to watch and I for one expect it to be very bullish for our Digital Lifestyle investing theme if and only if because of Amazon’ 2019 Prime Day and all the other retailers that tried to cash in on it. I suspect, however, the report will reveal more gloom for department stores. All in all the week’s economic data points will help solidify the current quarter’s gross domestic product expectations, which are sitting at 1.6%-1.9% between the New York and Atlanta Fed.

Based on what we’ve seen of late from IHS Markit for Japan, China and the Eurozone, that still makes America the best economic house on the block. Granted, the U.S. vector and velocity are still in the down and slowing positions, but we have yet to see formal signs of a contracting domestic economy. As Tematica’s Chief Macro Strategist Lenore Hawkins pointed out in her most recent assessment of things, we’ll need to keep tabs on the dollar for “The deflationary power of a strengthening US dollar strength in the midst of slowing global trade and trade wars just may overpower anything central banks try.”

Odds are that as the latest economic figures hit, especially if they keep the economy’s recent vector and velocity intact, we will see more speculation on what the Fed might do next. While there’s no Fed interest-rate meeting scheduled for August, the Kansas City Fed will hold its widely watched annual Jackson Hole symposium Aug. 22-24 in Wyoming. The central bank doesn’t usually discuss monetary-policy plans at this event, but as noted above, we aren’t exactly in normal times these days.

 

The Thematic Aristocrats?

Given the recent market turbulence as prospects for more of the same in the coming weeks, I’m sitting back and building our shopping list for thematically well-positioned companies. Given the economic data of late and geo-political uncertainties as well as Lenore’s comments on the dollar, I’m focusing more on domestic-focused, inelastic business models that tend to spit off cash and drive dividends. In particular, I’m looking at companies with a track record of increasing their dividends every year for at least 10 years. And of course, they have to have vibrant thematic tailwinds at their respective back.

Perhaps, we can informally call these the “Thematic Aristocrats”?

I’ll have more as I refine that list.

WEEKLY ISSUE: Uncertainty is back, but we’re thematically prepared

WEEKLY ISSUE: Uncertainty is back, but we’re thematically prepared

Key points inside this issue:

  • The Fed, Trump, tariffs and the data bring uncertainty back to the market
  • What it means for investors
  • We will continue to hold Disney (DIS), Apple (AAPL), Amazon (AMZN) and AT&T (T) shares.
  • What to watch this week

The Fed, Trump, tariffs and the data bring uncertainty back to the market

Between the number of S&P 500 companies reporting last week to the Fed’s FOMC meeting and the pieces of economic data coming at us, we knew it was going to be a busy and potentially volatile week. What few saw coming was the attempt by Fed Chairman Powell to give the market the 25 basis point rate cut it was expecting and regain the position of the market not knowing exactly what the Fed’s next move might be. But then we received the July ISM Manufacturing Index and the July IHS PMI data for the four global economic horsemen (China, Japan, the eurozone and the US). In aggregate those data points signaled the continued slowdown in the global manufacturing economy.  

Granted, the sequential pick up in the July ADP Employment Report fostered the view the domestic economy hasn’t frozen over just yet, but Friday’s July Employment Report reveled slower job creation month over month. 

Normally, economic data like we’ve received in the back half of last week would be enough to ignite the market doves and stoke the view that another rate cut by the Fed was more likely before we exit 2019. And it was that view that led the major market indices higher on Thursday, that was until President Trump did something that arguably next to no one saw coming – announced another layer of tariffs on China that would go into effect on September 1. The implications of that move, which would likely lead to yet another trimming of forecasts for both the economy and earnings, pulled the market lower on Thursday afternoon. 

And on Friday morning, China responded by saying while it does not want a trade war, its not afraid to fight one. Soon thereafter, President Trump is “open to delaying or halting the 10% tariff on September 1” if China were to take action between now and then. Remember, we shared our concern that trade talks could devolve into playground taunting and fighting. Well, we are there and sticking with the analogy, it’s likely going to keep the stock market on the uncertainty teeter totter for the next few weeks. 

If some were hoping for a more normal August for stocks following this week’s Fed meeting, we’re sorry to say that’s not likely to happen. In the past we’ve shared several analogies about investing – it’s not crock pot cooking, you can’t fix it and forget it or investing is not a like a photo, i.e. snapshot in time, but much like a good film it’s an evolving story. As this latest chapter begins to unfold, it will be mean assessing and re-assessing expectations as new developments are had and their ripple effects determined.

What it means for investors

Odds are this will uncertainty will result in the usual back and forth for the market in the coming weeks, which will also see the usual end of summer low trading volumes. While a good chunk of Wall Street is at the beach, I’ll remain vigilant and continue to leverage our thematic lens.

More than likely, we will see the herd once again focus on domestically focused as well as inelastic business models as it looks for ports of safety. We’ve have a number of these among the Thematic Leaders and the Tematica Select List – Chipotle Mexican Grill (CMG), Dycom Industries (DY), Costco Wholesale (COST), Axon Enterprises (AAXN), AT&T (T), and USA Technologies (USAT). Unlike the shoot from the hip go to choice of the herd that tends to zero in on electric utilities that group of six have the added benefit of thematic tailwinds propelling their respective businesses.

As August drips by, I’ll continue to look for thematically well positioned companies that offer favorable risk to reward tradeoffs in terms of share prices as I look to position us for what lies ahead. In the meantime, I would recommend subscribers catch the August 5, 2019 issue of Bloomberg Businessweek as the cover story focuses the coming streaming video war that I’ve talked about both here and on the Thematic Signals podcast. The author likens it to “The Hunger Games”, and in many respects I can see why that is a good comparison.

While we were recently stopped out of Netflix (NFLX), I’ll remind you that among the Thematic Leaders and Tematica Select List we have several companies — Disney (DIS), Apple (AAPL), Amazon (AMZN), and AT&T in particular – that are focusing on this market. Each brings their own particular set of strengths ranging from content to addressable customer base, but all three have other businesses besides streaming video to drive profits and cash flow that can fund their respective streaming businesses.

  • We will continue to hold Disney (DIS), Apple (AAPL), Amazon (AMZN) and AT&T (T) shares.

What to watch this week

After all the happenings for last week that I described above, this week looks to be yet another frenetic one for corporate earnings with more than 1,100 reports to be had, but the pace of June quarter earnings begins to slow and we face a lighter economic data schedule as well. And to be clear, even though we will face a plethora of June quarter reports, let’s remember that exiting this week roughly 78% of the S&P 500 has reported and next week another 13% of that group will be doing so. What this means is the vast majority of reports next will have far less of an impact on the market. This doesn’t diminish them from an ownership of data and information perspective, but rather a smaller impact is likely on earnings revisions and trading ranges. 

