Open for Business – Part 1…

(@HistoryInPix: Yosemite National Park, 1915)

361 Capital Market Commentary | January 28, 2019

All it took last week was a major IRS sickout, a LaGuardia slowdown, Federal workers shopping at food banks, plunging political polling data, and several defecting GOP Senators to end the longest U.S. Government shutdown in history. Note to everyone, save this list for future use. So now that it is over, we have clipped about a half a percent off of Q1’s GDP growth. Focusing on the future, the U.S. now still has one other big item on the ‘Open for Business’ agenda and that is to end the tariff and trade threats and let the goods start flowing across the borders again. Without this, American workers will get paid less (or worse) and American customers will pay more for all of their purchases. The global economy is working with one hand tied behind its back which is a terrible thing with several major regions currently slowing down. Growth will help everyone, so let’s get Washington back to work, and negotiating, so that we can have a real good reason to buy risk-oriented assets again.

If the White House and Congress need a reason to open U.S. trading with the rest of the World again, they should place a call to Caterpillar and NVIDIA tonight. Both companies gave earnings updates today that dug a very big hole for their shareholders. China was blamed for the construction equipment slowdown at Caterpillar, and for the gaming chip shortfalls at NVIDIA. The current U.S. Government will need to open up trade again with China and other foreign nations, or else new leaders will. Someone who gets foreign trade, and China specifically, is Howard Schultz who is now testing the waters for a Presidential run. Starbucks has 3,300 stores in China versus about 12,000 stores in the U.S. If Howard wants to jump into the mud pool of Presidential politics, he will prove to be a tough one to bet against.

Also big this week will be the FOMC meeting. The Fed has basically told us that they will sit on rates this meeting, but their further commentary will be more interesting; especially if they shed more light on the Wall Street Journal story from Friday about possibly relaxing their desire to shrink the Fed’s balance sheet. If they back off, then the market could catch a jump higher. But earnings and company forward guidance will again be the focus for the week. Hopefully, companies can avoid the messes that Cat and NVIDIA created for us today.

At the top of the ‘Want to Know’ list for the week… Will the FOMC will back off the balance sheet shrink?

Federal Reserve officials are close to deciding they will maintain a larger portfolio of Treasury securities than they’d expected when they began shrinking those holdings two years ago, putting an end to the central bank’s portfolio wind-down closer into sight.
Officials are still resolving details of their strategy and how to communicate it to the public, according to their recent public comments and interviews. With interest rate increases on hold for now, planning for the bond portfolio could take center stage at a two-day policy meeting of the central bank’s Federal Open Market Committee next week.(WSJ)


While the Fed considers policy moves, the U.S. economy continues to throw eggs at their meetings…

Richmond Fed Manufacturing Order Backlog Index

Or, as you say in German, eier…

@C_Barraud: #GERMANY JAN PRELIMINARY MANUFACTURING PMI: 49.9 V 51.5E (1st contraction in 49 months)

IHS MArkit Germany Flash PMI

Or, in Japanese, you say tamago…

Callum Thomas Tweet

And in France, you say des oeufs…

Jeroen Blokland Tweet

But no ovos in Brazil because things are actually getting better under the new administration…

Potential Shutdown Effects on Growth

Lots of Davos commentary last week. Keep a close eye on what the largest active money manager said…

Greg Jensen, co-chief investment officer of Bridgewater Associates, said he sees a more negative outlook for growth than the markets and policy makers.

“While people have certainly diminished their growth expectations and you’re hearing all about that at Davos, we don’t think they’ve done it enough,” he said in an interview on Bloomberg TV Wednesday from the World Economic Forum. “Earnings expectations particularly in the U.S. are too high, and generally the Fed and other policy makers are still expecting stronger growth than we see.”

