It’s not just Amazon gutting retail

There’s so much talk of Amazon bringing doom to all things retail that I think it’s fair to take a step back and look at the bigger picture. A massive downsizing of US retail was inevitable. We have 600%+ more retail space in shops, malls and megastores than any other first world country. That’s a big tell.

Adding to that, as Americans we tend to overspend, beyond our means, and use debt to drive that consumption forward. That is to say, we can’t collectively always afford what we’re buying, so we tend borrow to buy. That cycle of debt-driven overconsumption did not end well in 2007-2008. Since then we’ve seen mid-tier and low-tier discretionary spending trends at many retail stores flat to down as consumers try to deleverage.

It’s also becoming more obvious that online shopping is driving sales away from brick and mortar companies who haven’t had the wherewithal to create a cohesive online shopping experience — or who have failed to effectively solidify customer loyalty. Further, as companies like Amazon grow and offer a sort of “Walmart of the Internet” approach to allow someone to do most of their shopping on a single website, ill prepared stores will suffer, losing more sales and customers.

But I feel that there are much bigger catalysts at work here as well. We’re confronting a generational shift from tangible consumerism to intangible consumerism. Retail stores have trouble selling intangibles. An example of that would be GameStop, who should be flourishing in the age of electronic sports and online gaming, but is instead collapsing in on itself due to its inability to execute online. Meanwhile, companies like Activision Blizzard, Valve, EA Games and others have created extremely lucrative online game distribution platforms, tying together the purchasing, social and gaming experience.

The same is true of application spending. Surely no customer is going to trek out to a store to download an application on to their phone, tablet or computer. That used to be the case, however, as software was too bulky to download and vendors were cautious to distribute online for fear of piracy. But much has changed since the early days of software distribution.

How we buy, what we buy and whom we buy it from are all changing. This appears to be a generational shift perhaps almost as much as it is a correction in retail overabundance to more normalized levels.

Full disclosure: Short the NASDAQ 100.

US new-home sales drop 9.4% in July

Uh oh! Is the new housing bubble beginning to deflate? My thought is yes, but let’s not move to hastily to that conclusion before walking through some facts:

1: Many lenders were / are offering mortgage down payments from 1-3% (sometimes as low as 0%). This means that even if a buyer is not able to save money such that they can make a reasonable down payment (or have money set aside if they lose their job, have to make a major repair, etc) they can still be granted a mortgage to buy a property that they make default on.

2: Home values have reached levels near or beyond the highs of 2007 (depending on which region one examines). This means that for most working people buying a home is not something that they can reasonably afford. And if they can they do so under extreme financial stress, making debtors who acquire a mortgage on a property more prone to defaulting.

3: The millennial student debt bubble has grown to over $1.4T. These poor souls who were overcharged for an education that may not lead to better income prospects have little chance of obtaining a mortgage for a home if they are hamstrung by so much debt, poor job prospects and potentially low credit scores. In addition, many millennials have opted to downsize and live in smaller spaces (micro apartments, studios, pods in the parents’ backyard, etc).

4: Many people whom are intending to buy a new house must also sell their existing property. It is more and more difficult to do so with prices on the rise. Somewhere either demand must rise to the higher prices or the supply must fall to more reasonable prices. I suspect the latter will happen given the current macroeconomic environment (final stages of current business cycle).

5: A lot of quasi-affordable housing stock is being leveled and replaced with gaudy, poor quality McMansions by rabid speculators. These housing units tend to have shorter lifespans before major repairs are necessary since builders prioritize quantity over quality. As a result, housing stock that is the most desirable to middle class buyers is being eviscerated while unaffordable, low quality and undesirable housing stock is growing. This is a large, and mostly unrealized problem as of yet.

Without near zero interest rates, and the Fed holding an enormous amount of defunct MBS (mortgage backed security) notes there would be no housing bubble right now. But because we are in an artificially low interest rate environment with massive stimulus in the mortgage market, there is likely a large bubble in real estate valuations that is extremely perilous.