Corporate earnings to watch

In terms of which reports I’ll be focusing on this week, it should come as little surprise that they are the ones touching our various investment themes. Here’s my short list:

  • Monday, August 5: Tyson Foods (TSN), International Flavors & Fragrances (IFF), Insulet (PODD) and ShakeShak (SHAK). 
  • Tuesday, August 6: Tenneco (TEN), ADT (ADT), AMN Healthcare (AMN), Comscore (SCOR), LendingClub (LC), Disney (DIS), 
  • Wednesday, August 7: CVS Health (CVS:NYSE), CyberArk (CYBR), Physicians Realty Trust (DOC), Darling Ingredients (DAR), Skyworks (SWKS), Tivity Health (TVTY), 
  • Thursday, August 8: Activision-Blizzard (ATVI:), Alarm.com (ARLM), Dropbox (DBX), Synaptics (SYNA:Nasdaq), Uber (UBER) 
  • Friday, August 9: US Concrete (USCR)

Economic data to watch

Before we tackle the coming week’s economic data, I’ll mention GDP expectations from the Atlanta Fed and New York Fed started last week off between 2.0%-2.2% and as we exited the week those expectations sat at 1.6%-1.9%. As I touched on above, the employment data we received last week pointed to a still growing economy but the take on the manufacturing economy per the July ISM Manufacturing Index and the July US IHS Markit PMI data pointed to a slowing domestic manufacturing one. 

We have only a handful of meaningful economic data coming at us this week in the form of the July inflation reports and ISM’s July reading on the US service economy. Given our pension for looking at other data set in addition to the formal economic data, we here at Tematica will be on the lookout for the last Cass Freight Index and other truck tonnage figures as well as the weekly railcar loading data. Those have been signaling the slowdown we’ve seen in the government produced economic data, and as such we’ll keep a close watch on them in order to stay one step ahead of the herd. 

Should the coming economic data be continue to disappoint relative to expectations and signal the vector and velocity of the domestic economy is down and even slower than recent revisions suggest, odds are the market will increasingly expect another Fed rate cut sooner than later. Our concern, however, is the intended effect of this week’s rate cut and another one should it come to pass on business investment could be muted by the continued trade uncertainty and weakening global economy. As we’ve seen with falling mortgage rates that didn’t stimulate demand earlier this year, in the near-term businesses may stay on the sidelines given the trade and economic uncertainties despite more favorable interest rates.


Central Bankers’ New Clothes

Central Bankers’ New Clothes

In this week’s musings:

  • Earnings Season Kicks Off 
  • Central Bankers’ New Clothes 
  • Debt Ceiling – I’m Baaack
  • Trade Wars – The Gift that Keeps on Giving
  • Domestic Economy – More Signs of Sputtering
  • Stocks – What Does It All Mean

It’s Earnings Season

Next week banks unofficially kick off the June quarter earnings season with expectations set for a -2.6% drop in S&P 500 earnings, (according to FactSet) after a decline of -0.4% in the first quarter of 2019. If the actual earnings for the June quarter end up being a decline, it will be the first time the S&P 500 has experienced two quarters of declines, (an earnings recession) since 2016. Recently the estimates for the third quarter have fallen from +0.2% to -0.3%. Heading into the second quarter, 113 S&P 500 companies have issued guidance. Of these, 87 have issued negative guidance, with just 26 issuing positive guidance. If the number issuing negative guidance does not increase, it will be the second highest number since FactSet began tracking this data in 2006. So not a rosy picture.

Naturally, in the post-financial crisis bad-is-good-and-good-is-bad-world, the S&P 500 is up nearly 20% in the face of contracting earnings — potentially three quarters worth — and experienced the best first half of the year since 1997. In the past week, both the S&P 500 and the Dow Jones Industrial Average have closed at record highs as Federal Reserve Chairman Powell’s testimony before Congress gave the market comfort that cuts are on the way. This week’s stronger than expected CPI and PPI numbers are unlikely to alter their intentions. Welcome to the world of the Central Bankers’ New Clothes. 

Central Bankers’ New Clothes

Here are a few interesting side-effects of those lovely stimulus-oriented threads worn in the hallowed halls of the world’s major central banks.

https://www.tematicaresearch.com/wp-content/uploads/2019/07/2019-07-12-EU-EM-Neg-Yields.png https://www.tematicaresearch.com/wp-content/uploads/2019/07/2019-07-12-Greek-below-UST.png

Yes, you read that right. Greece, the nation that was the very first to default on its debt back in 377BC and has been in default roughly 50% of the time since its independence in 1829, saw the yield on its 10-year drop below the yield on the 10-year US Treasury bond. But how can that be?

Back to those now rather stretchy stimulus suits worn by the world’s central bankers that allow for greater freedom of movement in all aspects of monetary policy. In recent weeks we’ve seen a waterfall of hints and downright promises to loosen up even more. The European Central Bank, the US Federal Reserve, the Bank of Canada have all gone seriously dovish. Over in Turkey, President Erdogan fired his central banker for not joining the party. Serbia, Australia, Dominican Republic, Iceland, Mozambique, Russia, Chile, Azerbaijan, India, Australia, Sri Lanka, Kyrgyzstan, Angola, Jamaica, Philippines, New Zealand, Malaysia, Rwanda, Malawi, Ukraine, Paraguay, Georgia, Egypt, Armenia, and Ghana have all cut rates so far this year, quite a few have done so multiple times. From September of 2018 through the end of 2018, there were 40 rate hikes by central banks around the world and just 3 cuts. Since the start of 2019, there have been 11 hikes and 38 cuts.

That’s a big shift, but why? Globally the economy is slowing and in the aftermath of the financial crisis, a slowing economy is far more dangerous than in years past. How’s that?

In the wake of the financial crisis, governments around the world set up barriers to protect large domestic companies. The central bankers aimed their bazookas at interest rates, which (mostly as an unintended consequence) ended up giving large but weak companies better access to cheap money than smaller but stronger companies. This resulted in increasing consolidation which in turn has been shrinking workers’ share of national income. For example, the US is currently shutting down established companies and generating new startups at the slowest rates in at least 50 years. Today much of the developed world faces highly consolidated industries with less competition and innovation (one of the reasons we believe our Disruptive Innovators investing theme is so powerful) and record levels of corporate debt. It took US corporations 50 years to accumulate $3 trillion in debt in the third quarter of 2003. In the first quarter of 2019, just over 15 years later, this figure had more than doubled to $6.4 trillion.

