A November 16th report from Morgan Stanley Research suggests that the U.S. economy will continue to muddle along at a reasonable pace despite headwinds from global macro-economic conditions in Europe, China and other emerging markets. That said, the lack of productivity in large cap U.S. firms is troubling, and if the problem is related to structural issues in the economy, it likely portends a more general economic slowdown.
Morgan Stanley analysts Adam S. Parker and team note that sales per employee have been positive for the biggest 1500 US equities for the past 30 years, with only three blips downward on the historical chart. Moreover, sales per employee have moved negative in aggregate for the fourth time recently, though they remain solidly positive for the biggest 50 firms.
Economists keep talking about the lack of productivity – the goods and services produced by one hour of labor.We have some hours when we are very productive,and others, well, when we aren’t.For a trip down memory lane(which maybe isn’t productive), we attended COMDEX in 1999, where the keynote speaker at that time was MFST then-CEO Bill Gates. He said that his average programmers were quite talented,and no doubt those roles were coveted jobs. But he went on to add that his top 10 or so programmers were 100xas productive as the“average one.”So, there were 10 people who could do in 2-3 days what the average programmers could do in an entire year. As a reminder, these average guys weren’t average Americans, they were average MSFT programmers.
With that in mind, looking at recent economic data, you can see that “productivity” (as defined by this simple metric) is now trending negatively for the large cap universe (stocks 51-300), driven by energy which went on a hiring spree before the bottom fell out in late 2014.
Parker et al explain their positive thesis in the face of this negative news. “Part of the reason the economics statistics differ from our assessment is that only about 15% of the workforce is employed at the top 1500 public equities, an important difference between what economics and strategy are evaluating for sure. Our belief is that productivity for the economy might not be very good, but that profit margins will remain pretty elevated for a while for US equities. Companies are investing in software and efficiencies, and reducing headcounts or replacing employees with lower-cost alternatives where possible. This is productive for companies in our view…”
Morgan Stanley Overweight on financial and consumer discretionary sectors
The MS analysts highlight that the firm is currently Overweight financials and consumer discretionary, and Underweight energy, industrials and staples.
Parker and team note they are concentrating their investments in financials and reiterating their Overweight call. They continue to believe the U.S. consumer will spend more, and are taking stakes in the credit card stocks. The MS portfolio currently holds DFS, AXP, and COF. They are selling their 2% position in KKR, 2% position in CIT, and 1% position in ZION, but adding a 2% position in GS, and adding 1% to existing positions in COF, BLK, and JPM.
The net effect of this is to keep our weighting in financials constant, but “improve the quantitative support for the fundamental recommendations.” The analysts still think financials have a good risk-reward ratio heading into the Fed rate hike cycle.
Parker et al. also point out they have been overweight consumer discretionary all year and it has been the best performing sector so far, but their portfolio is still in the doldrums. The MS team is selling off its 2% position in HOG and adding a 2% position in LOW. They continue to think housing is still looking reasonably strong, and home improvement might have a couple of quarters left in a nice run.
In terms of their Harley Davidson stake, the analysts say that “HOG has been quite disappointing since their blowout quarter a year ago,and appears poorly positioned for current discretionary appetites. We’ve had a bad call there, but the fundamental news has changed and we don’t want to hold a loser.”
As far as their bullishness on consumer discretionary sector goes, it boils down to the fact that more people are working, and are working more hours per week, and are making more money per hour, while the drop in the price of oil has kept the cost of living from moving up much yet.