November 18, 2022

Don’t Give Up on Tech

Way back in the 1990’s when I was managing capital for a corporate pension department, I used to enjoy reading the annual reports that companies, whose stock was held by our firm, would mail to us as a hard copy. One particular report that stood out to me was from the Microsoft company (MSFT) whose products, especially Office, have been central to my desktop organization to this day. What captured my attention though, had to do with the customary picture of the top executives and board members, that appeared in all annual reports. This particular picture had two differences that stood out. The first was the number of executives that weren’t wearing a tie, and the second was one executive holding a basketball. My takeaway, was that picture was an oracle into the future of technology, focused on skill over style and organization over fraternity. Now we come to 2023 and the narrative is to attack the major tech firms even as they have done more to enrich this country than at any time since the industrial revolution enriched the middle class in the 20th century. I bring this up, because those same major tech firms are beginning to layoff employees for the first time in recent memory, is this a good thing?

 Beginning last week, the release of Consumer and Producer price inflation data showed modest change lower. Likewise, the impact from the midterm elections still presently leaves the Senate runoff to complete the expectation, but in the meantime the House has modestly flipped, giving the markets some comforting gridlock. The war in Ukraine is currently an ongoing uncertainty, although its impact is diminishing as it fades from the global narrative. And Europe and China continue to harvest the impact of internal headwinds that are influencing any commitment to those markets, a difficult choice. Only the US has shown some promise, not necessarily reason for a happy dance, but as economic growth manages to show further weakness, and the macro inflation picture continues its trend lower, the overall picture needs to be closely watched.  

 The big change that I’m watching for will be the release of the Unemployment Data on December 2nd. In the meantime, yesterday’s data on Continuous Jobless Claims showed a modest increase, which is not surprising. As mentioned in the first paragraph, the tech layoffs, being explicitly advertised, have an impact that has the potential to alter, in my opinion, the frequent reckless perspectives from analysts. The first is while the numbers are not extreme, Amazon (AMZN) announced the layoff of 10,000 employees, curiously low since Amazon hosts over 1,500,000 employees globally.  The same can be said for Meta (META), which cut 11,000 people on November 9, and Twitter (TWTR), where 3,700 people lost their jobs on November 4. The number of employees being laid off, compared to the number of employees globally, suggests, in my opinion, that the changes are more focused on the reduction of expenses, rather than a response to pubic inflation. This is worth noting, because the most familiar tech companies have respectable Gross margins (>50%), and low Net margins (<20%). This is because their Operating expenses tend to be split between ongoing reinvestment and traditional compensation. And with the spike in growth of post pandemic hiring based on virtues such as community obligation and nearly invisible pay scales, even Google stated college diplomas were no longer necessary to apply.  And the salaries by most measure have outpaced previous generations, and between recent multiyear growth in wages and benefits, the tech balance sheets might be facing the first reduction in Operating expenditures, which could show a marginal increase in net profits. Neither a common occurrence for tech.

 Does that make the large cap tech sector a better investment than the analysts are suggesting lately? In my opinion, it’s compelling in relative value, but right now the evidence will be in the employment data and the earnings results, when they arrive. In the meantime, there is definitely good news in the air, and while the technical condition of the broad indexes suggests some correction lower from recent consolidation, the light at the end of the tunnel isn’t yet shining bright, but at least it’s starting to become visible. 

November 11, 2022

What’s Going On

The broad indexes moved higher this week, led by the technology sector that has a woeful year, to say the least. But coming off yesterday’s release of CPI inflation data (Consumer Price Index) the reaction was for the indexes to move sharply higher, and the interpretation of that data is at the root. Our favorite Algochums obviously found the data proof that inflation has peaked and is going lower. The Pindudes jumped in to cover open, and derivative, shorts, but maintained some composure. And lastly the investor, such as myself, sat tight, maintained higher cash and continued the search for opportunities that are still present. Why? Because yesterday’s new data point was a welcome treat, but also, just one data point that is still telling us inflation is still too high. So, what’s going on?

 The strategy this year has been to maintain an allocation that favors less volatility when economic cycles are shifting lower, as they are now. Inflation has brought the Fed into aggressive mode with the explicit intent to slow the economy down and everything that goes with that, such as job losses. Maintaining investments in sectors that are less impacted by changes in the economic cycle and hold favorable fundamentals are the first place to start. These investments are focused on the products and services that are less likely to see the same pullback from the consumer. For example, makeup, fragrance and hair care product company Este Lauder (EL), or, global warehouse style retailer Costco (COST), a beverage and convenient food company Pepsi (PEP), are all companies that bring to the consumer, what the consumer always needs. Other sectors providing more calm include the healthcare, pharmaceutical companies such as Abbvie (ABBV) and service healthcare companies such as UnitedHealth Group (UNH). Most of the companies in these sectors have strong balance sheets, and also share their profits with investors in the form of dividend payments, a procedure that is less important and therefore less followed by our growth investments because they are focused on reinvesting excess free cash back into the company. And that can only be realized if inflation and the economy begin to look better than it does now. What about our growth investments?

