What’s Going On With The Stock Market?
Why is the stock market selling off? First, it was China. Then it was oil. Wait maybe it was the Fed raising rates? No, it was possibly soft consumer spending. Or was it worries about banks and energy sector bankruptcies? I got it, it’s the strong dollar! Or maybe commodities?
It’s not just you or me wondering, even a Bloomberg editor is scratching his head.
At this year's Sohn Investment Conference, Dan Sundheim, the founder and CIO of D1 Capital Partners, spoke with John Collison, the co-founder of Stripe. Q1 2021 hedge fund letters, conferences and more D1 manages $20 billion. Of this, $10 billion is invested in fast-growing private businesses such as Stripe. Stripe is currently valued at around Read More
I’ve written about China several times including two previous newsletters so I’m not going to rehash any of that here. If you want you can reread my newsletter about China here.
Instead, I want to focus on what is actually going on in the US economy. Oil prices and other commodity prices have plunged. As a response, energy and mining companies have severely cut back on spending. This in turn has meant falling sales at industrial companies (which have already been hurt by a strong dollar) that sell products to the energy and mining sector. On the flip side lower prices mean lower input costs for other companies. For instance Delta Airlines just reported record profits due to lower fuel costs. Even companies like homebuilders or Coca-Cola will benefit (from lower lumber and aluminum prices respectively). Benefiting the most are U.S. households. They are saving on average over $1000 per year in lower gas and heating costs.
The chart below shows the various components of the US economy.
We can see that US exports which have been negatively impacted by a rising dollar make up just 12% of our economy. Manufacturing which has been hit by the aforementioned stronger dollar and by lower demand from the energy sector makes up just 14% of the economy. Even better the energy sector only employs around 1% of all Americans. Consumers, the group that benefits the most from low energy prices, make up 69% of the US economy.
How are consumers doing? Well according to the executives of two companies we own Visa (V) and Dow Chemical (DOW) consumers are doing well.
Here’s what Visa had to say:
“This is already evident in January U.S. aggregate payment volume numbers, which show a modest uptick of one percentage point to 11% through January 21. To date, macroeconomic weakness is not evident in U.S. consumer spending, but this could change as the year progresses.”
“there has been much talk over the past few weeks of the slowdown in the U.S., our business volumes in January have been strong.”
“Ecommerce continue to grow at a much higher rate than the spending at physical stores. We saw mid teens eCommerce growth during the holiday period versus mid single digits growth in the physical world. More than 25% of all spending on Visa Cards during November and December was online up from less than 20% just three years ago.
Also the pattern of spending during the holidays has changed, while Black Friday and Cyber Monday remain important shopping days, less spending is consolidated on these two days than recent years and more people delay their spending to later in the season this year.”
Dow Chemical also reported record results due to lower energy prices and strong consumer demand. Here’s what they said:
“The global economy continues to be volatile and we see that trend persisting for the near term. However, we also see strong demand from consumers in the U.S. as well is in China and that plays well through our consumer driven portfolio, technologies and narrow and deeper stock market focus.”
“What we are seeing though is very strong trend lines which we said in our call, which I think gives us strong views towards our ability to grow earnings, is this notion that the consumer is active in the United States and the consumer is becoming increasingly active in China and then actually this is the beginnings of good spending in Europe.”
“We do believe low energy price, low oil prices are seeping into the economy and that’s creating a stimulus that actually is of the right kind and I think if that stimulus continues to be what it is short of major tectonic events geopolitically, I think the confidence in the real economy will emerge continually from the consumer.”
Both companies continue to see strong consumer spending. It’s also worth noting that Visa reported that consumers are changing their spending habits by making more online purchases and buying things outside traditional major retail days. I think these two facts help explain why executives at consumer companies continue to report healthy consumer demand and spending yet some economic data releases have shown weaker than expected consumer activity. In particular the shift from physical to online stores seems to have been problematic for the Census Bureau as reports have emerged of problems with the data they gather.
As consumers continue to reap the benefit from low energy prices spending should ramp up. It takes a bit of time for consumers to start spending as this study from the Atlanta Fed shows.