Along with the shrinking workers’ share of national income, we see a shrinking middle class in many of the developed nations – which we capitalize on in our Middle Class Squeeze investing theme. As one would expect, this results in the economy becoming more and more politicized – voters aren’t happy. Recessions, once considered a normal part of the economic cycle, have become something to be avoided at all costs. The following chart, (using data from the National Bureau of Economic Research) shows that since the mid-1850s, the average length of an economic cycle from trough to peak has been increasing from 26.6 months between 1854 and 1919 to 35 months between 1919 and 1945 to 58.4 months between 1945 and 2009. At the same time, the duration of the economic collapse from peak to trough has been shrinking. The current trough to (potential peak) is the longest on record at 121 months – great – but it is also the second weakest in terms of growth, beaten only by the 37-month expansion from October 1945 to November of 1948.

https://www.tematicaresearch.com/wp-content/uploads/2019/07/2019-07-12-Economic-Cycles.png

Why has it been so weak? One of the reasons has been the rise of the zombie corporation, those that don’t earn enough profit to cover their interest payments, surviving solely through refinancing – part of the reason we’ve seen ballooning corporate debt. The Bank for International Settlements estimates that zombie companies today account for 12% of all companies listed on stock exchanges around the world. In the United States zombies account for 16% of publicly listed companies, up from just 2% in the 1980s. 

This is why central bankers around the world are so desperate for inflation and fear deflation. In a deflationary environment, the record level of debt would become more and more expensive, which would trigger delinquencies, defaults and downgrades, creating a deflationary cycle that feeds upon itself. Debtors love inflation, for as purchasing power falls, so does the current cost of that debt. But in a world of large zombie corporations, a slowing economy means the gap between profit and interest payments would continue to widen, making their survival ever more precarious. This economic reality is one of the reasons that nearly 20% of the global bond market has negative yield and 90% trade with a negative real yield (which takes inflation into account).

Debt Ceiling Debate – I’m baack!

While we are on the topic of bonds, the Bipartisan Policy Center recently reported that they believe there is a “significant risk” that the US will breach its debt limit in early September if Congress does not act quickly. Previously it was believed that the spending wall would not be hit until October or November. As the beltway gets more and more, shall we say raucous, this round could unnerve the markets.

Trade Wars – the gift that keeps on giving

Aside from the upcoming fun (sarcasm) of watching Congress and the President whack each other around over rising government debt, the trade war with China, which gave the equity markets a serious pop post G20 summit on the news that progress was being made, is once again looking less optimistic. China’s Commerce Minister Zhong Shan, who is considered a hardliner, has assumed new prominence in the talks, participating alongside Vice Premier Liu He (who has headed the Chinese team for over a year) in talks this week. The Chinese are obviously aware that with every passing month President Trump will feel more pressure to get something done before the 2020 elections and may be looking to see just how hard they can push.

Trade tensions between the US and Europe are back on the front page. This week, senators in France voted to pass a new tax that will impose a 3% charge on revenue for digital companies with revenues of more than €750m globally and €25m in France. This will hit roughly 30 companies, including Apple (AAPL), Facebook (FB), Amazon (AMZN) and Alphabet (GOOGL) as well as some companies from Germany, Spain, the UK and France. The Trump administration was not pleased and has launched a probe into the French tax to determine if it unfairly discriminates against US companies. This could lead to the US imposing punitive tariffs on French goods.

Not to be outdone, the UK is planning to pass a similar tax that would impose a 2% tax on revenues from search engine, social media and e-commerce platforms whose global revenues exceed £500m and whose UK revenue is over £25m. This tax, which so far appears to affect US companies disproportionately, is likely to raise additional ire at a time when the US-UK relationship is already on shaky ground over leaked cables from the UK’s ambassador that were less than complimentary about President Trump and his administration.  

That’s just this week. Is it any wonder the DHL Global Trade Barometer is seeing a contraction in global trade? According to Morgan Stanley research, just under two thirds of countries have purchasing manager indices below 50, which is contraction territory and further warning signs of slowing global growth. This week also saw BASF SE (BASFY), the world’s largest chemical company, warn that the weakening global economy could cut its profits by 30% this year.

Domestic Economy – more signs of sputtering

The ISM Manufacturing index weakened again in June and has been declining now for 10 months. The New Orders component, which as its name would imply, is more forward-looking, is on the cusp of contracting. It has been declining since December 2017 and is at the lowest level since August 2016. Back in 2016 the US experienced a bit of an industrial sector mini-recession that was tempered in its severity by housing. Recall that back then we saw two consecutive quarters of decline in S&P 500 earnings. Today, overall Construction is in contraction with total construction spending down -2.3% year-over-year. Residential construction has been shrinking year-over-year for 8-months and in May was down -11.2% year-over-year. Commercial construction is even worse, down -13.7% year-over-year in May and has been steadily declining since December 2016. What helped back in 2016 is of no help today.

While the headlines over the employment data (excepting ADP’s report last week) have sounded rather solid, we have seen three consecutive downward revisions to employment figures in recent months. That’s the type of thing you see as the data is rolling over. The Challenger, Gray & Christmas job cuts report found that employer announced cuts YTD through May were 39% higher than the same period last year and we are heading into the 12thconsecutive month of year-over-year increases in job cuts – again that is indicative of a negative shift in employment.

Stocks – what does it all mean?

Currently, US stock prices, as measured by the price-to-sales ratio (because earnings are becoming less and less meaningful on a comparative basis thanks to all the share buybacks), exceed what we saw in the late 1999s and early 2000s. With all that central bank supplied liquidity, is it any wonder things are pricey?

On top of that, the S&P 500 share count has declined to a 20-year low as US companies spent over $800 million on buybacks in 2018 and are poised for a new record in 2019 based on Q1 activity. Overall the number of publicly-listed companies has fallen by 50% over the past 20 years and the accelerating pace of stock buybacks has made corporations the largest and only significant net buyer of stocks for the past 5 years! Central bank stimulus on top of fewer shares to purchase has overpowered fundamentals.

This week, some of the major indices once again reached record highs and given the accelerating trend in central bank easing, this is likely to continue for some time — but investors beware. Understand that these moves are not based on improving earnings, so it isn’t about the business fundamentals, (at least when we talk about equity markets in aggregate as there is always a growth story to be found somewhere regardless of the economy) but rather about the belief the central bank stimulus will continue to push share prices higher. Keep in mind that the typical Federal Reserve rate cut cycle amounts to cuts of on average 525 basis points. Today the Fed has only about half of that with which to work with before heading into negative rate territory.

