Stocks recovered a large part of their Wednesday losses yesterday. Wednesday’s decline was attributed by many to certain one-day option activity. Maybe so. Maybe it was profit taking. But one-day reversals happen often in both up and down markets and can generally be ignored. Bond yields held rather steady throughout.
With all that said, in a week of little new economic news, there were some disturbing tidbits. Fedex# and Nike both had disappointing earnings reports. In both cases the root cause was slower revenue growth than expected. Both claim that cost discipline and savings can overcome the headwinds of weaker economic times ahead. The reaction of both stocks to earnings, however, suggests investors are skeptical. Fedex is one of the world’s largest shippers of goods. At times it can prosper by gaining market share or introducing new efficiencies. But softer traffic trends will generally overwhelm steps the company can take over the short-term. For whatever reasons, Nike is experiencing a slowdown in demand for sneakers and related apparel. Again, maybe some of the damage is self-inflicted. But as the economy slows, and credit costs start to pinch, consumers can get by with one less pair of sneakers in their closet.
One way to offset the pain of an economic slowdown is to consolidate via acquisition. This week AON#, a giant insurance broker, and Bristol-Myers, the big drug firm, both announced deals that were received less than enthusiastically by shareholders. AON’s last big merger deal fell apart before completion while Bristol’s big acquisition of Celgene proved to be a disaster. Also in the news were talks that Warner Brothers Discovery and Paramount were discussing a business combination. Both have been losing large sums in the streaming world. Both themselves were the result of consolidating mergers. Will another combination creating an even bigger streaming entity result in a company with greater long-term profit potential? Or will it be the next Penn Central of the entertainment business?
The bottom line is, as we noted earlier this week, that slower revenue growth is difficult to offset. Layoffs, which have been few and far between so far this year, are generally a reactive step to slowing business. The news this week suggests they are coming. Christmas is just a few days away and sales are common everywhere. That’s not unique at this time of year. Sales up until the last two weeks appear to have held up rather well. Today and tomorrow are key days that will determine the success of the entire season. For some, the entire year.
The most powerful positive trend lately has been data supporting an increase in the pace of population growth. Birth rates are stabilizing while deaths are slowing as Covid’s ravages fade into history. More importantly, immigration is surging. Nothing is more important to sustaining economic growth than positive population trends. They get far less attention on Wall Street than gyrations in interest rates and Federal Reserve actions. Central bank actions matter greatly in the short-term, but if the Fed pushes too hard or not hard enough, over the long-term growth is a function of population growth and productivity improvements. AI offers long-term potential to boost the normalized rate of productivity growth but its impact to date has been nominal. The same can be said for autonomous vehicles. Better infrastructure can also help. But despite trillions of dollars allocated, so far little has been spent. The net is that accelerating population growth may be just enough to avoid a recession. But the higher costs to borrow remains a near-term headwind.
Next week is a holiday shortened week. Many have already left for an extended vacation. There is little reason to expect any robust move in stock or bond prices until after New Year’s. But starting January 2, the investment horizon shifts a bit. Right now, what is dominating markets is momentum developed since the bond rally began in early November, plus increased optimism that the new year will bring a soft landing and lower short-term interest rates. For hedge funds, 2023 is over. January 2 starts a new year. Early January will be a time to reset bets. Remember that hedge fund managers are generally paid based on annual performance. Their time horizon starts at one year and declines steadily to zero at the end of 2024. Thus, their focus will be on businesses that can maintain or accelerate growth in a softening economy. They will focus on companies likely to benefit from lower short-term interest rates, as well as companies that will benefit from other trends such as increased infrastructure spending, growing needs to support AI and EVs, etc. Areas that were hot in 2023, like leisure, entertainment, and travel, may face greater headwinds in 2024 as consumer savings wane at the same time credit card costs pinch. One good exercise is to examine stock performance in 2023 looking for companies whose shares rose or fell much faster than changes in earnings. Several of the Magnificent Seven stocks grew much faster than earnings this year. Can they repeat in 2024 or will the excitement wane a bit? On the other hand, banks got pounded last year amid a few high-profile failures. 2024 could be a rough economic year, but rates will be falling and the yield curve likely will uninvert sometime during the year. Bank stocks have had strong rallies since the start of November. Is that a harbinger of a better 2024? I’m raising questions one might ask, not offering recommendations. But I will say that looking backwards and chasing last year’s trends probably is a bad way to set the table for 2024.
I would start with the following assumptions and use them to select pockets of interest.
• Economic growth will slow through mid-year at least. Soft landing or recession are equally possible. As 2023 began, investors were set for higher rates and a likely recession. As 2024 begins, the expectation is lower rates and a soft-landing. By the way, the yield on 10-year Treasuries today is almost exactly what it was at the end of 2022. Not all predictions are right.
• Slower growth and lower inflation mean an accelerated decline in revenue growth, at least until growth reaccelerates.
• Infrastructure spending follows a long permitting process. Some is finally ready to be spent.
• AI is for real. The leading players are obvious and growing fast. AI applications consume lots of computing power and lots of electricity. Suppliers will be hard pressed to keep up.
• EVs are here. But so far, except for Tesla, no one wants them. The Biden administration wants to keep out low-cost foreign competition. But Americans aren’t going to buy high cost EVs, with an inadequate charging network in place simply because someone in Washington says it’s the environmentally friendly thing to do. I see more EV related bankruptcies in 2024 than success stories.
• Soft landing or recession, the Fed is going to cut rates in 2024. One can debate how fast and by how much but the trend is clear.
• Political acrimony will get worse in 2024 but Wall Street won’t care, as least until next fall. The worst outcome would be a White House, Senate, and House all controlled by the same party. Wall Street will root for gridlock assuming a Trump-Biden race at the top.
• Investors almost always underestimate the impact of leverage. A revenue shortfall of a percentage point or two means a much larger impact on the bottom line. The opposite is true as well but less impactful amid a slowing economy. Cyclical companies with high fixed costs are most vulnerable.
You can all add to my list. The important point is don’t expect January to replicate December. The focus will change as will leadership. Stay nimble and adjust as necessary.
Merry Christmas to all!
Today, Steve Carlton is 79. Since I won’t publish Monday, I thought I would identify some famous names born on Christmas Day. They include Clara Barton, Humphrey Bogart, Cab Calloway, Barbara Mandrell, Jimmy Buffett, Sissy Spacek, and Justin Trudeau.
James M. Meyer, CFA 610-260-2220