Jensen, who helps oversee the world’s biggest hedge fund at Bridgewater, said that he expects to see lower interests rates, particularly on the short-end of the Treasury curve. Regions that have priced in high growth expectations will be hurt the most. On the other hand, some emerging markets that have already suffered from the U.S.’s tighter monetary policy will benefit as policy makers resume easing, he said.


More details on the Caterpillar miss and lowered guidance…

They nailed it in October when they said that the environment would not get any better.

Disappointment in an FY19 outlook that calls for only a “modest sales increase.” That view is planting some concerns that profit margins could be compressed if manufacturing costs remain elevated and demand ends up being weaker than expected.

The strong dollar curtailed overall sales and revenue growth in the fourth quarter. Given the policy-rate differentials and the relative strength of the U.S. economy, an assumption is being made by investors that the strong dollar will remain a headwind for sales and revenue growth.
The acknowledgment that sales for the company’s Construction Industries segment declined in Asia/Pacific due to lower demand in China has fed into the market’s broader concerns about a global growth slowdown.

Disappointment that the core Construction Industries segment, which accounted for ~40% of consolidated sales and revenues, saw its profit margin contract 100 basis points to 14.8%. (Note: Caterpillar’s consolidated operating profit margin expanded by 230 basis points to 13.1%)


And the NVIDIA puke…

FYI: puke is the technical term for whenever a stock drops 15% in a trading day.

The latest drop came Monday after the chip maker warned that revenue for its just-ended fiscal fourth quarter would come in about 19% below its previous forecast of $2.7 billion. Nvidia had previously cautioned that sales of its graphics processors used in videogaming PCs would be disappointing for the period due to bloated inventories left over from the bursting of the cryptocurrency-mining bubble. It now says the weakened economy in China and slow sales of its newest chips are playing a role as well. Nvidia also added that data-center sales for the period fell short.

Chips for videogaming account for more than half of Nvidia’s business, so problems in that segment are bad enough. But the data-center business has been a major reason Nvidia became one of the most valuable semiconductor companies. Its graphics processors are key components in artificial-intelligence systems that cloud-computing giants such as , Microsoft and Google parent Alphabet Inc. are building into their networks. As such, Nvidia has benefited from their booming capital investments.


Texas Instruments also had some important China commentary on their conference call…

“the weakness in demand in our products that began in the third quarter continued into the fourth quarter. Demand came in mostly as expected, although Personal Electronics, and specifically smartphones, was weaker, including Chinese smartphone manufacturer. On a regional basis, demand in China was weaker than the other regions. End markets within China, though, behaved directionally consistent with the rest of the world. We are seeing signs from our customers and the channel that this weakness is primarily from increased caution due to trade tensions. We assume that this weakness is a combination of lower local end demand, as well as reduced exports, but we do not have visibility to distinguish between the two”.

Back to more U.S. centric datapoints, the RV industry is seeing a sharp slowdown…

The RV Industry Association’s December survey of manufacturers found that total RV shipments finished the month with 28,363 wholesale shipments, a decrease of (-21.7%) from the 36,227 units shipped last December.

Total RV Shipments Monthly vs. Last Year

Eric Peters has thoughts on Cheap Beer…

Cheap Beer: “The story of this cycle starts with the permanency of profit margins,” said my favorite strategist. “Record non-financial profit margins have persisted for so long that people came to view them as a permanent feature of corporate America.” US profit margins are roughly 12.5%, double their level when the secular bull started in 1980. “And we’ve had this long, steady expansion. So companies leveraged their cashflows. And of course, the businesses that were not particularly cyclical were especially attractive to lever up.” The buyback machine spun and spun.

Cheap Beer II: “In a recession, people buy lots of cheap beer,” continued my favorite strategist. “But you throw enough leverage on even the most stable cash flow and you turn an acyclical beer brewery into just another cyclical.” So much for resilience through diversity. “When the financial market shock comes, these previously acyclical companies will be forced into a deleveraging, notwithstanding the stable aspects of their operating businesses.” And by transforming the acyclical into cyclical we’ve lost another volatility dampener for markets.