 It is always, in my opinion, in the best interest of long term growth to maintain sector diversification in portfolios, to better capture the overall changes in the markets and economic cycles that will always ensue. But this year while favorites such as Apple (APPL), which has eked out a much better year (-9.4%) than say Amazon (AMZN) or semiconductor company NVIDIA Corp (NVDA) both down -46.9% and -53.9% for the year respectively. So why stick with them? Well, yesterday’s softer inflation data tells us just how that sector of technology companies will perform when the economy and inflation begin to normalize. And as the markets have moved lower, I’ve not shied away from investing in the sector as normalization may not be with us, but the sector only needs hope and certainty to recover, and that will eventually happen. And it’s those new investments that have focused on the technological changes that have impacted many different sectors. These investments are the other side of fundamental consideration, they include what I refer to as Event conditions as well. An event condition has always been the strategy of investors looking for companies that will be acquired or perhaps go out of business, but for my strategy the focus is on events that will have genuine impact on the economy and culture and therefore the companies as well. For example, industry cloud-based software solutions for the global healthcare industry Veeva Systems (VEEV) has done more to organize the data heavy healthcare industry by allowing providers wider access patient data instantaneously. A software and services company PTC Corp (PTC) is providing a new technology called Digital Twin that is impacting sectors such as Industrials and Energy to help focus on better servicing of processes such as warehouse machinery and refining facilities through virtual technology. This isn’t new, older tech companies such as General Electric (GE) are engaged, and the expansion of its impact is definitely an event in the making.

 As we come into the last six weeks of this year another casualty of the portfolios has been fixed income. On the lighter side, our exposure to the asset class has been comparatively light since 2003, when yields first reached historic lows and bonds became less interesting, and useful, all which pointed to greater risk. Much of that risk has been realized this year, enough to impact portfolios. But just as cycles effect the stock market, those same cycles can impact the fixed income markets as well. In my opinion, the aggressive moves by the Fed to increase interest rates has made the fixed income asset class more interesting than I’ve witnessed in the last 20 years. That isn’t to suggest the Fed is finished, but the higher yields go, the better the intermediate term advantage they will play in portfolios. In the meantime, the seasonal factors and the softer inflation data could be negatively divergent on Tuesday when the Producer Price Index (PPI) is released. If not, the markets could stay positive into the end of the year, but that isn’t a good reason not to be cautious. Recession is coming sometime over the next twelve months, and the Fed has promised to remain aggressive in the interim, both good reasons to continue looking for opportunities, and to maintain the current strategy as well. 

November 3, 2022

A Click Bait Strategy?

 It appears that Jerome Powell has found a new strategy, joining the ranks of social media as a last resort. This week the Federal Reserve Board voted to increase interest rates another .75%, but it was his comments and the responses to a variety of trigger worthy questions that brought out the click bait. “Job gains have been robust”, ouch, “the unemployment rate has remained low”, ouch, “inflation remains elevated” run for cover! The speech from Chairman Powell is important, in my opinion more than his more aggressive, and popular, off the cuff statements.

 In response to questions regarding a pause in rate hikes the response was that “although rates could be increased less there was no reason to think a pause was near.” The intent was to maintain the track of raising rates for the foreseeable future until there was “good evidence” that a series of monthly readings show inflation was declining. Sounds like common sense, although the scarier language does have some impact, we’ll just have to see how it all effects the markets for now. As expected, after yesterday’s comments the broad indexes moved sharply lower. That was more of a reaction than simple fear.

 Inflation is the story of the consumer. In the 1970’s when I was out of college and working on Wall Street in various accounting jobs, I made a salary respectable for the times, and had no hesitation to spend it without regard to cost. In short, I was oblivious to rising inflation because I had little responsibility to anyone but myself. Flash forward and we find ourselves at a time where for the last two decades the country has seen clear declines in marriage and childbirth, leaving nearly two generations with more consumers that are responsible for no one but themselves, feeling the power of undisciplined spending. That is what the Fed knows they have to slow down, and that can only happen if wages stop increasing, and most troubling of all, jobs are lost.

 Which brings us to tomorrow when we’ll see the monthly release of Unemployment Data. The expectation is for Job Growth for October to increase by 200K and the Unemployment Rate to increase from 3.5% to 3.6%. On the wage side, for the year, Average Hourly Earnings is expected to decline from 5% to 4.7%. If these numbers meet the consensus, that would be good, but not great. Over the next few months, the same outcomes would need to be evident to the Fed, who are clear in understanding the lagging outcome of the data they watch.

 Spend, print money, create a deficit, keep printing more. That is the current fiscal strategy of government. I don’t need to emphasize my wish for an outcome of the election that creates gridlock. This because both sides of our government have been recklessly spending for decades and that habit running into wall might be an important piece of the solution to bring inflation down as well. Also, worth noting is preexisting capital that has been raised since the pandemic, along with overall budget parameters, in my opinion, could see spending moving toward infrastructure, technological and industrial manufacturing, and away from the pockets of the voters

 

For now, the markets are working off an overbought technical condition created by the rally in October. When that said condition reverses, additional buys, and sales will ensue. Cash will remain plentiful and without sounding too redundant, so will patience.