Friday, August 18, 2017

No Slowdown In The Growth Of e-Commerce Sales

It seems nearly every company reporting earnings now references a strategy to deal with Amazon (AMZN) due to Amazon's command of e-commerce sales. Beyond the simple delivery of packages and hard goods, AMZN is moving into many other areas like grocery, air transportation, etc. I discussed this in a post a few months ago. In that post I highlighted the profitability of Amazon's cloud business (AWS) and the company using AWS profits to fund growth in other industries.

Yesterday, the U.S. Census Bureau reported quarterly retail e-commerce sales for the second quarter of 2017. Not a surprise to many now, e-commerce sales continue to grow at a high rate, i.e., up 16.2% on a year over year basis for Q2. Traditional brick and mortar sales were up a small 2.9% year over year. The other notable highlight from the Census Bureau report, e-commerce sales now account for 8.9% of total retail sales. This is nearly three times larger than ten years ago.


Finally, due to the success of e-commerce broadly, many of the related stocks have been pushed to valuation levels far above the market's valuation. As the below chart shows a quick price run up can just as quickly turn in to a price decline. Are these e-commerce equities setting up investors for disappointment?


Certainly, valuations can become more stretched and these stocks can move higher for an extended period of time; however, investors with outsized positions in this industry should evaluate their overall exposure relative to their entire investment portfolio.


The Economy May Not Be At Full Employment

One economic conundrum has been the sub-par growth rate in average hourly earnings in spite of what appears to be an economy operating at full employment. In a fully employed economic environment, wages generally see fairly strong upside pressure and this becomes a concern with the Federal Reserve due to the upward pressure placed on the inflation rate. As the below chart does show, average hourly wages have grown at about a 2% annual rate since the end of the financial crisis. Prior to the onset of the last recession, wage growth was in the range of 3% to 4%. From a positive perspective though, wages have been growing faster than the rate of inflation for most of the last four years. Additionally, the differential wage growth and inflation in this cycle is on par with prior economic expansions.


The below chart shows the current unemployment rate is 4.3% and at a level reached prior to the 2008/2009 recession. Also included in the below chart (orange line) is the unemployment rate if the participation rate was equal to the participation rate prior to the 2008/2009 recession. The participation rate in March 2008 equaled 66.1% versus the current rate of 62.9%. At a 66.1% participation rate, the current unemployment rate would equal 9.0%. What this means in absolute terms is an additional 13 million people would be counted in the labor force, but unemployed.

Some economic strategist will say the 13 million person increase in the "not in labor force" figure is largely a result of baby boomer retirements. On the other hand, with such a low unemployment rate, one might ask why Amazon's (AMZN) recent national hiring day across twelve locations drew such long lines.


Certainly, given the reported unemployment rate of 4.3%, history would suggest wage growth should be more in the 4% range. However, if the participation should be higher and nearer the pre-financial crisis level, maybe the real unemployment rate is closer to 9% than the reported 4.3% rate and the current wage growth rate is in line with historical figures.


Interestingly, in a wage growth report released earlier this week by the San Francisco Federal Reserve Bank, references were made to workers being pulled back into the labor force. Also noted in the report was the fact newer job entrants put downward pressure on wage growth to the tune of about 2%.

And finally, I continue to evaluate the participation rate of the various employment age groups and the only group showing a participation rate higher than the pre-financial crisis participation rate is the 55 and over group. As the below chart shows, all other groups continue to show slack from a participation rate perspective.


In our view the unemployment rate is likely higher than the reported 4.3% given real demand examples like the Amazon National Hiring Day. Positively, wages are growing faster than inflation; however, the employment market is likely not as strong as it could be. However, this suggests additional employment growth can occur and provide further tailwind for economic growth going forward.


Sunday, August 06, 2017

Investor Fund Flows Favoring Bonds And Not Equities

The equity market has gone over a year without a pullback of at least 5% or more. The last 5% decline occurred in mid-June 2016 when, over a two week period, the market fell 5.5%. Even in the run up to the election last year, the equity market did not close down over 5%. This lack of volatility is showing up in popular volatility measures like the VIX, but the VIX may not be a good measure of expected future volatility.  Also, this lower level of volatility has some strategists suggesting investor's have become to complacent about the equity market and have willingly taken on more equity exposure as a result.