Cheap Beer III: “In a deleveraging cycle, you throw equity holders under the bus to save creditors,” explained the strategist. “The more leveraged the company, the more likely restructurings involve large asset liquidations, equity issuance, creating enormous uncertainty in forecasting what the business will look like.” GE was frantically buying back stock at $25 per share and is now implicitly reissuing at $8/share – what will the GE look like? What’s the P/E for that uncertainty? Low. “Before 1982, stock buybacks were illegal. They may well be again.”


Speaking of leverage, fewer investors would like to buy that new debt…

Luka Kawa Tweet

For the week, it was foreign assets which did the best as the U.S. dollar went into reverse…

Foreign Assets

While most are concerned about the moves in the S&P 500, Gold breaks out…

Are gold buyers worried about the Fed pulling back on the balance sheet shrink, the global growth slowdown, or maybe 80% marginal income tax rates?

7 Year Asset Class Real Return Forecasts

As international stocks are having a good 2019, a reminder of just how cheap they are versus U.S. stocks…

Below is a chart showing the U.S.’s CAPE versus the world ex U.S. (i.e. foreign stocks). Going back to 1980, both have an average CAPE ratio of about 22. Let me repeat: the historical valuation premium has been ZERO.

Beyond that, the amount of time each spends being more expensive than the other is basically a coin flip. That stat surprises a lot of people who assume that the U.S., being currently expensive, ALWAYS trades at a premium and for some reason “deserves to”. (After all, the U.S. is special.)


Global CAPE Ratios

Specifically looking at German price-to-earnings ratios…

Dax PE Ratio

The one asset class that continues to outperform is emerging market equities…

The threat of trade war hit emerging markets hardest. They peaked in January and never looked back. But this week, EEM closed at a 4 month high. The down trend from January was broken (top dashed line) and the region appears to now be exiting a 4 month base (yellow shading). Of note, the region also completed a low retest between October and December (bottom dashed line).
Emerging Markets

And if investing in EM is too calm for you, there is always one market in South America undergoing a significant political change right now that will get your heart rate spiking…

Venezuela's share of world GDP

Among sectors last week, the Semis just crushed it behind Texas Instruments and Xilinx earnings…

Sector Returns - Texas Instruments and Xilinx

Another very big week of earnings to pay attention to this week…

Most Anticpated Earnings Releases 1/28/2019

Bizarre chart of the week…

@OddStats: If you were to look at $SPX data over “the past decade” (at any point) and figure out what percentage of those days were positive year-to-date, you would find that it has never been higher than right now, this second. THAT’S ODD.

Percentage of Days in the Past Decade that were Positive YTD S&P 500

Excerpt from Seth Klarman’s recent 2019 Baupost Investor Letter…

Spend time to read the full letter when you have time. Outstanding as usual.

We would argue vehemently that democracy, and the liberties and protections it provides, is not just of importance to individual citizens, but also to businesses and markets. In a democracy, businesses have the benefit of equal treatment under the law, including unbiased regulation. Yet these days, the President often singles out for criticism enterprises he finds personally objectionable or executives who disagree with him politically. These anti-democratic tendencies are extremely dangerous, particularly as the Congressional Republicans show no interest in reprimanding him, even though his behavior violates a core principle of the conservatism they claim to espouse.

We would also argue that social cohesion is essential for those who have capital to invest. Businesses need a long-term horizon to plan, and social unrest makes planning more difficult. It can’t be business as usual amidst constant protests, riots, shutdowns, and escalating social tensions. It is not hard to imagine worsening social unrest among a generation that is falling behind economically and feels betrayed by a massive national debt that was incurred without any obvious benefit to them. If things get bad enough, we could see taxes once again raised to confiscatory levels. We should all be rooting for (and acting to support) social cohesion and a renewal of the American dream.