Ad spending drops as majors pull back

Advertising isn’t what it used to be as spending is continuing to plunge. Earnings of large digital advertising companies, such as Google, Facebook, Microsoft and Verizon are under threat (with the former two being the most concentrated risks due to their large exposure).

When major consumer staples pull back on hundreds of millions of dollars in ad spending I think it’s take to take notice. These trend setting marketing departments may just be the first dominoes to fall in the realization that advertising spending for well known brands may not actually lead to increased sales.

Further, there remains the question as to whether digital marketing is producing value for money spent. Personally I feel that in the last few years we’ve entered a period of hyperoptimism about the future of digital advertising. There are enormous problems that break the existing revenue model if they are to be realized by customers. Yet there is very little effort by large digital advertising companies to curb them because doing so would significantly impact earnings and growth. So it appears as though customers are departing en masse instead.

Full disclosure: Short NASDAQ 100.

US fiscal policy disappointment to drive dollar lower?

The U.S. gross domestic product report for the second quarter of 2017 confirmed that economic growth accelerated to a 2.6 percent annualized rate from the first quarter’s sluggish 1.2 percent pace. That should reassure equity investors, but dollar bulls face a number of significant headwinds, including weak inflation, bearish trading technicals and now potential for U.S. fiscal policy disappointment.

It’s been a tough year for the greenback, which has already fallen some 9 percent as measured by the Bloomberg Dollar Spot Index. Add to that the dour outlook issued by the International Monetary Fund, which earlier this week lowered its forecasts for U.S. GDP growth in 2017 to 2.1 percent from 2.3 percent, and cut its outlook for 2018 to 2.1 percent from 2.5 percent.

Source: https://www.bloomberg.com/view/articles/2017-07-28/stronger-growth-can-t-save-dollar-as-policy-risks-rise

Liquidity is not solvency

Apparently this is not a very well understood concept among the financial elite. Or perhaps they understand it all too well and are milking every incentive and easing measure for all of the salary, stock options and bonuses they can provide.

Not much has truly changed

Other than transferring an enormous amount of risk from the financial system in to the hands of central banks and governments, the underlying fragility of the financial system remains. Further, because the lenders of last resort are now burdened and their arsenal of financial ammunition near empty, there are not many options for the next economic hiccup.

With both US equities and bonds expensive by most measures, the logical alternative for most value conscious investors is to search for value in other asset classes: emerging markets, commodities, foreign exchange and real estate in distressed markets. But these options don’t come without risks of their own as their fates are tied to that of the US dollar (read more below).

With a great rally comes a greater upset

The last 7.5 years have been very generous to equity and bond investors. Perhaps too generous if current valuations are of any indication. What many are not prepared for based on current sentiment readings is a sustained downturn. Yet at the same time expectations of interest rate hikes by the Federal Reserve continue to rise (as they have in fits and bursts since jaw boning about such tightening began in 2013).

When rates rise, lending conditions tighten. And as that happens margin levels shrink, leverage is reduced as the cost of holding positions rises. This means that most of the time a series of rate hikes, as is being priced in to Fed Funds Futures, is the beginning of the end for modern bull markets in equities.

Yet stocks don’t seem to have received the memo. And they usually are last. 10 year Treasury Bonds, however, have seen yields rise from a paltry 1.3% to nearly 1.75% over the last few months. This may be more than just smoke signals as there are many foreign sovereign investors lightening up on Treasury Bond positions over the course of 2016, including China.

King Dollar’s mighty move

The US dollar has been rallying as of late on interest rate expectations as well. This has knocked down many commodities, outside of the energy sector, and caused renewed pressure on foreign currencies. Dollar strength should be watched carefully. If the dollar continues to rally (the dollar index is now testing 97) then we may see a renewal of equity selling as rate hike fears begin to permeate the US stock market.

