Stocks were mixed yesterday, in line with a mixed set of earnings reports. After the close, Apple# reported slightly better than expected results, and the stock moved about 4% higher. That alone will lift major averages this morning. Without the Apple impact, stocks look to trade fairly flat going into today’s conclusion of a two-day FOMC meeting that almost certainly will result in a 25-basis point cut in interest rates, the first rate cut since before the Great Recession. Of course, the real news will take place during Fed Chair Jerome Powell’s post-meeting news conference. Bulls will want to hear of the likelihood of more rate cuts to come. Those who scratch their heads wondering why the Fed should be cutting rates with an economy growing in excess of 2% will want to hear more as well. As I have been noting, the real market reaction may take a few days and will evidence itself in a changing shape of the yield curve. How that changes will tell us whether investors believe the Fed is in front or behind the real market.
In one clear sense, this market is an enigma. On one hand, manufacturing stinks. It stinks for a lot of reasons. The political environment is a strong headwind. Tariffs, uncertainty, political transitions in key countries like the UK and Germany, and swollen inventories all hurt. Key end markets, including autos and housing, are relatively stagnant. As I keep harping on, the world is vastly oversupplied. That means pricing power is about as bad as it gets for most manufacturers. Weak volume growth and bad pricing is an awful mix. On the other hand, the consumer is robust, confident, employed, and more than willing to spend.
The stock market reflects exactly this. Stocks of restaurant companies, hotels, specialty retailers, and consumer staples companies are leading the market. I want to highlight three: Procter & Gamble#, Coca Cola#, and McDonald’s#, to make a specific point. All three have long been leaders in their markets. All three were led by iconic CEOs. But after those CEOs left, their successors acted more like caretakers than leaders. Any company will die a slow death if it stops innovating and pressing forward. I remember when Toyota got customer service ratings of 98 versus less than 90 for America’s Big 3. It’s CEO, rather than boasting, said he wouldn’t be satisfied until the rating was 99+. Procter & Gamble got a bit complacent, replaced its CEO fairly quickly, concentrated on just 10 categories (getting rid of the small and slow growing units) and stepped up both innovation and marketing. In the June quarter all 10 sectors gained share. Coca Cola faced deteriorating demand for its iconic cola brands. It aggressively moved to other drinks, got out of the bottling business, and introduced Coca Cola Zero that has been a huge success. At McDonald’s, new management introduced all-day breakfast, added ordering kiosks, simplified the menu, moved to fresh meat from frozen and added delivery. The morals are several:
- Great companies whose culture runs deep, can withstand a less than superlative CEO provided its Board does its job and makes changes within a reasonable timeframe. The old giants that die generally do so because their Boards lack the courage to make change.
- Great consumer franchises are worth vastly more than is indicated on their financial statement.
- The consumer is alive and well, not only in the US, but all over the world. There is no developed nation that hasn’t seen a meaningful recovery in the balance sheet or employment security of its populace.
- The tortoise may not always win the race, but the jack rabbit always runs out of gas before it crosses the finish line.
I will offer one more example. Under Armour burst onto the scene with a line of athletic wear that threatened Nike and others. Nike and Adidas, among others, responded as good competitors do. Under Armour, in turn, tried to branch into other products like footwear and golf attire. It also sought out additional channels, like mass merchants and outlets. But it lacked the breadth as it diversified. While it signed one or two iconic athletes as spokespersons, Nike hired dozens. Sending more merchandise to retailers that discounted heavily, cheapened its brand. Lululemon came along, selling only through its own stores and online, and captured share at the high end, further weakening Under Armour’s position. The moral hear is that size and scale matter. One can compete against the big guys but trying to be everything to everyone too fast isn’t going to work if you are David fighting Goliath. Maybe in the bible, but not in the business world.
In time, a strong consumer will help to alleviate the oversupply condition that infects the manufacturing sector presuming no more capacity is added. But it will take time. It could take a lot of time. That is why investors keep gravitating to what is working rather than trying to guess when those industries with weaker fundamentals will start to turn around. Of course, there could be lots of opportunities if one could properly predict the inflection points. In the world of equity investing, it probably is safest to wait until that point has actually happened and the worst is clearly over. Picking tops and bottoms is more difficult than going with the flow, particularly when the flow looks like it is moving in the right direction for a considerable period of time.
Today, author J.K. Rowling is 54. Wesley Snipes is 57. Hard to forget Willie Mays Hayes.
James M. Meyer, CFA 610-260-2220