Stocks rose yesterday amid a few good earnings reports. However, after the close, the Justice Department announced that it would begin an investigation into antitrust activity at the big social media, search and Internet retailing companies. Put Facebook#, Alphabet# and Amazon at the top of that list. At the moment, this is an announcement of an inquiry, but if history serves as a guide, this is likely to be a cloud overhanging each of these companies for some time. Both Facebook and Alphabet have already paid hefty fines and adjusted the ways they do business. We have seen many times through history that large size brings with it many advantages, but it also brings circumspect views from those responsible to the public for oversight. Companies, in most cases, try to establish criteria to ensure they are good and responsible corporate citizens, but most of the time governments find their efforts insufficient, sometimes to the point where they cross the line and engage in illegal or non-competitive activity. This investigation will serve to determine, from the government’s vantage point, whether any of the companies crossed the line and what safeguards need to be put into place. The remedies could be as simple as better disclosure or as harsh as a corporate breakup and big fines. The most likely outcome is somewhere in between, although the media undoubtedly will discuss ad nausea the possibilities/probabilities of breaking up all three of these companies. For now, at least until formal charges are made or formal changes are offered, the impact on the stocks should be rather moderate. Furthermore, the three companies are not all the same; they will be treated differently. But I can’t remember a company with the overwhelming power they possess in search, social media, or Internet retailing that didn’t face some form of enforcement action over time.
Of course there are 497 other companies in the S&P 500. So far this earnings season, they seem to be doing a little better than expected. There have been very few earnings disasters so far. The most notable miss was Netflix for reasons we have spelled out previously and those were company specific. While global economic growth still shows indications of slowing, there are hints of stability. Growth rates now correlate better with the growth of working class population plus a modest gain in productivity. There is little question that tariffs, mostly precipitated by us, have impacted world trade and supply chains. The good news is that, at least for now, there seems to be little push to increase tariffs further (although that could change with just one tweet). The bad news is, with a few narrow exceptions, there isn’t much movement to reduce tariffs either. Thus, while we hope that pending rate cuts by the Fed and movements by other central banks to keep money flowing and interest rates low, near term hopes of growth of 3% or more seem more dreamlike than real at the moment.
House Speaker Nancy Pelosi and Treasury Secretary Mnuchin have reached an agreement on a 2-year spending plan that would also suspend the debt ceiling through the election cycle. The plan, however, would ensure $1+ trillion deficits per year and would explode Federal spending more than $320 billion above prior austerity targets. As one might expect, there is some pushback from both the right and left. The right doesn’t like the lack of spending restraint. The left wants more money for their social agenda. Neither is likely to be satisfied. There might be small accommodations to gain votes but what we see today is likely to be very close to the final outcome. In the short run, it will help to expand growth. But one day, when interest rates rise (and they will someday), the penalty of too much debt will be exposed. At the moment, markets are willing to ignore that.
The biggest overhang in world markets, and that includes the U.S., is oversupply of almost everything except labor. There is plenty of money; that’s a key reason rates are so cheap. Even where pundits suggest that supply is tight, it often isn’t. Take housing. You hear talk repeatedly that sales of existing homes are weak because there aren’t enough listings. If that were so, prices would be rising. While prices did rise for several years faster than the rate of inflation, that is hardly true today. Indeed, some formerly very hot markets, like California, have cooled off substantially. Prices are even starting to fall in some areas. Rents continue to rise in some markets but once again new supply will stop that from continuing.
Start with basic commodities. If you draw a trendline for the past five years, you will see downward sloping lines for almost all, including both oil and food commodities. Further up the production chain you see that manufacturers have little pricing power. The same goes for retailers. There is clearly too much retail selling space across our entire country. You continue to see ghost malls where only a handful of stores remain open and parking lots are more likely filled with excess used cars for sale than consumers looking to buy.
Why so much oversupply? I will offer three reasons:
- The Great Recession: In many sectors of the economy, demand simply hasn’t caught up with supply.
- China: China grew by building stuff for the rest of the world. As demand started to fade, China’s central government continued to build both supply and capacity in a futile effort to keep accelerating growth. At some point, it started to dump excess inventory overseas at cheap prices. Tariffs were one reaction.
- Declining global demand growth.
Central banks are continuing to try and stimulate by creating easy money conditions. But central banks can’t create spending; they can only improve the spending environment. Many governments around the world, notably Germany, are reticent spenders.
Over time, excess capacity will be absorbed. Some capacity, whether it is antiquated manufacturing plants or old malls, will have to be abandoned. Demand will grow slowly with population. But the process takes time. As it occurs, inflation will slowly increase, a sign balance is returning. Until then, it is a bit like a bad back caused by a pulled muscle. You know it will get better but it takes much more time than you want. In the meantime, the economic world is basically OK. Profits still grow albeit at a very slow pace. And stocks inch higher. We are barely 1-2% higher than we were at the end of January 2018. We haven’t had a 10% correction yet this year and one wouldn’t surprise me. But without evidence of an actual economic downturn, we would suggest patience is a good virtue and staying with quality is the best bet.
Today, Jennifer Lopez is 50. Lynda Carter is 68.
James M. Meyer, CFA 610-260-2220