Fears of the Fed are foolish

They say don’t fight the Fed. But what if the Fed is all talk? Over the last three years, there’s been a lot of talk of higher rates, even normalization. But what we have after all that talk is one lonely rate hike that is almost a year old now. The market seems to key in on every word every Fed official says, almost as if their words were seen as valuable insights.

But if each speaker’s rate forecast, economic forecasting track record and previous speeches are carefully examined the inconsistencies and inaccuracies accumulate. My opinion is that many of these officials, while they probably mean well, don’t have the requisite tools to forecast something as complex and intricate as the US economy. Why? Because no one does. Such tools do not exist.

But one thing is certain…

With a track record as dismal as Fed officials seem to have, their forecasts and banter about tightening should be taken with nothing more than a grain of salt. They don’t have a magic ball  and they can’t see in to the future much more than any other market participant, economist or statistician.

These are the same minds that brought us such failed monetary experiments as quantitative easing, which had the effect of redistributing middle class wealth to the already very wealthy, and bank bailouts which enabled more systemically reckless gambling.

As if flooding the system with credit would resolve the underlying structural solvency problems that our financial system and our government suffer from (hint: it made these issues worse by failing to address them in any meaningful way).

In conclusion, and I’m talking to you Mr. Market, let’s try not to take the hot air too seriously. After all, the people making it don’t seem to recognize the difference between liquidity and solvency.

Inflation data causes stock market to vomit

Rising gas prices are driving what is perceived as a ‘surge’ in inflationary data. Which isn’t all that surprising seeing as how crude oil has about doubled from its low.

Instead, the reaction to this data shows that there’s a lot of nervous market participants who apparently are convinced that this data set will increase the odds of an interest rate hike. And they’re taking their profits (or at least scaling out of positions).

Whether or not there is a hike depends largely on a seemingly reluctant, if not apprehensive Federal Reserve, whose promises to raise rates in 2016 have yet to be fulfilled.

But the data set we got today isn’t telling us anything new or interesting. It’s just a realization of higher energy prices working their way through consumables like gasoline.

 

Dollar downtrend confirmed; business cycle ending?

The end of the dollar rally is a topic that I’ve discussed previously. Now that the period of congestion (or sideways trading within a range) is over, the short and intermediate term trends seem to be re-aligning with the longer term downtrend in the exchange traded value of the US currency.

While this downward move is likely only in its early stages, it’s important to remember why the dollar rally happened in the first place: A Fed rate fake out.

dollar_chart

Time and time again from 2014 and on the Fed said it would raise rates. Talk of tightening even prompted taper tantrums and rate hike jitters leading to large, volatile market moves.

Now that the Fed has walked back on its promise of 4 rate hikes in 2016, and may not even hike again this year, reflation is beginning to show itself in various commodity prices. And this is a good thing.

The weakening of the dollar is the natural response to a situation where the international interest rate differential is being neutralized by a nervous central back here at home. What had caused the rally is now being discounted. And the rally started at a much lower exchange traded rate — so chances are that this downturn in the dollar has much farther down to go.

Translation? Higher commodity prices, resource stocks will continue their rally and the international players that benefit from a weaker dollar (like exporters) will benefit. Prices for food and energy will rise. Services will follow.

This is the natural final inning of a business cycle approaching. There’s nothing wrong with it provided that an exit plan is mapped out.

Correction brings opportunities in resource sector

The resource sector is getting slammed today on account of a marginally higher dollar, and one dissenting Fed member (Bullard) jawboning an April rate hike (conceivably to test the market’s reaction).

In all likelihood, given that the Fed has all but lost its credibility and certainly doesn’t want to be credited with causing deflation, a rate hike will not happen in April.  In fact, if anything I expect more dovish language on account of a deteriorating domestic housing market, more global economic uncertainty and the fact that we are right in the midst of election season (and the Fed seems to have more of a democratic bias — perhaps because many republicans are openly hostile toward the Fed).

