November 20, 2017

Thursday’s one-day rally evaporated on Friday as stocks closed lower amid little news. There wasn’t much new to digest over the weekend, and this week’s calendar is light because of the Thanksgiving holiday on Thursday.

Friday, of course, is the day we refer to as Black Friday. In the past, this was the so-called day that retailers moved into the black for the year. It was also labeled as the biggest shopping day of the year. That was never true, but it certainly has been an important date as it marked the start of the traditional selling season, highlighted by big sales. But as time passed, the sales that started in the wee dawn hours of Friday morning got spread out over time. Stores began to open Thanksgiving evening. Some now start their sales as early as today. Given the importance of Christmas season to retailers, others got the jump even earlier. Christmas decorations in some stores now go up as soon as Halloween ends. Soon, Labor Day may be heralded as the start of Christmas season.

Technology has also changed everything. The Internet has diverted sales from traditional stores. Next Monday is Cyber Monday, but Internet retailers are moving their sales back calendar-wise to stay in stride with traditional retailers. All of this dilutes the significance of Black Friday. While it remains an important shopping day, and all your local TV stations will have field reporters in the malls to memorialize the day, as investors, we learn less and less from Black Friday.

With that said, there are reasonably high expectations this year despite the dismal performance of department stores throughout the year. With the stock market at record highs, unemployment down to 4%, and consumer confidence soaring, there are few reasons not to be optimistic. There are always a few negatives to throw into the mix, and this year is no exception. Gasoline prices are the highest in four years, but they probably aren’t high enough to sap much purchasing power. For sure, there are no killer toys or fashion trends either. But there is an iPhoneX and an Apple watch that will get lots of attention, not to mention a slew of new videogames. At least Apple# should have a good Christmas.

In relatively quiet times like these, time is available to look over your portfolio. One would think that in a year when stocks are up roughly 15% there would be few losers. But that isn’t true. This has been a rather bifurcated market this year with a few key groups, notably technology, doing most of the heavy lifting. Foreign markets have mostly had good years as well. But there are losers besides the aforementioned department stores. Energy stocks have lost ground despite the fact that oil prices today are the highest they have been in over two years. Elsewhere, there have been small pockets of weakness scattered among consumer discretionary and healthcare. Tax laws require that if you want to sell a stock to realize a loss you cannot buy the same stock back for 31 days, or the loss cannot be deducted. In a year with large gains, investors near the end of the year actively try to harvest losses. When sellers outnumber buyers, prices go down. Thus, while all losers of the class of 2017 won’t go down in the fourth quarter, many will see significant selling pressure between now and the end of the year. That pressure quickly evaporates as the calendar changes into 2018. A favorite tactic has been to sift among this year’s losers to find companies that might bounce back next year. That trend is highly accentuated in January, leading to what many have called the January bounce. December selling pressure quickly morphs into January bargain hunting.

If you sell your losers in November, you give yourself the option in late December to buy them back before the January bounce as long as you wait the required 31 days.

The trick, of course, is to separate the companies that hit a short term pothole in 2017 and not a sinkhole from which they might never climb out. Some retailers are so sick that they may never flourish again. I suspect the cycle of closing stores to right-size a marketplace that will continue to lose share to the Internet is only in its early innings. You will know it is ending when the majority of big retailers start achieving same store sales growth in line with nominal GDP growth. In English, that means that when the two growth numbers are equal, retailers in total will be maintaining share. Last week, Wal-Mart# reported 2.7% same store sales growth, beating expectations, and its stock rose by 10% the next day. In the long term scheme of things, 2.7% growth isn’t cause for celebration. But placed against the negative growth rate of some large chains, it looked spectacular.

Big box retailers aren’t the only industry in secular decline. Newspapers are disappearing, and magazines that used to weigh pounds appear anorexic. Radio stations are losing share to music streaming and may never recover. The same is probably true for ad revenue for individual TV stations. Despite some help from President Trump, the use of coal to generate electricity is going to continue to slide. Before long, electric and hybrid vehicles will take significant share from traditional gas-powered cars. One can make money on these stocks occasionally when near term expectations get too extreme on the downside. But they are very difficult stocks to own in long term portfolios. It is much more prudent to step aside and watch market shares stabilize (if they ever do) than try and pick a bottom.

With that said, keep in mind that the two primary drivers of stock prices are earnings and dividends. Earnings are almost certain to rise next year. Interest rates are more difficult to forecast. At some point, inflation expectations will rise. It is possible that at some point in 2018, they will trigger a sudden and unexpected rise in the 10-year yield. If that happens, it could easily set off the correction so many have long feared. We saw that happen in 1994, for instance.

But that time doesn’t seem to be now. Taxable sellers will defer taking gains until early next year. Other than trying to guess how strong Christmas season might be, there will be little in the way of new data for a few weeks. Stocks traditionally do well in Q4, and there is no reason to expect otherwise this year.

Today Bo Derek is 61. Joe Walsh of The Eagles is 70. Former VP Joe Biden is 75. Actress Estelle Parsons turns 90.

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.

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