Something Out of Nothing

“I have thee not, and yet I see thee still.” – William Shakespeare, Macbeth

It was a struggle to find something to write about for this issue. I was apprehensive about writing the same thing again for yet another consecutive week – a market that does nothing but stay overpriced in an economy that keeps going weakly sideways, despite the ongoing attempts to see new inflection points in the data that might lead to a growth breakout. It’s been like that since the beginning of last year, really, and the third-quarter economic breakout for GDP that was predicted in early September is going the way of the breakout that was predicted for the second quarter in early June and the breakouts that were predicted last year. The latest example is the once-predicted 3.7% quarterly GDP rate for Q3 now being down to 1.9% in the Atlanta Fed’s run-rate “nowcast” (though the NY Fed remains higher at 2.3%).

A picture is worth a thousand words, it is said, so the one below is a weekly chart of the S&P for the last two years.

As can be seen, the market has essentially gone sideways since the end of the year-end rally in late 2014. We’ve had two scary dips and one rather inane post-Brexit breakout that is now fading back to the original starting point. So there is good reason that the theme of this week’s issue is exploring the ramifications of nothing, because nothing is what we’ve mostly been getting.

A tweet from Barry Ritholtz led me to a reminder article at the website Farnam Street on the importance of avoiding stupidity, along with famed investor Charlie Munger’s (Warren Buffett’s investing partner) remark on the long-term advantages of avoiding stupidity versus trying to be brilliant.

Now it must be said that in real time, it isn’t always easy to discern what constitutes stupidity and what doesn’t, especially in the auction markets that make up the world of investing. Prices are made by the majority and while we all know that the majority can get it completely wrong at times, picking those times based simply on bromides about running or not running with the herd can be perilous. Which brings us back to Charlie Munger and Warren Buffett.

In the late 1990s, it was widely believed that Warren Buffett was an investment dinosaur too old and too technologically unsophisticated to understand the “new economy,” the latter a then-popular phrase (later forgotten, though not without considerable residual embarrassment) that characterized the still-nascent shift to the Internet as a distribution system for goods and services. Buffett would smile and chuckle and allow that no, he didn’t really understand a lot of what was going on underneath the hood of these technology companies. Dinosaur!

What Buffett did understand, though, was the near-impossibility of making a good return on your money over the long run by paying the era’s stratospheric prices, slogans about a new economy notwithstanding. To justify a really high price, you’ve got to have great certainty about the cash a business is going to generate down the road.

Warren Buffett and Charlie Munger are not only smart (though not perfect) at picking good businesses at a good price, they are smart enough and lucky enough to be relatively immune from the opinions of the crowd. Most asset managers don’t have this luxury – they are constrained to the tyranny of the calendar-year ranking race and their investors, some of whom are patient but most of whom hear the siren songs of the market. That is how they and we end up making the same mistake over and over again – staying out of the market when everyone feels miserable (and so prices are too low) and staying fully invested when everyone feels great (and so prices are too high).

Current equity valuations are way too high for a market with so little (and in many cases declining) growth. There are always slogans and explanations about why they are not really too high (i.e., “this time is different”), but the truth is that when you buy things at very high prices, it’s really hard to make much money afterwards. Valuation alone won’t make prices go up or down, but it does tell you how much you realistically stand to gain or lose. When prices are high, you stand to gain little and lose a lot. Right now, prices are high.

Last week I wrote that the market was poised to go higher, and so of course it fell, though not by much. As we enter the peak of the earnings season, we are still going sideways, and that is something to keep an eye on. Even bad years have rallies during earnings season, and while it’s still too early to call the current quarter one way or another, an earnings season that does nothing will be a market to get away from. Caveat emptor.

The Economic Beat

The report of the week was the September retail sales report. Some rejoiced in it – the headline gain was an expected monthly increase of +0.6% (seasonally adjusted, or SA) overall, 0.5% excluding autos. However, the “core” rate (excluding autos, gas and building materials) was low at 0.1% and led to the Atlanta Fed’s GDP downgrade. The year-on-year rate rose for the second consecutive month to 2.8% overall (NSA), up a tenth from last month and slightly ahead of the year-to-date growth rate of 2.7%. Excluding autos, trailing twelve month (TTM) sales are up 2.5%, also up for the second consecutive month. Below 3% is stall speed, however. Apart from some strength in auto sales that is probably related to the new model year, I didn’t see anything new and exciting in the report. It’s interesting to note that the best performer over the past 12 months is in the going-out category (“food services and drinking places”).

An item that caught my eye during the week was the 1.2% insured unemployment rate (not seasonally adjusted) in the latest weekly jobless reports. While I do believe that certain factors are conspiring to make the number not quite comparable to earlier times (e.g., a smaller manufacturing base and the rise of the gig economy), it is nonetheless notable that the rate is the lowest on the record. Yes Virginia, we are at full employment.

Even so, the labor market conditions index was negative again at (-2.2), where zero is neutral, and last month was revised downward from (-0.7) to (-1.3). The index gets very little attention on the Street, but the fact that it’s been negative eight of the last nine months might be saying something about the trend in employment growth. Job openings fell in August, according to the labor turnover survey (JOLTS), while the hire rate remained steady at 3.6%, unchanged from both July and a year ago.

On the price front, import and export prices both rose somewhat, chiefly due to higher oil prices. Year-on-year import price changes remain negative at (-1.1%) and exports at (-1.5%), but it’s something of a victory as they’ve both been under (-2%) a long time. Producer prices rose by 0.3% in September, a little more than expected, and now stand at +0.7% year-on-year, or +1.2% when excluding food and energy.

Oh yes, and there were the FOMC minutes. They said nothing new – we already knew that three members are leaning towards an increase and the FOMC will remain data dependent.

Next week brings the New York Fed manufacturing survey for September, along with the month’s industrial production on Monday and the Philadelphia Fed survey on Thursday.

Tuesday brings the consumer price index (CPI) and the homebuilder sentiment index, Wednesday housing starts and the Beige Book, and Thursday has existing home sales. Many Fed speakers are set to speak throughout the week, which could add to volatility. Only three weeks to go to the election, and thank God when it is over.

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