Stocks fell for the second straight session after Federal Reserve Chairman Jerome Powell noted that he saw no reason for a rate cut anytime soon. He said that the board believed the unusually low inflation numbers in the first quarter were transitory and didn’t yet warrant a cut in rates in order to stimulate more inflation. Mr. Powell, who persistently has noted that market conditions will dictate Fed action, left open the possibility of a future cut if inflation remains persistently low.
With that said, while observers can offer many reasons why the economy might stumble, why the dollar might skyrocket or fall, or why inflation expectations are due to change, I would argue there are always those kinds of possibilities on the horizon. Yes, Brexit could end in turmoil sending Europe into a recession. While there are politicians within Great Britain holding that option open, it doesn’t seem to be anyone’s first choice and not the likely outcome. A trade deal with China could fall apart, and President Trump could raise tariffs on all imports to 25% or higher. But that is hardly in anyone’s best interests. What is far more likely is a modest trade deal that both Trump and Xi will cite as the best trade deal ever whether it contains meaningful enforcement measures or not. The obvious fact is that the U.S. and China are destined to be primary economic competitors for many years to come. It would be righteous if both sides played by the same set of rules, but in the real world one has to deal with the hand dealt. China cheats. It steals our intellectual property and forces a technological transfer of information in exchange for allowing Americans to do business there. Will a treaty change that? Around the edges maybe but not in any sort of 180-degree reversal. A third big fear is that the government won’t extend the debt ceiling forcing a default of Treasury debt. If that were to occur, the Democrats would take all the heat. In the run up to the 2020 election, they likely won’t have the stomach for that.
In other words, there are always a lot of things that could happen. But, individually, none are likely. What is likely is that our economy continues to grow at 2.5% or maybe a tad higher with inflation well anchored at or below 2%. That could continue for a very long time. We went almost a decade without any change in Fed Funds rates until a rate increase in December 2015. The most recent increase was in December 2018. If the economy were to track along the path I suggested, rates could and should remain unchanged until there is some meaningful deviation away from the track described. That could take six months or six years. I would suggest as investors that the longer we go without any change in rates, the more satisfied we should be. Today’s economy isn’t artificial. As investors, you even get a proper return on cash with money market funds now yielding over 2%, above the pace of inflation.
If there is a near term risk for equity investors, it isn’t the economy, it’s valuation. Yesterday a company named Beyond Meat came public. Beyond Meat makes a plant-based meat substitute. A 10-year old firm, it sells broadly in the U.S. including many leading supermarkets and even some restaurant chains like Carl Jr. Think of it as the Ben and Jerry of meat, very focused on being healthy and having a small carbon footprint. Its burgers are pea protein based, don’t contain anything genetically modified, and even bleed red (via beet juice) when cooked. But they aren’t perfect. They are relatively high in sodium, and they have more calories than a lean hamburger. This is largely due to a potato starch recipe. But any flaws didn’t seem to catch the attention of investors yesterday. The stock doubled its IPO price, and this morning now trades at a market cap of $4 billion even though it doesn’t make a profit. The entire veggie-based meat substitute market today is less than $1 billion in sales or about 1% market share. Beyond Meat has plenty of competitors including one now working with Burger King to test the Impossible Whopper (I couldn’t make this up any better if I tried!).
My point is that markets peak when skepticism rolls into acceptance, then complacency, and finally, euphoria. When you buy a stock you are buying a piece of a company. You are not buying a product. Beyond Meat wants to expand to Europe and develop other products. Maybe that will all happen. But what is the value of the business. Lyft loses billions of dollars selling a commodity service. There is no difference between a Lyft ride or an Uber ride. In many cases, the same car has both a Lyft and Uber decal. Today, the company loses money on every ride. There is a dream that soon your city of choice will have no traditional cabs or ride sharing vehicles. Instead it will have driverless vehicles taking us from place to place. I have little doubt that will happen some day but not in the next five years except, perhaps, in a few test markets. If you want to bet on new technology, look at 5G, not driverless cars if you are thinking over the next five years. If you think I am an old fuddy-duddy, look at some of the projects offered to Lyft and Uber investors five years ago. While revenues have met expectations, huge losses have piled up in place of expected profits. And, yes, then both companies were talking of a future world of driverless cars. And, by the way, even if driverless cars work and can be made safe, something I conceded is very possible over a reasonable time frame, the ride sharing companies are going to have to buy tens of thousands of these vehicles. They will need working software that allows you, the rider, to tell it accurately where to meet you, where to go, how to navigate around detours, plus deal with weather, luggage, etc.
In other words, in my view, we are beginning to enter that world where dreams are separating from reality. All bull markets end when optimism gets too far separated from the truth and, in many cases, this is all centered in the IPO market. I will be shocked if Beyond Meat justifies its $4 billion market cap any time soon. I will be surprised if Lyft earns a dime over the next five years. 90% of IPOs ultimately sell below their original offering price. These times aren’t any different. There is no reason the bull market can’t continue for a very long time but when fiction starts to replace reality, take it as a warning sign. Stocks are not wildly overpriced here- just a few IPO and high-tech names so far. But a healthy correction would be cathartic. This market needs to get rid of its complacency. The sooner that happens, the better we will all be in the longer term.
Today, Frankie Valli is 85.
James M. Meyer, CFA 610-260-2220