The stimulus coming from most of the world’s major and many of the minor central banks likely will push the major averages higher until something shocks the market and it realizes, there really are no new clothes. What exactly that shock will be — possibly the upcoming debt ceiling debates, trade wars or intensifying geological tensions — is impossible to know with certainty today, but something that cannot go on forever, won’t.

Seeing Through the Smoke of the Trade War

Seeing Through the Smoke of the Trade War

I’d like to open this week’s piece with a bit of Twitter wisdom – as much as an oxymoron as that sounds.

The impact of Federal Reserve Chairman Powell’s sweet whispers to the market that the 2018 rate hikes are on hold for 2019 is wearing off as politics and trade tensions dominate the markets. I’m going to go out on a limb here and suggest that prescriptions for Xanax and the like have been on the rise inside the beltway in recent weeks. Those headlines investors are trying to navigate around are dominated by talk of the trade war with China, which has evolved from last year’s Presidential tweet.

Fourteen months later, the May 23rd, 2019 comment from Ministry of Commerce spokesperson Gao Feng in Mandarin, (according to a CNBC translation) casts a different tone.

“If the U.S. would like to keep on negotiating it should, with sincerity, adjust its wrong actions. Only then can talks continue.”

So that’s going well. China appears to very much be digging in its heels and preparing for a prolonged battle. We are hearing talk of a ‘cold war’ on the tech sector and the New York Times wrote, “Mnuchin Presses Companies For Trade War Contingency Plans.”

With all that, it is no wonder that the CBOE S&P 500 Volatility Index (VIX) has moved above both its 50-day and 200-day moving average.

May has not been kind to the major US indices.

^SPX Chart

^SPX data by YCharts

Many market bellwethers that had previously been investor darlings are in or shortly will be in correction territory.

GOOGL Chart

GOOGL data by YCharts

But the US economy is strong right? As we’ve mentioned in prior pieces here and here, not so much. This week the Financial Times reported that non-performing loans at the 10 largest commercial US banks rose 20% in the first quarter. That was in a quarter in which GDP came in above 3% and above expectations. What happens in a weak quarter? Those banks aren’t being helped by falling interest rates either, which crush their margins. The yield on the 10-year Treasury note has fallen below the mid-point on the Fed’s target range for the overnight funds rate. A flat-to-inverted yield curve just screams economic party-on.

As we look at growth in the second quarter, remember that the first quarter build-up in inventories was a function of the trade war. Businesses were stocking up before tariffs and in response to all the uncertainty. This buildup was a pull forward in demand for stockpiling which serves as a headwind to growth in later quarters.

We are also seeing reports of trade war related supply chain disruptions, which means declining productivity. Remember that the growth of an economy is a function of the growth of the labor pool (all but tapped out) and growth in productivity. The Atlanta Fed’s GDPNow estimate reflects this with second quarter growth down to 1.3% from 1.6% on May 14th. Following the week’s slump in April core-capital goods orders the New York Fed’s Nowcast reading for the current quarter fell to 1.4% from 1.8% last week.

While the headlines are dominated by the trade wars or the latest drama in DC, what most aren’t watching is the most important factor in the global economy today – the rising dollar.

The US Dollar Index (ICE:DX) has been in a steady uptrend for over a year.

The broader Federal Reserve Trade Weighted US Dollar Index has broken above is December 2016 high and may be on its way to new all-time highs – if it breaks above 129.85, we are in unchartered territory.

Why does the dollar matter so much? About 80% of global trade relies on the US Dollar. Last year the Fed’s rate hikes drove up the price (AKA interest rate) of the dollar for other countries. As the US looks to reduce its trade deficit with many of its trading partners, that means less dollars available outside of the US. When the US imports, goods and services come into the country and dollars leave. A shrinking trade deficit creates a double whammy on the dollar of rising interest rate effects (higher price) and a reduction in supply.

The rising dollar obviously hurts the sales of US companies internationally, (think on this in light of that 20% rise in non-performing loans at US banks) but it is also major headwind to emerging markets, particularly given the massive amount of US dollar denominated debt in emerging economies. As quantitative easing pushed the dollar down, emerging economies gorged on US dollar denominated debt. That seemingly free lunch is now getting expensive, and if the dollar breaks into unchartered territory, that free lunch could turn into spewed chunks.

In addition to the problems with existing dollar denominated debt, the rising dollar increases the scarcity of capital in emerging markets. As the dollar increases relative to another nation’s currency, domestic asset values decline which means banks are less willing to lend. Investment declines and there goes the growth in emerging economies.

With respect to China and the dollar, as the US imposes tariffs on China, the roughly 8% decline in the renminbi versus the US Dollar has helped to offset the impact. This week the renmimbi dropped to nearly a six-month low, falling briefly below 7. To put that move in context, from the mid-1990s to July 2005, China had pegged its currency to 8.28 to the dollar. It only dropped below 7 in 2008 before the nation halted all movement as the financial crisis rolled across the globe. Trading resumed in 2010 officially within a managed band of a basket of currencies, but in practice primarily against the dollar. The big question now is will China let the renminbi stay below the 7 mark.

As global trade slows amidst trade wars, rising populism and dollar scarcity, exports in April in Asia showed the strain.

  • Indonesia -13.1%
  • Singapore NODX -10%
  • Taiwan -3.3%
  • China -2.7%
  • Thailand -2.6%
  • Japan -2.4%
  • South Korea -2%
  • Vietnam 7.5% (woot woot)

Looking at South Korea, semiconductors account for 1/5th of the nation’s exports and we’ve seen global semiconductor sales decline the fastest since 2009. With the ubiquitous nature of these chips, this says a lot above overall global growth. And that’s before the growing ban placed on China telecom company Huawei, which reportedly consumes $20 billion of semiconductors each year, is factored into the equation.

Worldwide Semiconductor Sales Chart

Worldwide Semiconductor Sales data by YCharts

It isn’t just the emerging economies that are struggling with a rising dollar. The Brexit embattled UK, (who just lost its current Prime Minister Theresa May) has seen its currency weaken significantly against the dollar, losing around 25% over the past 5 years – effectively a 25% tax on US imports from currency alone.

Pound Sterling to US Dollar Exchange Rate Chart

Pound Sterling to US Dollar Exchange Rate data by YCharts

The euro hasn’t fared well either. While above the 2017 lows, it has lost nearly 20% versus the dollar in the past 5 years – effectively a 20% tax on US imports from currency alone.

