It was another week of recovery as data skewed positively. Given that the economy seems, at least for the moment, to be in a phase of moderating growth and moderating inflation, it is logical that we are seeing a mixture of data, some positive and some not so positive. Growth in this economy, like the stock market, has been skewed toward the technology sector, specifically companies that are deep into the race to build out generative artificial intelligence infrastructure and applications. The rest of the economy is still growing, but at a very low single digit pace. That implies some sectors are or have been in their own mini-recessions. Consumers have become strapped both by the cumulative impact of inflation over the past three years and by slowing demand.
Well managed companies don’t stand still. They adapt. How they adapt varies. McDonalds is promoting $5 value meals in response to customer resistance to higher prices. Wal-Mart is increasing focus on costs, stripping out everything non-essential. Home Depot is focused on the professional builder who is thriving while still supporting the do-it-yourselfers’ needs. Real estate developers are converting offices to condos, shopping malls to mixed use facilities and warehouses to distribution centers. Any reader of my letters knows one of my favorite words is pivot. Good companies pivot. Mediocre companies make excuses. Good companies gain market share from mediocre ones.
We are in an environment where good companies can thrive. But not all companies can.
Wall Street has had a love-hate relationship with this economy. For a time, it liked weak economic news because it felt that was the precursor to lower inflation and, ultimately, lower interest rates. But as inflation has receded, and the Fed’s primary focus has shifted from a sharp focus on inflation reduction to ensuring labor force stability and positive growth, bad news has been received as it should… negatively. In a slow growing economy, as noted a moment ago, slow growth means a combination of vibrant growth in some sectors and declines in others.
We are now at the cusp of the Presidential election season. So far, we have heard a combination of feel good promises and nasty attacks. But as the Democrats move to Chicago for their convention and the first debate between Trump and Harris is only a few weeks away, both sides are trying to lay out specifics that they feel will attract voters.
So far, the promises are mostly based on handouts. Large child care credits, no taxes for tip income, eliminating taxes for social security benefits, big tax credits for first time home buyers, expanded student loan forgiveness. The list gets even longer. At the same time, neither side is saying how all these giveaways will be paid for. The reality is that much of what is promised won’t be made into law assuming Congress is roughly evenly divided. From Wall Street’s point of view, that will be fine.
In most elections, voters choose based on their own perception of which candidate will help them the most economically. Obviously, there are other important issues like abortion and border security, but the reality is that most vote with their wallets. That would seem to favor the Republicans given the negative feelings Americans have collectively about the impact inflation has had on their lives for the past three years. But then there is the Trump factor. You either love him or you hate him. The fight is for those in the middle, the suburban housewives, Hispanics, the young voting for the first time. So far, both have focused on reinforcing their bases through rallies and canned speeches. Both candidates chose VP candidates who reinforced their appeal to their respective bases.
Wall Street has no better feel yet than the rest of us how that will turn out. As such, markets have not moved in any particular direction based on a likely Presidential outcome. A Trump win would likely mean lower taxes, higher tariffs, greater uncertainty, and less regulation. A Harris win would mean higher taxes and more regulation. Both Trump and Harris like to spend and neither seems to care too much about deficits. That probably means deficits will stay near $2 trillion per year for the next four years, and borrowing costs a bit higher than normal given the increased funding needs. While a debt crisis may still be years off, any notion that borrowing rates will return toward pre-pandemic levels is a pipe dream. That means the ability to self-fund only gets larger and it strongly favors companies with enormous cash flows. That includes most of the Magnificent Seven but also leaders throughout corporate America from Wal-Mart to Caterpillar, to the big drug companies, to the largest banks.
Stocks go up roughly 75% of the time. The exceptions are recessions or times of massive overvaluation. The most recent decline, in 2022, was a result of a rightsizing of valuation combined with the reality among the big tech companies that spending on future moon shots had to be tempered when demand started to flatten out a bit. Today, by most measures, stocks are fairly or slightly overvalued. That means the upside will be dictated by the pace individual companies can grow. If nominal growth in the U.S. over the next few years is low-to-mid single digit, the winners will be companies capable of growing at a high single digit rate or more. That isn’t an easy task. Only the best will thrive. As investors, as Warren Buffett likes to say, own the best at a fair price rather than mediocrity that seems cheap. Those become your classic value traps. Macy’s and Intel are two classic examples.
Sometimes great companies lose their mojo when leadership changes. But if the genes are right, new leadership can right the ship. Last week, Starbucks hired a new CEO from Chipotle. Wall Street thinks Nike will be next. We have seen rejuvenation work at Coca Cola, Procter & Gamble and McDonalds. It will happen again. Great companies have active Boards.
I want to end with one thought. The root of virtually all growth in this generation has been technology. Whether it is robots in an auto assembly plant, the advent of the PC, the smartphone, the Internet, streaming, mobile ordering, or genetic engineering, technology is the driver of growth. When you see the top of the S&P filled with tech names, it’s no accident. That doesn’t mean these great companies will be tomorrow’s leaders. That remains to be seen. But anyone who thinks whatever greatness lies in store tomorrow or decades from tomorrow can happen without major technological advances is simply dead wrong. Understanding the technological engines that will propel tomorrow’s economy is the key to successful investing. That doesn’t mean all success stories will be tech giants. But it does mean technology will be at the core of tomorrow’s great enterprises. Over 80% of McDonald’s traffic comes through the drive-thru windows. Technology drives that. Online retail drives revenues for Wal-Mart and so many others. To succeed, farmers need the latest from Deere and others. It’s easy to focus on last month’s unemployment rate or last week’s CPI. But don’t lose sight of the big picture. Technology drives growth and investors who make the right bets within technology stand the best odds of long-term success.
Speaking of technology, Microsoft CEO Satya Nadella is 57 today. Bill Clinton turns 78.
James M. Meyer, CFA 610-260-2220