Stocks were mixed yesterday. The Dow finished lower because of weakness in United Healthcare.
This morning there is a lot of news to consider.
- Late yesterday, Disney# rolled out its new Disney+ streaming product expected to begin service on November 12th at a cost of $6.99 per month, a bit over half of what Netflix charges. While there might be some Netflix subscribers who switch immediately, it is much more likely that those enticed by the Disney offering will add it onto their Netflix base, at least initially. The main message this morning is that there will be room for both. Disney’s stock looks likely to open higher. Netflix’s shares are down about 1%, which I don’t view as much of a negative reaction. The losers from this announcement will be the surfeit of other over-the top services vying for consumer dollars.
- Chevron# is buying Anadarko Petroleum for $65 in cash and stock. This is the first really big deal in the energy sector in quite some time and could set off a reactive set of mergers over the coming months. In slow or no growth industries merger synergies is one way to move and try to counteract the pressures of slow demand.
- Banks have started to report earnings, and the early news is good. Credit quality seems fine, loan growth is OK and banks are maintaining net interest margins despite rising short term rates.
These three highlight the abilities of Corporate America to succeed and grow in a slow growth, low inflation environment. When stocks were falling and the yield curve started to invert, at least at the short end, talk of pending recession started to increase. We have spoken many times about the cause of recessions. They always are a derivative of either an economic or financial imbalance. Generally, the economic imbalance is a function of unequal supply and demand pressures that result in either cost-push or demand-pull inflation. Central banks naturally react by raising interest rates to slow down demand and offset inflation. Financial imbalances occur when debt levels rise to a point where the ability to service the debt erodes. We saw that in spades during 2006 and 2007 when the housing market collapsed and foreclosures skyrocketed. While total debt outstanding today is at record levels, debt service costs are not a major concern courtesy of low interest rates. Obviously, should interest rates rise significantly, as a result of either central bank action or rising inflation, debt service would once again become a big concern. But that isn’t the case today, and isn’t likely to be for some time to come.
In fact, if you look at today’s environment, the outlook is quite good. Inflation is low. The only inflationary pressures come from a steady but slow increase in wages. But those are being offset by a gradual rise in productivity. Nominal growth (i.e. growth adjusted for inflation) remains in the 2-3% range. Weekly jobless claims are at 50-year record lows. We are secure in our jobs, and wages, in real terms adjusted for inflation, are rising. We have more money to spend or save and we are doing both. You can’t ask for more.
The dollar is also steady suggesting world markets are in good balance. That doesn’t mean everyone is growing at the same rate but it does mean that the relative growth rates around the world don’t require major currency adjustments to reset. Thus, decent growth, low interest rates, adequate excess capacity, stable currency markets and no major wars in sight all combine to paint a pretty nice picture.
If one wants to suggest a recession is coming, the obvious question is how will this balanced world I just described become unbalanced? Might all the excess worldwide capacity suddenly be consumed setting off an inflationary spiral? Perhaps, but not over a 1-2 year span. Might central banks tighten too aggressively and weaken demand? That is even less likely. The Fed has essentially said it is on hold. The same goes for the ECB. China continues to stimulate but it really isn’t part of the world banking system yet given how its government controls its currency.
There are some who predict the Fed’s next move will be to lower rates. Maybe. When you are on hold, market forces eventually will force a move just as you are required to move the steering wheel slightly every once in a while, as you drive in a straight line. But those making noise about the next Fed rate move seem to forget that the Fed went almost nine years between rate increases before its December 2016 move. Despite periodic tweets from President Trump, the Fed right now sees no need to move in either direction. If the White House is so hung up on growth, all it needs to do is eliminate the tariffs it has put in place over the past year. By the way, in case you haven’t noticed, US Steel set a 52-week low yesterday at a price less than half of what it was when Mr. Trump initiated 25% tariffs on imported steel. Tariffs are a tax and a barrier to growth. Period.
With that aside, unless governments increase their level of economic interference, it is entirely possible that we can go years with only a light tap on the steering wheel, i.e. an occasional 25-basis point move in rates in either direction. Unless there is a surge in productive capital investment, growth in excess of 2-3% cannot be sustained. And there is no indication of any pending surge in capex.
Markets, obviously, can get ahead of themselves. We have seen bear markets after periods of euphoria. A surge in new issues bears watching and could become a concern. But the market’s muted reaction to Lyft suggests that we aren’t in that euphoric stage yet. Uber comes next. Last night it revealed that it has lost $7 billion over the past two years and may not be profitable for a long time to come. The number of users (those using one or more of its services at least once a month) has been rising but I suspect much of that is because of relatively new services like Uber Eats and not a rush of new Uber riders. Like Lyft, Uber may experience an early surge and then drift back to fair value. If that happens, it will only reinforce the strong market and it will send a message to all the private equity giants waiting in line to go public that if the economic model isn’t ready for prime time, investor interest may be muted.
Thus, while skeptics keep looking for signs of weakness that really aren’t there, and we see no reason to expect a balanced economy to become unbalanced any time soon. Valuation matters and stocks aren’t particularly cheap right now. But earnings season often creates opportunities. Having some fresh powder to take advantage of isn’t a bad idea.
Today, David Letterman is 72. Ed O’Neill is 73. You may love him in Modern Family but to me he will always be Al Bundy.
James M. Meyer, CFA 610-260-2220