Euro to US Dollar Exchange Rate Chart

Euro to US Dollar Exchange Rate data by YCharts

If all that isn’t enough to get your attention, then just wait until later this summer when we have another debt ceiling drama to which we can look forward. With how well the left and right are getting along these days on Capitol Hill, I’m sure this will be smooth sailing. With volatility still relatively low (but rising) perhaps putting on a little bit of protection on one’s portfolio would be in order?

And on that note, have a great holiday weekend!

Weekly Issue: Streaming Services and the Middle Class Squeeze

Weekly Issue: Streaming Services and the Middle Class Squeeze

Key points inside this issue

  • Stocks continue to melt higher on hopes, but details will matter in the end
  • Our price target on Middle-Class Squeeze company Costco Wholesale (COST) remains $250.
  • Netflix: Mark your calendars for Apple and Disney events
  • Taking a look at LendingClub (LC) shares as consumer debt climbs

 

Sorry, we’re a day late with your weekly issue. I’m just back from InsideETFs 2019, the industry event for the exchange-traded (ETF) industry. This isn’t the first time I’ve attended the event, and attendees continue to hear about the uptake of ETFs, as well as the growing number of differentiated strategies to be had. Some, in my opinion, are faddish in nature, looking to capture assets even though their strategies may not be ones that survive more than a few years. We’ve got a long issue this week, so I’ll suffice to say that such ETFs are not thematic investing, but rather trend investing and we’re already starting to see several of those older trend products being repositioned to something else.

As we close out this week, we’ll be halfway through the first quarter of 2019. Hard to believe, as we have yet to go through the swarm earnings reports from retailers, but it’s true. Given what appears to be the rollbacking of items that weighed on the stock market during the last few months of 2018, we’ve seen all the major stock market indices rebound hard, even though the global economy continues to slow. Once again, this has made the US the best house in the neighborhood, which has likely bid up assets and made the dollar a headwind to multinational companies in the process. As we are fonding of saying, the devil is in the details and that includes any would be progress on US-China trade and Congress with immigration reform. We remain cautiously optimistic, especially on the China trade front, but recognize that more time is likely to be needed until a Trump-sized “big deal” can be reached.

As we get set for the second half of the quarter, we here at Tematica will continue to not only watch the data and our Thematic Signals to assess what’s the next likely step for the market from here, but also the happenings in Washington on trade and infrastructure.

 

Tematica Investing

Odds are, the Thematic Leaders have seen some lift from the sharp rebound in the market thus far in 2019. As we can see in the chart above, several of them are going gangbusters, including Chipotle Mexican Grill (CMG), Netflix (NFLX), Alibaba (BABA) and Axon Enterprises (AXXN). This morning we’ll get the first Retail Sales report since before the federal government shutdown, and in my view, it will more than likely continue to show what it did during all of 2018 – digital shopping taking share and Middle-Class Squeeze leader Costco Warehouse (COST) continuing to win consumer wallet share.

On a reported basis, Costco’s January same-store sales rose 6.6% (7.3% excluding the impact of gasoline prices and foreign exchange). Exiting the month, Costco operated 768 warehouse locations vs. 746 this time last year, a 3% year over year, which reflects its stated path to open more locations in 2019, allowing for the steady growth of its high margin membership fee revenue stream. In my view, this lays the groundwork for a favorable earnings report from Costco on March 7, which is also when it will publish its February sales results.

  • Our price target on Middle-Class Squeeze company Costco Wholesale (COST) remains $250.

 

Netflix: Mark your calendars for Apple and Disney

While we have our calendars out and are marking them for that upcoming Costco date I mentioned early, let’s also circle March 25th, which is the rumored date of Apple’s next event. Per the Apple rumor mill, the company will not only showcase its new news subscription service (say that three times), but also unveil its video service as well. This video service falls into the category of one of the best, worst kept secrets, given the number of deals it has inked for original shows and movies. The news subscription service, which is expected to be called Apple News Magazines, comes after Apple acquired Texture, the would-be Netflix (NFLX) of magazines last year.

While we could see a new device or two, this event will be focused primarily on Apple’s Services business, which it is using to further its position inside our Digital Lifestyle investing theme.  Much like Proctor & Gamble’s (PG) Gillette razor blade business, I would not be surprised if Apple adopts a similar mindset with its devices being the razor that gets replaced periodically, while its far more profitable Services business is the one that people consume on a frequent basis.

Soon after Apple’s event, Disney will hold its annual Investor Day on April 11th at which it is expected to unveil its much discussed, but yet to be seen Disney streaming service dubbed Disney+. Given its robust library of films, content, and characters, Disney should not be underestimated on this front, and in my view much like Apple and its Services business, success with Disney+ could change the way Wall Street values DIS shares. Key items to watch will be the Disney+ price point, original content rollout, and subscriber growth.

Stepping back, if one were to argue that we are on the path to a crowd of streaming services between Netflix, Amazon (AMZN), Hulu, CBS, NBC, AT&T (T), and now Apple and Disney, I would have to agree. In many ways, we’re heading for cable-TV without the cable box, but on an ala carte basis. While we’ve argued that consumers will go to where there is great content, the more streaming services there are the more likely we see the proliferation of good or not so good content. The risk they run is that just like cable channels that need to be filled with content, so too will their streaming services. Also too, one unknown is how many services will a person subscribe to? Past a certain point, consumers will balk, especially if all they’ve succeeded in doing is replicating that high cable bill they sought to originally sought to escape.

Needless to say, I’ll be watching the unveiling and uptake of these new services from Apple and Disney with an eye for what it may mean for Digital Lifestyle company Netflix (NFLX). One interesting item to watch will be to see what is actually included in the Disney and Apple services at launch and over time. Both companies are rumored to be working on streaming gaming services as are Microsoft (MSFT) and Alphabet (GOOGL), which to date is something Netflix has resisted at least publicly. If Apple were to bundle a gaming, video and news service along with Apple Music into one digital content bundle, that would offer some consumer wallet leverage over other single, stand-alone services.

 

Taking a look at LendingClub shares

Earlier this week, Tematica’s Chief Macro Strategist Lenore Hawkins posted a Thematic Signal for our Middle-Class Squeeze investing theme following the news that a record 7 million Americans are 90 days or more behind on their auto loan payments. Lenore went on to show some additional data that consumer loans from banks are in contraction mode, which as we know is a sign the US economy is not going gangbusters.