David Moss, a Harvard Business School professor, teaches a course on democracy and has found that over much of American history, partisanship was cutthroat and political divides were wide and bitter. Yes, people said horrible things about each other. But when critically important issues were being decided, even while participants in the debate were intensely focused on winning, they were also focused on how their actions might affect democracy over the long run. More recently, it seems as though politics has been transformed into an intense focus on immediate victory, the system be damned. We have seen behavior in national and local politics where those in power changed the rules to the disadvantage of those out of power (or about to come into power) simply because they could. As stewards of your capital, we see these ominous and widening social divides as risks to the economy and even to the system. Politicians have been putting self-interest and party ahead of country. Absent facts, truth, and science, we expect poor governmental decisions to become the rule and not the exception. There is no hedge to such risks, other than to work together to reverse course, heal the divides, and strengthen American democracy.


Speaking of reading, the best words of wisdom for the week…

“I have known no wise people who didn’t read all the time—none, zero,” Mr. Munger once said. “You’d be amazed at how much Warren reads—and at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”


Three in four Americans are now worried about climate change…

The results suggest that climate change has moved out of the realm of the hypothetical for a wide majority of Americans, said Anthony Leiserowitz, director of the Yale program.

“It is something that is activating an emotion in people, and that emotion is worry,” he said. The survey found that 69 percent of Americans were “worried” about warming, an eight-point increase since March.

“People are beginning to understand that climate change is here in the United States, here in my state, in my community, affecting the people and places I care about, and now,” Dr. Leiserowitz said. “This isn’t happening in 50 years, 100 years from now.”


Americans say global warming is personally important

And maybe seven of eight Hamptonians are now worried about climate change…

At the end of December, there were 2,197 homes for sale in the beachfront towns, an 82 percent jump from a year earlier and a record in 12 years of data-keeping by appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate. Purchases dropped for a fourth straight quarter, the firms said in a report Thursday…

Purchases in the fourth quarter tumbled 35 percent, the biggest drop since 2009, according to Miller Samuel and Douglas Elliman. For the 360 homes that changed hands, the median price was $995,000 — the same as it’s been for four of the past eight quarters, said Jonathan Miller, chief executive officer of Miller Samuel.


Americans say global warming is personally important

Friendly fraud..

How Facebook knowingly used young kids to steal from your wallet. Do you still “Like” them?

For years, the company ignored warnings from its own employees that it was bamboozling children.

A team of Facebook employees even developed a method that would have reduced the problem of children being hoodwinked into spending money, but the company did not implement it, and instead told game developers that the social media giant was focused on maximizing revenues.

When parents found out how much their children had spent – one 15-year-old racked up $6,500 in charges in about two weeks playing games on Facebook – the company denied requests for refunds. Facebook employees referred to these children as “whales” – a term borrowed from the casino industry to describe profligate spenders. A child could spend hundreds of dollars a day on in-game features such as arming their character with a flaming sword or a new magic spell to defeat an enemy – even if they didn’t realize it until the credit card bill arrived.


Are the Reds and Blues throwing shade at Howard Schultz, or just upset at him starting in the pole position?

Significantly more U.S. adults continued to identify as political independents (42%) in 2018 than as either Democrats (30%) or Republicans (26%). At least four in 10 Americans have been political independents in seven of the past eight years, including a record-high 43% in 2014…
Over the past 30 years, when Gallup has regularly conducted its surveys by telephone, independents have typically outnumbered Republicans and Democrats. However, in just the past decade, an increasing proportion of adults have identified as independents, reaching 40% for the first time in 2011 and generally maintaining or exceeding that level since then. As a result, since 2011, the percentage of independents has exceeded the percentage identifying with the Democratic Party by 11 points on average, and the percentage identifying as Republicans by 14 points.

US Party Identification

Finally, the most viewed documentary in January by the investing community was easily FYRE: The Greatest Party That Never Happened…

And even if you remember the story from the news, the documentary is still a must watch.

Josh Wolfe Tweet Fyre

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