Two topics that I have written about many times came to the forefront in the news this past week:
- How the Internet is disrupting and hence, changing many industries.
- The corporate and individual behavioral patterns changed that occurred as a result of 2008.
Let's examine both more closely.
The Internet is clearly forcing change everywhere. One thing is clear: unless you are at the forefront of technological shifts, you will stagnate and/or decline.
On-line retailing, led by Amazon (NASDAQ:AMZN), is the best example to demonstrate this shift. We all know box stores are suffering with sales down 3% year over year while the Internet retailers are flourishing - up 8.1%. Today we are all shopping online to some degree to get the best pricing and speediest, least costly delivery from all over the globe.
The winner/longs and losers/short are clear. Some other well-known disruptors include Uber (Private:UBER), Airbnb (Private:AIRB), Expedia (NASDAQ:EXPE), Netflix (NASDAQ:NFLX), Skype, WhatsAPP and Spotify (Private:MUSIC).
The Internet is impacting almost every business. Have you seen the recent GE ad where a son is telling his family that he will be a programmer at GE? GE is calling itself the "digital industrial company."
There was a major article in the WSJ last week on how the recession of 2008 created economic trauma and lasting scars leading to a mindset shift towards a conservative bias at every level: individual, corporate and even government. I postulated that the economy would have lower highs and higher lows for many years.
In the past, if gasoline prices declined by over $2.50 per gallon and the consumer saved $1 trillion, you would have assumed a huge bump in consumer spending. However, results are in and the consumer spent only 55% of the increase in disposable income and saved the remainder. The savings rate now stands over 5.2%. Corporations remain cautious too and continue to control costs, capital spending and cash flow. Balance sheets have improved and interest costs as a percentage of operating income have declined meaningfully. Have you noticed the capital and liquidity ratios of the major banks? Pretty impressive!
The financial markets remain stuck within a narrow band as investors are confused, global economies remain stuck in a rut with below average growth, both bulls and bears are frustrated, and investors continue to reduce risk during this period of complexity and uncertainty. It is the money manager's job to analyze all the data, step back and reflect, control risk and look for solid investments both on the long and short side.
As I have said, the stock market is statistically undervalued and it means having to look under the hood to find the real winners and losers to long and short. I have never been this company specific in my portfolio. Historically, I could rotate from one group to another depending on where you were in the economic cycle. But growth remains within a 2-2.5% band. The second quarter, though, will be at the top end of that band led by the consumer after a weak first quarter.
Since there is so much change out there, it is easy to select the winners and losers within industries and amongst all countries. Global valuations are merging too as interest rates are low everywhere. Selection comes down to management, strategy, industry fundamentals, currency, politics and valuation. Mergers are across all borders at similar valuations from one country to another.
Let's take a look at the key data points reported last week by region and see if there are any substantive changes in our core beliefs:
Economic growth in the second quarter has accelerated as anticipated in the United States led by the consumer: retail sales rose 1.3% in April, the strongest gain in a year; consumer sentiment hit 95.8, its highest level in 14 months; job opening increased to 5.76 million, the second highest level on record while producer prices, x-food and energy, rose only 0.1% and 0.9% y/y. Second quarter GNP will most likely bounce back to a gain over 2.5% from a slow first quarter.
Economic growth in China in April slowed down from a surprisingly strong March: factory output rose 6.0%, fixed asset investment rose 10.5%, housing grew 10.1% and retail sales jumped 10.1%. It is clear that weakness overseas has impacted China's growth. If you combine March and April results, you'd see that China will expand its GNP between 6-6.5% in 2016, which is still the envy of virtually every other major industrialized nation. One month does not make a trend unless it is an inflection point which is not the case here.
Economic growth in the Eurozone and Japan slowed in April. First quarter GNP was revised down in the Eurozone to a gain of 0.5% led by Germany and has continued to slow further in April. A mild winter boosted first quarter results. Fears over Brexit overshadow the Eurozone as it has multiple implications…mostly negative for near term growth and stability.
The BOJ is focused on the recent strength of the yen and how best to stabilize/lower its value. Watch the yen and you will have a grip on where Japan's economy and financial markets will be going. I remain cautious on both the Eurozone and Japan. Negative rates are not the panacea many hoped for.
Industrial commodity prices continue to weaken as the speculative surge last month reversed itself. Traders got caught once again. I believe that underlying trends remain positive for industrial commodity prices as producers cut production and future spending plans while demand continues to increase. Studies by Glencore and BHP show capital spending plans cut over 70% over the next few years from 3 years ago. The seeds for the next up cycle in commodity prices are being sown. Patience is needed.
Oil prices have held up in the mid $40s price/barrel as production cuts outside of OPEC have largely offset the increase in production in Iran. Oil companies worldwide have cut future exploration budgets for the next 3 years by 50% from spending levels 3 years ago. I still look for a balance of production/consumption by early 2017 and that prices will be capped at $55 per barrel at which time the shut in shale production becomes economic.
Let's wrap this up.
I can't overemphasize the global shift in mindset since 2008. Exuberance and speculation has turned into caution and conservatism for corporations and consumers alike. Financial regulators have tightened while monetary regulators have eased virtually neutralizing each other. The net impact is a world with less growth, less inflation, and low interest rates.
That is why my core belief of lower highs and higher lows in economic activity remains so relevant when considering the proper asset allocation. As Janet Yellen said, "economic cycles don't die of old age." My bet is slow, beneath average growth for the next few years. Companies with the right strategies will win. But patience is needed and don't trade out of positions needlessly. Invest for the trend, not the data point.
So review the facts, reflect, consider proper asset allocations along with risk controls, and do the necessary research on each investment.