What we are seeing is the consumer looking to get their financial house in order, most likely after ringing up credit card, auto loan and student debt over the last several quarters. A new report from LendingTree (TREE) points to total credit card debt having climbed to more than $1 trillion in under five years, with more people using personal loans to manage existing debt. This has led the amount owed on personal loans to double what it was five years ago and the number of outstanding loans to rise some 50% in the last three years. According to the report’s findings, managing existing debt was the most popular reason for a personal loan, representing 61% of all loan requests in 2018. Of that percentage, 39% of borrowers plan to use their loans to consolidate debt, while 22% planned to use it to refinance credit cards.

From a stock detective’s point of view, the question to ask is what company is poised to benefit from this aspect of our Middle-Class Squeeze investing theme?

One candidate is LendingClub (LC), which operates an online credit marketplace that connects borrowers and investors in the US. It went public a few years ago and was heralded as a disruptive business for consumers and businesses to obtain credit based on its digital product offering. That marketplace facilitates various types of loan products for consumers and small businesses, including unsecured personal loans, unsecured education and patient finance loans, auto refinance loans, and unsecured small business loans. The company also provides an opportunity to the investor to invest in a range of loans based on term and credit.

Last year 78% of its $575 million in revenue was derived from loan origination transaction fees derived from its platform’s role in accepting and deciding on applications on behalf of the company’s bank partners. More than 50 banks—ranging in total assets of less than $100 million to more than $100 billion—have taken advantage of LendingClub’s partnership program.

LendingClub’s second largest revenue stream is derived from investors fees, which include servicing fees for various services, including servicing and collection efforts and matching available loans with capital and management fees from investment funds and other managed accounts, gains on sales of whole loans, interest income earned and fair value gains/losses from loans held on the company’s balance sheet.

In the past LendingClub was tainted with uncertainty given several investigations, but in mid-December, it settled with the SEC and DOJ, with the SEC stating:

“The SEC’s Enforcement Division determined not to recommend charges against LendingClub Corporation, which promptly self-reported its executives’ misconduct following a review initiated by its board of directors, thoroughly remediated, and provided extraordinary cooperation with the agency’s investigation.”

The SEC’s comments are a positive affirmation of the company’s internal procedures and policies, which also helps reduce the potential negative impact from the still-remaining Federal Trade Commission complaint. The FTC’s complaint against LendingClub charged it has misled consumers and has been deducting hidden fees from loan proceeds issued to borrowers.

Those recent developments have improved the company’s risk profile at a time when its core business has been growing given Middle-Class Squeeze pains being felt by more consumers. According to data TransUnion, subprime personal loan balances have been climbing since 2014 and are forecast to increase 20% this year to a record $156.3 billion.

Here’s the thing, the year-end shopping season isn’t just for shopping,  it’s also the seasonally strongest time of year for subprime loan originations, which according to TransUnion rose to 5 million loans at the end of 2018. That sets up what is likely to be a favorable December quarter earnings report from LendingClub when it issues those results next week (Tuesday, Feb. 19). The thing is I continue to see far more upside to be had with Middle-Class Squeeze Thematic Leader Costco Wholesale, which is not only growing its very profitable membership fee income stream the company is also a dividend payer.

 

Apple’s negative pre-announcement serves as a reminder to the number of risks that have accumulated

Apple’s negative pre-announcement serves as a reminder to the number of risks that have accumulated

 

We are “breaking in” to share my thoughts with you on the implications of Apple’s (AAPL) downside December quarter earnings news last night. Quickly this is exactly of what I was concerned about in early December, but rather than take a victory lap, let’s discuss what it means and what we’re going to do. 

Last night we received a negative December quarter earnings preannouncement from Apple (AAPL), which is weighing on both AAPL shares as well as the overall market. It serves as a reminder to the number of risks that have accumulated during the December quarter – the slowing global economy, including here at home; the US-China trade war; Brexit and other geopolitical uncertainty in the eurozone; the strong dollar; shrinking liquidity and a Fed that looks to remain on its rate hike path while also unwinding its balance sheet. Lenore Hawkins and I talked about these at length on the Dec. 21 podcast, which you can listen to here.

In short, a growing list of worries that are fueling uncertainty in the market and in corporate boardrooms. When the outlook is less than clear, companies tend to issue conservative guidance which may conflict with Wall Street consensus expectations. In the past when that has happened, it’s led to a re-think in growth prospects for both the economy, corporate profits and earnings, the mother’s milk for stock prices.

These factors and what they are likely to mean when companies begin issuing their December quarter results and 2019 outlooks in the coming weeks, were one of the primary reasons we added the ProShares Short S&P 500 (SH) shares to our holdings in just under a month ago. While the market fell considerably during December, our SH shares rose 5% offering some respite from the market pain. As expectations get reset, and odds are they will, we will continue to focus on the thematic tailwinds and thematic signals that have been and will remain our North Star for the Thematic Leaders and the larger Select List.

 

What did Apple have to say?

In a letter to shareholders last night, Apple CEO Tim Cook shared that revenue for the quarter would come in near $84 billion for the quarter vs. the consensus estimate of $91.5 billion and $88.3 billion, primarily due to weaker than expected iPhone sales. In the letter, which can be read here, while Apple cited several known headwinds for the quarter that it baked into its forecast such as iPhone launch timing, the dollar, supply constraints, and growing global economic weakness, it fingered stronger than expected declines in the emerging markets and China in particular.

Per the letter, most of the “revenue shortfall to our guidance, and over 100 percent of our year-over-year worldwide revenue decline occurred in Greater China across iPhone, Mac, and iPad.”

Cook went on to acknowledge the slowing China economy, which we saw evidence of in yesterday’s December Markit data for China. Per that report,

“The Caixin China General Manufacturing PMI dipped to 49.7 in December, the first time since May 2017 that the reading has been below 50, the mark that separates expansion from contraction. The sub-index for new orders slid below the breakeven point of 50 for the first time since June 2016, reflecting decreasing demand in the manufacturing sector.”

In our view here at Tematica, that fall in orders likely means China’s economy will be starting off 2019 in contraction mode. This will weigh on corporate management teams as they formulate their formal guidance to be issued during the soon to be upon us December quarter earnings season.

Also, in his letter, Cook called out the “rising trade tensions with the United States”  and the impact on iPhone demand in particular.

In typical Apple fashion, it discussed the long-term opportunities, including those in China, and other positives, citing that Services, Mac, iPad, Wearables/Home/Accessories) combined to grow almost 19% year-over-year during the quarter with records being set in a number of other countries. While this along with the $130 billion in cash that Apple has on its balance sheet exiting the December quarter, bode well for the long-term as well as its burgeoning efforts in healthcare and streaming entertainment, Apple shares came under pressure last night and today.