My thought is that Bullard’s bluff will be called. That means the lower prices I am seeing now across the resource sector could be a wonderful opportunity to allocate capital at a discount.

Stay nimble.

The backwards logic of QE’s supposed wealth effect

The Federal Reserve has recently admitted, through various policy speeches and interviews, that quantitative easing’s primary goal was to foster a wealth effect by raising asset prices across the board.

If that’s true, then why did the middle class largely evaporate over the same period?  Because the middle class does not own large amounts of financial assets.

Numbers don’t lie

Income inequality and wealth inequality are significant issues. The problem is growing and will continue to do so because the monetary policies enacted thus far have exacerbated the underlying imbalances in the economy.  Growing the wealth of the wealthy at the expense of the rest of the population is not only counterproductive, it’s actually dangerous.

The primary driver of US economic activity is consumption.  That means that a prosperous middle class is critical to a flourishing US economy.  Spenders that have an increased sense of wealth and rising incomes will buy larger homes, make more discretionary purchases, be better equipped to support larger families and ultimately that adds to our GDP.

Economic sanity must be restored

Favoring the wealthy and large corporations has created the problems that our economy will face in the future.  Adding to that, the enormous student debt owed by today’s generation of new entrants to a workforce with less high paying jobs will significantly hinder their ability to buy a home, car or make large discretionary purchases.  Thus robbing future demand from the economy.

This is a significant headwind for the US economy as we move forward in to a future that has been defined by the actions of today.  The only means of reaching an escape velocity whereby the middle class can thrive again is to re-examine the current economic paradigm with a focus on the future.  And I don’t mean in terms of 4 years or the next election cycle.

We can decide our destiny

The future of our country can be a wonderful one should we so choose to exert the effort necessary to make it so.  But that will mean difficult choices about spending priorities, it will mean forgiving large amounts of student debt and favoring the individual over the interests of the corporation (as a change).  It will mean bringing back regulation that strengthens oversight of Wall Street and banks (Glass-Steagall would be a good start).

Most importantly, though, we need to focus on our country.  Minimizing participation in global conflict and putting forward programs to rebuild our nation’s infrastructure.  Our roads, trains, power lines, water pipes and broadband delivery systems can all use a massive investment to bring the US back to being a global leader. A position we have earned, but have failed to maintain.

Seesaw market creates opportunities in volatility

There is a lot of emotion charging the market, creating exaggerated moves both up and down.  One day everything is fixed, the next everything is broken.  Manic depression wouldn’t even begin to describe the back and fourth being witnessed.

But with chaos comes opportunity.  And the opportunity here is finding beaten up, misunderstood and frankly cheap assets.  Right now the areas that seem to be most attractive are commodities, commodities companies, energy and energy companies.

The global markets are pricing in worldwide depressed demand.  Oil producers are pumping at frantic rates, more concerned about the flow of cash than the margin on each sale.  This has created a glut of energy supply — and with little demand oil prices have crashed below $30.00 to about $28.00 a barrel for West Texas Intermediate Crude (WTIC).

Consider the following opportunity: The US dollar has had a rally which induced a de facto tightening even before the US Federal Reserve raised interest rates.  As such, one can reasonably expect that the actual pace of interest rate tightening, with the backdrop of a softening US economy, will likely be subdued.

Markets have priced in a more aggressive interest rate hiking cycle, which is putting pressure on everything that’s priced in dollars.  Even stocks.

I think that we’re getting ahead of ourselves here.  The Federal Reserve is unlikely to let this situation turn in to a full blown 2008 panic again, unless there is a desire to bring back all the calls to audit the Fed and the political upheaval that protests and social unrest would bring.  Instead, especially given that it’s a critical election year, I believe the Fed will tap the breaks and ease off the gas, leaving interest rates at 0.25% and possibly cutting them to negative levels if the global slowdown increases in momentum.