Stocks fell sharply in the last hour erasing early day gains. Investors got excited early when Russia claimed to have approved a Covid-19 vaccine. They may have, but what they “approved” was nothing more than a drug passing Phase I clinical trials. It’s nice there is another vaccine candidate making progress, but that is all there is to say about the announcement. The bigger economic news yesterday was the midday and afternoon collapse of silver and gold after big runs up. Oil followed suit but didn’t drop as much. Nonetheless, despite lower numbers of new virus cases in the U.S. stocks took a breather.
After the close Tesla excited investors announcing a 5-for-1 split. After Apple’s# stock popped when it announced a 4-for-1 split, investors were hoping for a repeat performance from Tesla. Splits, of course, by themselves create no economic value. But when emotions rule, even splits matter.
What we did see yesterday was a rise in Treasury yields as inflation expectations rose alongside an improved economic outlook. 10-year yields are up again this morning. Essentially our economic outlook today correlates with the state of Covid-19. When hot spots fade and new virus counts decline, investors and economist get excited. (Actually, I am not sure economists ever get too excited.) We’ll see whether the improved trends can withstand school re-openings. Over the past few weeks, more schools have gone virtual. Even college football appears likely to be suspended for the fall, and possibly resume play in the spring. At least baseball is hanging in there. Unfortunately, the Phillies bullpen has contracted a disease worse than Covid-19. Oh, well. At least pro sports are back. Overseas, in Europe, where the number of cases had held at low levels for months, there have been recent upticks, consistent with the re-opening of schools. The virus isn’t going away.
After the close, Joe Biden announced Kamala Harris to be his VP pick. From a Wall Street perspective, this was about as perfect a pick as he could make. She is experienced, not too far left, and uncontroversial. One never wants the VP choice to cost votes. Of course, voters are voting for the top of the ticket, but as Sarah Palin showed a dozen years ago, a bad VP choice can spoil the party. I expect no market action to her selection, at least for now. Both party conventions are on deck. Democrats meet next week with Republicans to follow the week after. Platforms will be dissected but the real fight begins after Labor Day with the first debate scheduled for late September. Until then, we will most likely have to endure a lot of accusations based on distorted facts.
Finally, Congress remains stalemated over a fourth Covid-19 relief bill. Given it’s an election year, it is logical to expect a compromise fairly soon. Without one, the number of small business failures will escalate sharply. While both sides blame each other, voters will blame both sides. In Congress, crisis begets action. The longer Congress stalls, the closer we get to crisis. There will be a bill. The only question is when.
Retreating back to the economic world, lately we have been experiencing the largest negative real interest rates in decades. Clearly, it pays to be a borrower, not a lender. It also pays to own financial assets given the ultra-low cap rates tied to these low yields. In the stock market, that means ever higher P/E ratios. High P/E ratios favor non-dividend paying growth stocks the most, as all of their return is tied to growth in earnings. I don’t want to get too deep into the mathematical weeds but the proof is a simple set of equations. Conversely, when rates rise, P/Es contract and value stocks gain favor.
This week, there has been a trend in that direction. Rates have risen, economic optimism is rising, and investors have shifted towards value. Banks, oils and industrials have been leaders while the tech giants have paused. We have seen this mini-rotation several times since the pandemic began. It is hard to tell whether we are seeing another head fake toward value, or whether a fundamental leadership change is at hand. Lately, while a few big tech names, like Apple and Facebook# have forged to new highs, others, like Amazon, Tesla, Alphabet# and Netflix have stalled. Since almost by definition we are closer to the point where the virus fades either naturally or due to an available vaccine, it would appear likely that quality companies that have taken a one-time beating from Covid-19 finally should be able to make a solid recovery. As investors, we have to divide that pack between those in good shape that will return to new heights once the pandemic ends, and those that will suffer enduring pain due to either permanent lifestyle changes (think movie theaters) or become so burdened with debt that returning to old profit levels will take a very long time (think airlines). That is what happened to the banks after the Great Recession.
Let me give a couple of specific examples of what I mean. Look at consumer branded apparel. Throughout the pandemic, Lululemon has continued down the road to success. It sells its goods completely online or through its own stores. Obviously, with stores closed by state edict, Lululemon has had to pivot to 100% online. It wasn’t all that hard. The company has sailed through in good shape and its stock has been trading near record highs for months. At the other end of the spectrum is Ralph Lauren. It was a great name but has faded a bit in recent years. The company has multiple lines of similar goods separated by price points, Purple at the top and Polo near the bottom. While it owns a few of its own stores, most sales go through department stores and similar apparel outlets. That excludes what it sells through its outlet stores. Of course, most outlet stores were closed for months. Ditto the department stores. Unlike Lululemon, Ralph Lauren had not developed much of an online presence. With traditional sales channels closed, and a fading brand trying to rediscover its mojo, the stock and company have floundered. Take a third name, VF Corp#. VF has a host of brands but two have stood out in recent years, Vans and North Face. Vans has been the go-to place for teens and millennials for stylish comfortable shoes. It sells through multiple channels including its own stores, both standalone and in malls. North Face is more dependent on third party retailers. Since it focuses on winter outerwear, Covid-19 hit at the right time. North Face has seen increased competition in recent years at the high end from Canada Goose and Moncler. But unlike Ralph Lauren, which still seems to be looking for direction. VF is fighting back. While store re-openings are very important, the company has strongly ramped its internet presence and continued to develop new products for the coming fall and winter seasons. It is still having a much more difficult time than Lululemon but has a path back to prosperity that is much more defined than Ralph Lauren. Its shares are well off prior highs but there is a path back if the stock market is right that economic recovery will continue and retail traffic will return.
Three companies, all in the same universe traveling down three very different paths. One is well recognized by investors already. One is still groping, a risky bet that will only pay off if the company finds the right path forward as it moves away from department stores and outlets to greater control of its own destiny. And one with strong brands moving quickly to adjust distribution, while staying leading edge and relevant with its most vibrant brands. Three very different choices and, likely, three very different outcomes, both long term and short-term.
As long as the Fed stays with its policy of anchoring rates well below expected inflation, the market’s path is forward, barring a true spike in Covid-19 infections. But the path is bound to have bumps. School re-opening could lead to a spike. So could colder weather forcing most of us back indoors. If too many schools stay virtual, or too many restaurants close assuming patrons stay away when outdoor dining ends, we could witness a bigger than expected correction. The recent upward ride for stocks could be a case of too much good news. But corrections should stay moderate until the election gets closer.
Today, Pete Sampras is 49. George Soros turns 90.
James M. Meyer, CFA 610-260-2220