 

Odds are there will more negative earnings report to come

In light of the widespread holding of Apple shares across investor portfolios, both institutional and individual, as well as its percentage in the major market indices, we’re in for some renewed market pressure. There is also the reality that Apple’s decision to call out the impact of U.S.-China trade will create a major ripple effect that will lead to investors’ renewed focus on the potential trade-related downside to many companies and on the negative effect of China’s slowing economy.

In recent months we’ve heard other companies ranging from General Motors (GM) to FedEx (FDX) express concerns over the trade impact, but Apple’s clearly calling out its impact will have reverberations on companies that serve markets tied to both the smartphone and China-related demand. Overnight we saw key smartphone suppliers ranging from Skyworks Solutions (SWKS) and Qorvo (QRVO) come under pressure, and the same can be said for luxury goods companies as well. We’d note that Skyworks and Qorvo are key customers for Select List resident AXT Inc (AXTI, which means if we follow the Apple revenue cut through the supply chain, it will land on AXT and its substrate business.

All of the issues discussed above more than likely mean Apple will not be the only company to issues conservative guidance. Buckle up, it’s going to be a volatile few weeks ahead.

 

Positives to watch for in the coming weeks and months

While the near-term earnings season will likely mean additional pain, there are drivers that could lift shares higher from current levels in the coming months. These include a trade deal with China that has boasts a headline win for the US, but more importantly contains positive progress on key issues such as R&D technology theft, cybercrimes and the like – in other words, some of the meaty issues. There is also the Federal Reserve and expected monetary policy path that currently calls for two rate hikes this year. If the Fed is data dependent, then it likely knows of the negative wealth effect to be had following the drop in the stock market over the last few months.

Per Moody’s economist Mark Zandi, if stocks remained where there were as of last night’s close, it would equate to a $6 trillion drop in household wealth over the last 12-15 months. Per Zani, that would trim roughly 0.5% to 2019 GDP – again if the stock market stayed at last night’s close for the coming weeks and months. As we’re seeing today, and given my comments about the upcoming earnings season, odds are that 2019 GDP cut will be somewhat larger. That would likely be an impetus for the Fed to “slow its roll” on interest rates or at least offer dovish comments when discussing the economy.

Complicating matters is the current government shutdown, which has both the Census Bureau and Bureau of Economic Analysis closed. Even though there will be some data to be had, such as tomorrow’s December 2018 Employment Report from the Labor Department, it means the usual steady flow of economic data will not be had until the government re-opens. No data makes it rather difficult to judge the speed of the economy from all of us, including the Fed.

Given all of the above, we’ll continue to keep our more defensive positions companies like McCormick & Co. (MKC), Costco Wholesale (COST), and the ProShares Short S&P 500 shares intact. We’ll continue to watch input costs and what they mean for corporate profits at the margin – case in point is Del Frisco’s (DFRG), which is benefitting from not only falling protein costs but has been approached by an activist investor that could put the company in play. With Apple, Dycom Industries (DY), and AXT, we will see 5G networks lit this year here in the US, which will soon be followed by other such networks across the globe in the coming years. Samsung, Lenovo/Motorola and others have announced 5G smartphones will be shipping by mid-2019, and we expect Apple to once again ride that tipping point in 2020. That along with its growing Services business and other efforts to increase the stickiness of iPhone (medical, health, streaming, payments services), keeps us long-term bulls on AAPL shares.

When not if but when, the stock market finds its footing, which likely won’t be until after the December quarter earnings season at the soonest, we will look to strategically scale into a number of positions for the Thematic Leaders and the Select List.

 

Weekly Issue: Looking Around the Bend of the Current Rebound Rally

Weekly Issue: Looking Around the Bend of the Current Rebound Rally

 

Stock futures are surging this morning in a move that has all the major domestic stock market indices pointing up between 1.5% for the S&P 500 to 2.2% for the Nasdaq Composite Index. This surge follows the G20 Summit meeting of President Trump and Chinese President Xi Jinping news that the US and China will hold off on additional tariffs on each other’s goods at the start of 2019 with trade talks to continue. What this means is for a period of time as the two countries look to hammer out a trade deal during the March quarter, the US will leave existing tariffs of 10% on more than $200 million worth of Chinese products in place rather than increase them to 25%.  If after 90 days the two countries are unable to reach an agreement, the tariff rate will be raised to 25% percent.

In my view, what we are seeing this morning is in our view similar to what we saw last week when Fed Chair Powell served up some dovish comments regarding the speed of interest rate hikes over the coming year – a sigh of relief in the stock market as expected drags on the economy may not be the headwinds previously expected. On the trade front, it’s that tariffs won’t escalate at the end of 2018 and at least for now it means one less negative revision to 2019 EPS expectations. In recent weeks, we’ve started to see the market price in the slowing economy and potential tariff hikes as 2019 EPS expectations for the S&P 500 slipped over the last two months from 10%+ EPS growth in 2019 to “just” 8.7% year over year. That’s down considerably from the now expected EPS growth of 21.6% this year vs. 2017, but we have to remember the benefit of tax reform will fade as it anniversaries. I expect this to ignite a question of what the appropriate market multiple should be for the 2019 rate of EPS growth as investors look past trade and the Fed in the coming weeks. More on that as it develops.

For now, I’ll take the positive performance these two events will have on the Thematic Leaders and the Select List; however, it should not be lost on us that issues remain. These include the slowing global economy that is allowing the Fed more breathing room in the pace of interest rate hikes as well as pending Brexit issues and the ongoing Italy-EU drama. New findings from Lending Tree (TREE) point to consumer debt hitting $4 trillion by the end of 2018, $1 trillion higher than less five years ago and at interest rates that are higher than five years ago. Talk about a confirming data point for our Middle-class Squeeze investing theme. And while oil prices have collapsed, offering a respite at the gas pump, we are seeing more signs of wage inflation that along with other input and freight costs will put a crimp in margins in the coming quarters. In other words, headwinds to the economy and corporate earnings persist.

On the US-China trade front, the new timeline equates to three months to negotiate a number of issues that have proved difficult in the past. These include forced technology transfer by U.S. companies doing business in China; intellectual-property protection that the U.S. wants China to strengthen; nontariff barriers that impede U.S. access to Chinese markets; and cyberespionage.

So, while the market gaps up today in its second sigh of relief in as many weeks, I’ll continue to be prudent with the portfolio and deploying capital in the near-term.  At the end of the day, what we need to see on the trade front is results – that better deal President Trump keeps talking about – rather than promises and platitudes. Until then, the existing tariffs will remain, and we run the risk of their eventual escalation if promises and platitudes do not progress into results.

