NOVEMBER 2019: NO MO’ MOMO
The following is not investment advice.
Over the following months, a review of thousands of SEC filings has led me to believe that there isn’t too much value in the US stock market. My definition of value is based on CFA teachings and the teachings of Graham and Doddsville. Many of my peers define value in terms of momentum and technical analysis. Daily I hear not to worry about a market downturn because the market always comes back. “Buy on the Dip”. This is true, of course, but I argue that should we have a downturn at this point in the short term credit cycle, we will find less resilience compared to past recessions.
In recent weeks, I have hypothesized about catalysts of a downturn. What could go wrong? Last week, Uber and Lyft received bad news. In California, Gavin Newsom signed into law the Assembly Bill 5 – transforming the business models that allowed Uber and Lyft to attract capital. If you were to ask Uber and Lyft about why the classification of workers matters so much, the honest answer is insurance; namely: Worker’s Compensation.
Now that costs will rise significantly across the board, how is the cash situation to endure the change? Not good. Uber recently borrowed $1.2 Billion to make an acquisition (original planned raise was $750 Million). Considering Uber raised $8 Billion only in May, 4 months ago, the governance comes into question. Why go into so much debt when you can sell stock to the public at such high valuations? Why not make stock for stock acquisitions? Better yet, why acquire companies when the parent company is struggling? This is the catalyst of a downturn – these companies both can’t facilitate debt, and choose to keep growing inorganically rather than improve operations. I can’t find the wisdom here, and I’m left wondering if Uber is just a $60 Billion taxi company losing $11 Billion now. As I write this, there is a Reuters out saying Uber is pivoting to ‘freight’ instead of ridesharing…. Stay tuned for D-Day at the Q3 Earnings report of Uber.
Keep in mind, this will probablybe a secular reversal, and while many stocks will drop, the “momentum” (momo) stocks will fall furthest. The small cap world is figuratively littered with the ‘high growth’ companies that never turned a profit. Most people would be shocked by the fall of them from IPO prices 5+ years ago.
Retail has jumped going into holiday shopping, but competition is fierce from online. Seems as though investors are betting on consumers to spend more this year offline, while wages have mostly stayed the same since last year.
My last memo received overwhelming response to the ETF narrative. I’ll take it a step further and say that using futures instead can be safer and cheaper for the sophisticated investor. Futures are showing that from now until December, most indices will drop: Smart money isn’t betting on reaching new highs before year end. Hard to disagree.
Let’s talk about macro.
We come to a point at which there isn’t much to give, as observed from public government reports. It is not unfair to say that the real economy is being sacrificed to keep the financial economy going.
Last week, the Eurozone dropped interest rates below 0%. Just after that, PMI (Manufacturer Index) missed consensus estimates throughout the EU, most notably in Germany. Europe is desperately trying to spurn growth with business investment, but it just isn’t there. Most of the EU is in recession, including Germany. Is this a sign of the times? I think so. Will other developed economies move down in concert? I think so, especially Great Britain. Likelihood of a trade deal seems mixed for me – can China survive? If no deal materializes, real wages will either stagnate or drop, which is the opposite of what China wants. Still watching these developments as they manifest.
The US Dollar is holding up, especially in light of even more countries going to negative rates. As long as the dollar retains relative strength, its stock and bond markets will continue to be stable. Earlier this year, I had investments in Australia, which did well in large part due to the strength of AUD relative to USD. Frankly, I feel this is the reason that emerging markets will not outperform – their currencies are plagued with weakness to the USD (among other things). If the US dollar weakens, less investment will flow to countries that are ever-strengthening. Perhaps it’s the strength of USD that is causing retail to jump.
I’ll make an absurd prediction that rates will fall lower. Inflation doesn’t exist mostly, muting the long end of the yield curve. Hard to think the US yield curve in particular will normalize to an uptrending curve. The corollary to this hypothesis being that the bonds begin to lose substance, wherein the country has a sovereign default and bonds are sold en masse. Nonetheless, home starts are still at high points this quarter, so there’s that. All considered, select treasury bonds did increase in value by roughly 12% during the period April 2000 until September 2002.
Further… If you aren’t sure why a country goes negative, here’s an abstract. Investors holding currencies that are prone to inflation or weakening relative to a benchmark currency will naturally opt to hold the benchmark currency (including the Yen, the Swiss Franc, etc.) Because of the demand, rates are negative, costing those investors to hold money in Yen and Francs. While the USD is certainly a sound benchmark and would attract capital on negative yield terms, import ability would be the first to go, affecting not only US standards of living, but also the export ability of the world at large. If the US doesn’t buy from and invest in emerging markets, who will?
Another bright spot has been oil. Oil prices dropping is a tax cut Courtesy of OPEC – production costs in many industries have significantly dropped. But the US treasury, for instance, gets huge advantage for an economy diversified away from oil. If oil prices rise, OPEC has nothing to lose, and everything to gain. With ARAMCO initial public offering on the horizon, this is certainly a conflict of interest that will be in the prospectus.
To summarize, Global weakness is beginning to surround us, and I feel there are more worries than optimisms. Being selective with investments is obviously the best call right now, and it always will be. Finding long positions in the US stock market is never easy, and the old adage “better to be lucky than good” comes to mind. We all hear stories of those ‘brilliant’ hedge fund managers that had the foresight to play a crash correctly. “Wow, what I wouldn’t give to be in that guy’s fund.” Proliferation of easy to use ETFs has led to most portfolio managers’ laziness, and because of this, there is an advantage to the advisor that knows what he/she is buying.
Having said all of that, should there be a downturn, the world will spring back.