Stocks were mixed yesterday as companies reacted in starkly different ways to earnings results. While Microsoft#, for instance, rocketed to a new all-time high, 3M# sank more than 10% as it fell well short of forecasts.
In many ways, the current stock market and economy resemble the late 1990s. You may recall that in 1994 the bond market had a rough year with rates rising sharply. Stocks ended flat after a year of much volatility. In some ways, 1994 and 2018 were similar. Last year the Fed increased short term rates four times, more than many market observers expected after the Fed had increased rates less than 4 times over the previous decade. While rates today are lower than they were in the mid-90s,and inflation is lower as well, in both instances it appears that a solid economy emerged out of a relatively brief period of bond market turmoil.
Again, if you look back to the nineties, a relatively robust first half of the decade, which was interrupted by bond market turmoil in 1994, evolved into a very different economy after 1994. The contrast proved to be very bleak if you looked at it through the lens of the stock market. Because after 1994, the stock market took on a very stark and bifurcated appearance. While averages leapt to new highs with the Dow crossing over 14,000 by early 2000, it became a market of haves and have-nots. The haves were centered around technology as America was fascinated both by the emergence of the Internet and enthralled by the rapid growth of PCs and servers. It was a decade led by names like Microsoft, Intel, and Cisco# plus upstarts like AOL, Yahoo and Amazon. At the same time, it was a nifty fifty kind of market when investors took comfort in large companies capable of reporting consistent growth in earnings, dividends, and free cash flow. These included the big drug companies, staples like Procter & Gamble#, and- ahem- GE. It wasn’t unusual by the end of the decade to see these darlings sell at 30+ times earnings or more even as organic growth was slowing to sub-5%.
The “losers,”stocks that got left behind, were mostly what we called smokestack America, the big manufacturing companies, auto suppliers, and utilities. Similar to today, economic growth in the late nineties was steady but not spectacular. But what caught everyone’s imagination were the marvels of technology. That was the decade when Compaq and Dell exploded onto the scene. Computers were no longer just standalone devices. Email was emerging and “you got mail” was the AOL slogan that got all of us online. Yahoo brought the words portal and search into our technological vocabulary. PowerPoint presentations changed the way we communicated. Obviously, not all the young upstarts turned into adult giants. Many failed. Some were acquired. It’s a bit hard to believe that Verizon# now owns both Yahoo and AOL.
Technology made us more productive and, as I note often, increased productivity is the driver of growth. Sometimes productivity comes from big new machines. The car and the airplane are two obvious examples. I could go back two hundred years and mention the steam engine and the cotton gin.
Today’s world is both very different and remarkably similar. It may be hard to argue that social media and video games are making us more productive. In fact, the easier argument is the opposite. But technology is about to open new worlds. We are only at the beginning. Not all of us see this yet and those that do won’t get the ultimate conclusions right. Let me offer a few examples.
About a decade ago, DNA was first mapped. Today, gene sequencing and mapping are done at a fraction of the price. What cost millions and took months to accomplish now takes thousands and hours. A decade from now, it will cost hundreds and take minutes. What does that mean to you and I? It means that medical abnormalities caused by gene deformities can be detected and corrected. It means that just as you compare baseline cardiograms to new ones today to detect heart disease, future DNA maps will allow doctors to spot genetic mutations before any symptoms appear. Cancer could be diagnosed at its earliest stage hopefully leading to better treatment and outcomes.
One of the most fascinating companies today is Tesla. Its founder is a genius, and the company’s technology is amazing. The same can’t be said, however, for Elon Musk’s business acumen. The stock is struggling as a result. The key to Tesla’s future will be its ability to drive down unit costs with higher volume. For all the media hype and criticism, the key to the Tesla story is whether it can find the way to make an electric vehicle that offers superior performance at a price less than what a comparable car powered by an internal combustion engine would cost today. The early $100,000+ luxury sedans were a niche market. They were a stepping stone toward the mass market. At the moment, Tesla is having trouble driving down costs fast enough. Being capital constrained, it cannot afford to price the cars at a level that will attract the volume needed to bring down unit costs faster. Technology is helping to lower costs but not fast enough yet. Whether Tesla succeeds or not, someone ultimately will. In a similar fashion, the costs to produce solar energy are coming down rapidly and, someday in the not-too-far distant future, will drive significant electricity generation away from fossil fuels to alternative power generation.
The cloud and collaborative computing are driving down the costs of doing business. Artificial intelligence will replace low skilled workers as will robots and drones. Blockchain will speed production and delivery times. 5G networks, which will be ubiquitous within 5 years, will allow data to move at speeds 10-100 times faster than today making autonomous vehicles a coming reality.
Wall Street sees this. The stocks that are winning today include many companies leading the way in numerous of the business segments I just mentioned. But alas, as investors, simply buying stocks of companies in these businesses isn’t all that simple. As Warren Buffett likes to say, you don’t know who’s swimming naked until the tide goes out. Great companies have great managements. Renting a warehouse and filling it with a bunch of connected computers doesn’t make you a great cloud company. Some of today’s new leaders won’t survive to be tomorrow’s leaders. While some old-time favorites reinvent themselves and stay at the top (Microsoft is an example), more often than not yesterday’s leaders are replaced by new upstarts. Google# literally took over the search market previously dominated by Yahoo, and Yahoo never recovered. Compaq is gone, and AOL is a tiny shell of what it used to be.
As markets emerge from skepticism and move in the direction of euphoria, the rewards of being right increase but so do the risks of betting on the wrong horse. No one can tell whether today’s market resembles 1996 with 3-4 years to run or late 1999 with just a few months left. An emerging hot IPO market suggests we are pretty far along but, so far, the companies that have come public are real substantive enterprises. We still haven’t seen those startups which resemble more of a game plan than an operating business.
As investors, we have to look forward, not backwards. There are risky ways to play some of the hot new technology waves, and there are more conservative ways as well. But in a world of disruptive companies, for every winner, someone has to be left behind. Despite President Trump’s efforts to revitalize America’s coal and steel industries, I wouldn’t want to finance a new coal fired electricity generating plant. U.S. Steel’s stocks sits at a 52-week low while stocks are at all-time highs. Ford talks of electric cars while Tesla makes them, and GM is close behind. Macy’s idea of new age retailing doesn’t look all that different from yesterday.
Yesterday, Microsoft hit a new all-time high while 3M sank due to weak sales in many of its end markets. There is a message there, and investors would be smart to pay attention.
Today, Melania Trump is 49. Carol Burnett is 86.
James M. Meyer, CFA 610-260-222