 

The Stock Market Last Week

Last week we closed the books on November, and as we did that the stock market received a life preserver from Federal Reserve Chair Powell, which rescued them from turning in a largely across-the-board negative performance for the month. Powell’s comments eased the market’s concern over the pace of rate hikes in 2019 and the subsequent Fed November FOMC meeting minutes served to reaffirm that. As we shared Thursday, we see recent economic data, which has painted a picture of a slowing domestic as well as global economy, giving the Fed ample room to slow its pace of rate hikes. 

While expectations still call for a rate increase later this month, for 2019 the consensus is now looking for one to two hikes compared to the prior expectation of up to four. As we watch the velocity of the economy, we’ll also continue to watch the inflation front carefully given recent declines in the PCE Price Index on a year-over-year basis vs. wage growth and other areas that are ripe for inflation.

Despite Powell’s late-month “rescue,” quarter to date, the stock market is still well in the red no matter which major market index one chooses to look at. And as much as we like the action of the past week, the decline this quarter has erased much of the 2018 year-to-date gains. 

 

Holiday Shopping 2018 embraces the Digital Lifestyle

Also last week, we had the conclusion of the official kickoff to the 2018 holiday shopping season that spanned Thanksgiving to Cyber Monday, and in some cases “extended Tuesday.” The short version is consumers did open their wallets over those several days, but as expected, there was a pronounced shift to online and mobile shopping this year, while bricks-and-mortar traffic continued to suffer. 

According to ShopperTrak, shopper visits were down 1% for the two-day period compared to last year, with a 1.7% decline in traffic on Black Friday and versus 2017. Another firm, RetailNext, found traffic to U.S. stores fell between 5% and 9% during Thanksgiving and Black Friday compared with the same days last year. For the Thanksgiving to Sunday 2018 period, RetailNext’s traffic tally fell 6.6% year over year. 

Where were shoppers? Sitting at home or elsewhere as they shopped on their computers, tablets and increasingly their mobile devices. According to the National Retail Federation, 41.4 million people shopped only online from Thanksgiving Day to Cyber Monday. That’s 6.4 million more than the 34.7 million who shopped exclusively in stores. Thanksgiving 2018 was also the first day in 2018 to see $1 billion in sales from smartphones, according to Adobe, with shoppers spending 8% more online on Thursday compared with a year ago. Per Adobe, Black Friday online sales hit $6.22 billion, an increase of 23.7% from 2017, of which roughly 33% were made on smartphones, up from 29% in 2017.

The most popular day to shop online was Cyber Monday, cited by 67.4 million shoppers, followed by Black Friday with 65.2 million shoppers. On Cyber Monday alone, mobile transactions surged more than 55%, helping make the day the single largest online shopping day of all time in the United States at $7.9 billion, up 19% year over year. It also smashed the smartphone shopping record set on Thanksgiving as sales coming from smartphones hit $2 billion.

As Lenore Hawkins, Tematica’s Chief Macro Strategist, and I discussed on last week’s Cocktail Investing podcast, the holiday shopping happenings were very confirming for our Digital Lifestyle investing theme. It was also served to deliver positive data points for several positions on the Select List and the Thematic Leader that is Amazon (AMZN). These include United Parcel Service (UPS), which I have long viewed as a “second derivative” play on the shift to digital shopping, but also Costco Wholesale (COST) and Alphabet/Google (GOOGL). Let’s remember that while we love McCormick & Co. (MKC) for “season’s eatings” the same can be said for Costco given its food offering, both fresh and packaged, as well as its beer and wine selection. For Google, as more consumers shop online it means utilizing its search features that also drive its core advertising business.

As we inch toward the Christmas holiday, I expect more data points to emerge as well as more deals from brick & mortar retailers in a bid to capture what consumer spending they can. The risk I see for those is profitless sales given rising labor and freight costs but also the investments in digital commerce they have made to fend off Amazon. Sales are great, but it has to translate into profits, which are the mother’s milk of EPS, and that as we know is one of the core drivers to stock prices.

 

Marriott hack reminds of cyber spending needs

Also last week, we learned of one of the larger cyber attacks in recent history as Marriott (MAR) shared that up to 500 million guests saw their personal information ranging from passport numbers, travel details and payment card data hacked at its Starwood business. As I wrote in the Thematic Signal in which I discussed this attack, it is the latest reminder in the need for companies to continually beef up their cybersecurity, and this is a profound tailwind for our Safety & Security investing theme as well as the  ETFMG Prime Cyber Security ETF (HACK) shares that are on the Select List.

 

The Week Ahead

Today, we enter the final month of 2018, and given the performance of the stock market so far in the December quarter it could very well be a photo finish to determine how the market finishes for the year. Helping determine that will not only be the outcome of the weekend’s G-20 summit, but the start of November economic data that begins with today’s ISM Manufacturing Index and the IHS Markit PMI data, and ends the week with the monthly Employment Report. Inside those two reports, we here at Tematica be assessing the speed of the economy in terms of order growth and job creation, as well as inflation in the form of wage growth. These data points and the others to be had in the coming weeks will help firm up current quarter consensus GDP expectations of 2.6%, per The Wall Street Journal’s Economic Forecasting Survey that is based on more than 60 economists, vs. 3.5% in the September quarter.

Ahead of Wednesday’s testimony by Federal Reserve Chair Powell on “The Economic Outlook” before Congress’s Joint Economic Committee, we’ll have several Fed heads making the rounds and giving speeches. Odds are they will reinforce the comments made by Powell and the November Fed FOMC meeting minutes that we talked about above. During Powell’s testimony, we can expect investors to parse his words in order to have a clear sense as to what the Fed’s view is on the speed of the economy, inflation and the need to adjust monetary policy, in terms of both the speed of future rate hikes and unwinding its balance sheet. Based on what we learn, Powell’s comments could either lead the market higher or douse this week’s sharp move higher in the stock market with cold water.

On the earnings front this week, we have no Thematic Leaders or Select List companies reporting but I’ll be monitoring results from Toll Brothers (TOL), American Eagle (AEO), Lululemon Athletica (LULU), Broadcom (AVGO) and Kroger (KR), among others. Toll Brothers should help us understand the demand for higher-end homes, something to watch relating to our Living the Life investing theme, while American Eagle and lululemon’s comments will no doubt offer some insight to the holiday shopping season. With Broadcom, we’ll be looking at its demand outlook to get a better handle on smartphone demand as well as the timing of 5G infrastructure deployments that are part of our Disruptive Innovators investing theme. Finally, with Kroger, it’s all about our Clean Living investing theme and to what degree Kroger is capturing that tailwind.