Stocks posted a modest rally, led by energy shares in very light post-Christmas trading.
Indeed, that is likely to be the theme for the week, light trading perhaps with a slight upward tilt, and many hedge fund traders have wrapped up their books for the year and settled into a beach chair somewhere warmer than New York or Philadelphia, while individuals with lots of unrealized capital gains courtesy of an 8+ year bull market wait at least another week to cash in.
While there is no one set rule for all investors, the general rule of thumb with a new tax law taking effect next week promising lower rates and fewer deductions, is to move income out to 2018 and expenses back into 2017. I can’t caution enough, however, that every case is different. If you are possibly subject to the alternative minimum tax in either 2017 or 2018, those rules may not apply. But with the AMT lifted for many individuals next year and the standard deduction doubled, certainly waiting to take gains until 2018 will be the right decision for most. Stock prices are subject to the laws of supply and demand. Thus, with few sellers, even the modest numbers of buyers can push prices up.
With that said, it is hard to read much into trading patterns this week or next. Since next week is the first week of trading for 2018, some rush of selling by taxable investors is possible, but they account for less and less of daily trading volume each year. The rally over the last several weeks has obviously discounted the basic positives of tax reform, but it may take a few weeks for the second derivative impacts and the more subtle effects to be fully realized in stock valuations. A strong Christmas season and some recent oil supply shortages in Libya has helped two major sectors, retail and energy, recover at least part of their 2017 losses. The end of tax selling also helped. With that said, I think we can offer two conclusions relative to both retail and energy.
I will tackle retail first. The most common thought is that Amazon is killing all retail. While Amazon has an obvious impact, don’t tell that to Home Depot#, Best Buy or Lululemon. Indeed, there are places within the retail landscape where companies can thrive with or without the presence of Amazon. What Amazon does is offer a winning combination of price, service and value that is hard to replicate. But hard doesn’t mean impossible. Amazon may have raised the bar, but for those who meet the challenge, prosperity still lies ahead. What Amazon has done, however, is to make complacency life threatening. Lululemon has an admired brand, a solid game plan and a loyal base. Its clothes may be expensive, but its customers perceive the value. Indeed, within the activewear space, Lululemon, Nike# and Under Armour provide quite a striking contrast. Of the three, Lululemon is most in control of its brand. It sells directly only through its own stores, thereby controlling both distribution and price. Nike also sells through its own stores and direct online. But it also sells through select retailers and has started to sell through Amazon. As part of its new contractual relationship, Amazon will attempt to weed out counterfeit Nike listings, a perpetual problem for the retailing giant whose name has become synonymous with activewear. Under Armour has attempted to follow Nike’s lead. But following a period of very rapid growth, perhaps growth that was too fast to manage, the company seems to have lost its edge as a better version of Nike. Instead, today there is brand confusion. As Under Armour sought to place its products everywhere, its quality mystique faded. Thus, today, Lululemon is winning, Nike is regaining its stride, and Under Armour is struggling to remain relevant. Amazon isn’t the issue with any of them.
Indeed, in retailing, staying relevant is always the key. It isn’t just niche companies like Under Armour that are struggling. Sears is virtually dead. How close to dying is it? Its bonds coming due in 2018 sell at yields well above 25%. Eddie Lampert, who bought Sears and Kmart for their real estate, may now have two albatrosses to bury. Macy’s doesn’t have anywhere near the problems Sears has, but it appears to be off track. While a solid Christmas season may have bought it some time, Macy’s has to find a way to be a go-to destination for some large demographic group. There was the time Macy’s was the department store for middle class America. But its hot brands went elsewhere and as Macy’s service levels declined, it became an obvious Amazon victim. It never developed serious Macy’s branded products and many of the items it sells are available elsewhere, including at Amazon, at significant savings. The idea of department stores was always fair price and great service. While Macy’s still offers good service and promotional pricing, the value equation isn’t outstanding.
Think about where you shopped a generation ago. If you lived in Philadelphia, you might have gone to Market Street East to Wanamaker’s, Strawbridge’s, Gimbel’s or Lit Brothers. They are all long gone. Indeed, some of their replacements are gone as well. Retail can change rapidly. Amazon may be a catalyst for change, but it isn’t the only one. It’s just tough to stay ahead.
Let me switch to energy. Everyone talks about alternative energy sources. We talk of electric cars and autonomous vehicles. We see more and more windmills and solar panels. There are some who believe that within 10 years, more than half of new cars sold will be electric. Some will tell you it will take decades to transition. I am no smarter than anyone else. But I can tell you that when the digital camera was a completely superior value to the film camera, film disappeared overnight. Similarly, laptop computers replaced desktops. The car of tomorrow may be hybrid, electric or even based on fuel cell technology. But here is what I do know. The costs to make an electric car are going down. The time to recharge an electric battery is going down. The price of solar panels is declining rapidly. There will be crossover points. Cars that today get 20-35 miles per gallon will get 50+ mpg before long. Since gasoline usage accounts for 50% of the output of a barrel of oil, it doesn’t take rocket science to tell me what the future looks like for traditional fossil fuels. There probably will be one or maybe two more upcycles for the price of oil, but in the end, alternative fuel sources have to win. There are some who suggest that electricity demand will skyrocket as electric cars and bitcoin miners proliferate. They could provide a small blip. But ultimately, the price of solar panels in particular will get so cheap that the only purpose for utility plants and electric grids will be to provide power during weather extremes (too hot, too cold, too dark or too wet). It is only a matter of time before gasoline goes the way of coal. And despite Donald Trump’s assurances to the coal industry, that isn’t a pretty picture.
Where does this take me? Industries in transition are hard to invest in over the long term. As noted, there may be one more strong cycle for oil over the next few years, particularly if the economy stays strong. In addition, I can’t tell you when the crossover will be. But it was inevitable from Day One that mobile computing would demolish traditional publishing, traditional TV networks, and even the movie industry. That might make the old guard uninvestable, but it also creates giant opportunities for the next generation.
Today, Savannah Guthrie is 46. Cole Hamels is 34.
James M. Meyer, CFA 610-260-2220
Additional information is available upon request.
# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.
Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.