Keep in mind that this was done in December of 2014 so the projections would need to be adjusted to take into account the fact that oil prices have continued to fall. It takes about a year for the benefits of low energy prices to be felt. We are just past the year anniversary of the first major drop in oil prices but we haven’t yet reached the year anniversary of the second big drop.
So why is the stock market all bent out of shape about the strong dollar, the manufacturing sector, and the oil and gas sector if they make up such a small portion of the real economy? Well, here is that same chart I showed you earlier except this time I didn’t crop out the last column.
As we can see foreign profits make up 40% of the S&P 500 profits compared to 12% of GDP. Only 35% of the S&P is in consumer related services. The oil and gas sector also has an out-sized weighting in the S&P 500.
The chart below shows how sales have been going for companies that have reported earnings so far this year. As we can see the consumer focused companies are reporting solid growth while other sectors are not.
The problem is that it seems like Wall Street lives in a different world. Wall Street sees energy, industrial, and commodity companies which make up an outsize portion of the stock market compared to their true economic weight reporting bad earnings and assumes the economy is going down. In reality the economy is doing OK but it’s tough for Wall Street to see that because of the preoccupation with publicly traded companies compared to the economy as a whole.
For example, I recently read a story about the owner of a large trucking firm that was vacationing at the same ski lodge as a bunch of hedge fund guys from Wall Street. He said he was puzzled at how all the Wall Street guys were depressed and talking about how the economy was doing poorly and we were headed for a recession. He said his business was doing just fine with strong demand from retailers offsetting some weakness from energy customers.
Energy and industrial stocks should certainly be going down but the rest of the stock market should really be following the sales and earnings growth being reported. Consumers make up 69% of the economy and they are doing just fine as are companies that serve them. As long as they stay that way there is very little risk of recession.
All of this is the reason why we are overly concentrated in consumer or consumer linked stocks. We own consumer staples like Altria and Reynolds American, Nestle, Anheuser-Busch InBev, Darden Restaurants, and Verizon (technically not a consumer staple but try telling a teenager or a salesperson their cell phone isn’t a “staple”). We also own a large number of companies that benefit from increased consumer activity such as the aforementioned Dow Chemical as well as payment companies Visa and PayPal. Even Omnicom, a multinational ad agency, does well when companies want to run ads to induce consumers to buy their products.
No Company Profiled
No Company Profiled This Month.
About Our Portfolios
The Capital Appreciation Fund and the Dividend Fund are innovative, investor friendly alternative to traditional actively managed mutual funds called a Spoke Fund ®. We can also customize portfolios for clients seeking less risk and volatility by including allocations to other asset classes such as bonds and real estate.
Spoke Funds are significantly less expensive and more transparent than a large majority of mutual funds. Both portfolios are managed for the long term using value investing principles. Fees for both portfolios are 1.25% of assets annually. That figure includes both our management fee and all trading costs. We try to minimize turnover and taxes as well in both funds.
Investor accounts are held in your name (we never take investor money) at FOLIOfn or Interactive Brokers*.
For more information visit our website.
*Some older accounts may be custodied at TradePMR.
Historical results are not indicative of future performance. Positive returns are not guaranteed. Individual results will vary depending on market conditions and investing may cause capital loss.
The performance data presented prior to 2011:
- Represents a composite of all discretionary equity investments in accounts that have been open for at least one year. Any accounts open for less than one year are excluded from the composite performance shown. From time to time clients have made special requests that SIM hold securities in their account that are not included in SIMs recommended equity portfolio, those investments are excluded from the composite results shown.
- Performance is calculated using a holding period return formula.
- Reflect the deduction of a management fee of 1% of assets per year.
- Reflect the reinvestment of capital gains and dividends.
Performance data presented for 2011 and after:
- Represents the performance of the model portfolio that client accounts are linked too.
- Reflect the deduction of management fees of 1% of assets per year.
- Reflect the reinvestment of capital gains and dividends.
The S&P 500, used for comparison purposes may have a significantly different volatility than the portfolios used for the presentation of SIM’s composite returns.
The publication of this performance data is in no way a solicitation or offer to sell securities or investment advisory services.