June 21, 2017

Stocks gave back some of Monday’s gains yesterday in a relatively quiet session.  Oil prices continued to fall.  Now more than 20% below last year’s peak, oil is in its own bear market.

This morning, with no huge headlines, I am going to bounce around a bit and cover a bunch of unrelated topics.

Last Night’s House Elections – Democrats spent a lot of money trying to capture two seats in special elections, both held by new members of President Trump’s cabinet.  Despite the fact that both seats were in traditional Republican districts, Democrats were banking on anti-Trump sentiment to win.  While they closed the margin of defeat, Republicans won both seats, however.   It was a rough night for Democrats.  What they should have learned is two things.  First and foremost, the candidates have to run on a simple message.  President Trump won promising to make America great again. The Democrats never had a satisfactory response.  Second, while there is clearly some dissatisfaction with President Trump, that shouldn’t be taken by Democrats as an endorsement of the liberal agenda of the party’s left wing.  What Democrats may be missing is that Main Street America may be more in synch with Trump’s fiscal agenda than they are with the agenda of the liberal wing of the Democratic Party.  Thus, for the Democrats, it is back to the drawing board if they want to retake control of the House in 2018.   They need to come up with a message that resonates with voters.  Simply venting over Trump’s style isn’t likely to produce a big win.

Uber – By now, everyone should have heard of Uber, the disruptor of the taxi industry.  By most standards, it became the most valuable new private company in America, the king of the Unicorns.  Uber’s founding CEO was Travis Kalanick, an intensely-driven CEO who seemed willing to do most anything to win.  He moved the company at hyperspeed, but along the way made a lot of enemies as he installed a culture that took no prisoners and never accepted losing, no matter what.  In many ways he resembled Steve Jobs before he was fired by Apple and replaced by John Sculley.  Jobs was brilliant, driven, hard to get along with, and obstinate.  Kalanick was all of the above, and if anything, rougher around the edges than Jobs.  While Sculley was smart and easier to get along with, he lacked the intensity and drive to move Apple forward.  Ultimately, almost a decade later, Apple brought Jobs back and the rest is history.  We don’t know who will succeed Kalanick yet, but whoever is picked is unlikely to have his intensity or vision.  Uber won’t be the same.  It may lose its nasty streak and won’t be quite as disruptive in a bad way.  But the company’s valuation is predicated on Uber’s ability to continue being a disruptive influence.  There is a fine line between tough aggressiveness and being out of control.  Kalanick clearly stepped over the line too many times.  But if Uber hires its own John Sculley, it may flounder as Apple did.  Don’t be surprised some day to see a more humble and mature Kalanick back in the saddle.  History truly does have a way of repeating itself.

Oil – Oil prices bottomed well below $30 per barrel in early 2016 and then rallied to the mid-$50s.  But as prices rose, so did production.  While OPEC has announced a pair of modest production cuts, worldwide production today is near record levels, and it is rising.  Countries like Libya and Nigeria, long plagued by political unrest, have come back to market.  So has Iran.  Despite the fall in prices recently, U.S. rig count is still rising.  There are a lot of producers around the world who can make plenty of money with oil in the mid-$40s.  Peak demand should be just about now, at the height of both summer heat and peak driving season.  Even if production levels moderate a bit, slowing demand will keep inventories swollen until we enter the winter heating season.  What we have learned over the past year is that prices over $50 brings with it a surge in production.  Prices below $40 probably will bring proactive steps to cut supply.  A year ago, the range for future oil prices was thought to be $45-$70.  Now it might be $35-60.  What has changed?  Two things.  First, the cost to find and produce oil has continued to fall.  Second, new production can come online quicker than previously thought.  Bulls on oil count on the fact that large offshore megafields take years to develop.  But that only comes into play if oil demand grows faster than previously expected.  What is happening is the opposite.  Global warming has reduced winter heating demand, and gasoline demand in key markets like the U.S. has been below forecasts related to changing demographics, more urbanization, and more fuel efficient cars.  If Tesla and others are successful in creating an electric vehicle industry of size within the next decade, the future outlook isn’t pretty.

FANG – Facebook#, Amazon, Netflix and Google# (now Alphabet, but FANG is easier to say that FANA) have been market leaders now for several years.  Today, these four stocks have a combined market cap of close to $1 trillion.  Two decades ago, for all practical purposes, they barely existed.  Three of the four are now among the 10 most valuable companies in America.   Laws of large numbers say they can’t grow at anywhere near historic rates over the next two decades, but for now, no one cares.  They are market darlings until they stumble or until the market enters bear country.  All four should have solid earnings this coming quarter when results are reported in July.  All continue to gain market share rapidly.  They have also been leading the market this year.  That is until they hit a pothole a couple of weeks ago.  They have all recovered some of their lost ground; none have set new highs over the past two weeks.  From a trading perspective, therefore, they are in no man’s land.  They will either break out to new highs, perhaps on the backs of glorious second quarter earnings, or they will fall sharply if they fail to meet ever loftier expectations.  When expectations continue to rise, there is always a point where even the greatest company can’t meet them.  Are we there now?   I don’t know.  We will see in about four weeks.  The one point I would make is that if these stocks cede leadership, it is hard to see the market continuing to rise.

Saudi Arabia – This morning we learn that Saudi has a new Crown Prince, Mohammed bin Salman.  He is a very smart and strong willed young man.  He was the Defense head and the youngest of three sons of the Saudi king.  He has been highly visible for some years and an architect of Saudi’s economic austerity program.  While the timing of his selection may have surprised some, he clearly has been the most powerful of the king’s three sons.  He directed efforts to defeat rebels in Yemen, a battle that has proven to be difficult and extremely costly.  Of course, all eyes will be on any changes in the relationship with Iran, Saudi Arabia’s clear adversary in the Middle East.  The U.S. will be quick to align itself with the new prince, but Prince Salman is strong willed and smart.  He and Trump will be on the same side most of the time, but not always.  Saudi Arabia still produces over 10% of the world’s oil supply and that offers the Prince a lot of leverage.

The Trump Agenda – If you listen to Republican leadership in Congress, health care will be passed in the Senate before the July 4th recess, and massive tax reform is coming in the fall.   We’ll see.  The Senate needs 50 of 52 Republicans to vote yes.  Whether moderates and conservatives can find common ground is still in doubt despite what leadership says.  I doubt McConnell has the 50 votes today, but he is going to press as hard as he can in the weeks ahead.  Chances of passage are still around 50-50.  My presumption is that the House Conservatives will have to accept whatever the Senate passes or accept staying with Obamacare as it exists today.   That may be hard to swallow, but they will have little choice.  As for tax reform, until Republicans find a way to generate revenues to offset the rate cuts, it isn’t going anywhere.   Border adjustment remains unpopular.  Eliminating the state and local tax deduction is a much smaller step.  If there is tax reform, something much more moderate than originally contemplated still seems the most likely outcome.

The Phillies – When it is the summer solstice, the baseball season is barely two months old, and the sports conversation is all about who the last place Sixers will draft, you know all you need to know.  When you think that things can’t get worse, they lose 8-1.  Who gives up 7 runs in extra innings?  Time to become a soccer fan!

Today, Price William is 35.  Gretchen Carlson is 51.

James M. Meyer, CFA 610-260-2220

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# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.

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