A recent post by Dr. Ed Yardeni, Ph.D., and he puts out some great research, noted individual investors may have become too optimistic as well. In that post, Investors Hearing Call of the Wild, he included the below chart of U.S. equity ETF flows.


Fortunately, he does note in the post that 'some' of these ETF flows may have come from investors allocating dollars out of mutual funds. In fact ICI reports the total flow into U.S equities over the 12-month period ending in June is only $7.6 billion and not simply the $236.2 billion that flowed into ETFs. Nearly all of the equity flow came out of actively managed mutual funds. I do sense that investors going the passive route may be in for a surprise in the next market correction.

And finally, it should be noted that since the election last year, investors have placed more investment dollars into bond funds then stock funds. Additionally, over the course of the last five weeks ending July 26, 2017, investors have pulled $21.7 billion out of U.S. stock funds while world funds collected $28.3 billion. But still, bond funds have been the net favorite as flows total $36 billion over this same five week period.


In conclusion, as the file in the just noted link above shows, nearly three times as many dollars have flowed into bond funds versus stocks funds since the beginning of 2015. Maybe the potential bubble is in bonds and not stocks.


Saturday, August 05, 2017

The S&P 500 Index Is Expensive And Has Mostly Been So Since The Early 1990's

One can cite any number of stock valuation measures and conclude U.S. equities look expensive or are at least trading above their long term average valuation measures. In this environment one might conclude stocks are priced for perfection with little margin for error. Of course this might certainly be the case, but is this an uncommon position for the equity market? As the shaded areas in the below chart show, investors would have had a difficult time buying or holding onto stocks at valuation levels that were below their long term average valuation since the early 1990s.



Tuesday, August 01, 2017

Dividend Payers Are Underperforming

A year ago dividend paying stocks were significantly outperforming the non payers in the S&P 500 Index and the S&P 500 Index itself. If investors were chasing performance back then and loading up on the payers, today they would be disappointed. Below is a chart of the year to date performance of two dividend paying exchange traded funds, SPDR Dividend ETF (SDY) and iShares Select Dividend ETF (DVY). The return of the dividend focused ETFs is nearly half that of the S&P 500 Index.  The return difference is similar for one year. My year ago post contains some details on both ETFs.


Below is S&P Dow Jones Indices' average return summary for the payers and non-payers in the S&P 500 Index as of July 31. The return difference is not as large as noted above due to ETF construction differences, for example, not using all 420 dividend paying stocks in the S&P 500 Index.


The fact the dividend payers are underperforming the non-payers as well as the broader S&P 500 Index itself, seems to be further confirmation of investors seeming to favor growth oriented stocks over value ones. 


Sunday, July 30, 2017

Equity Valuations No Longer Matter?

One benefit to writing blog content is it serves as a record of ones past thinking and the results of any decisions made from the prior analysis. With that in mind I reviewed some of the topics written over a year ago, that is, in June/July of 2016. A few of the topics at that time had to do with valuations, PEG ratios and the fact the market was trading at an all time record high. In fact one article was titled, Is It Right To Be Bullish Near A Record Market High? The conclusion at that time was to stay invested in equities as I wrote then,


Saturday, July 22, 2017

Strong Earnings Growth And Favorable Valuations Lead To Weak Stock Returns

One factor utilized in uncovering potential investment opportunities is to evaluate companies and sectors that are projected to generate strong earnings and cash flow growth over the course of the next year or more. The risk associated with simply reviewing earnings growth rates is the fact other variables often influence the future price performance of a company's stock. A good case in point at the moment can be found in evaluating energy companies and the associated sector. For calendar year 2017 and 2018, the energy sector is expected to exhibit the highest earnings growth rate among all the S&P 500 sectors. For 2017 the year over year earnings growth rate for the energy sector is estimated to equal over 300%. In 2018 the YOY growth rate is projected to equal 41.3%.


Even reviewing the sector PEG ratios (P/E to earnings growth rate), the energy sector looks very attractive and is the only sector that has a PEG below 1.0.


Thursday, July 20, 2017

Jump In Investor Bullish Sentiment But Remains Below Long Run Average

Today the American Association of Individual Investors released their Sentiment Survey results for the week ending 7/19/2017. These results show individual investors' bullish sentiment increased 7.3 percentage points to 35.5%. This is the highest reading since early May when bullish sentiment was reported at 38.1%. This jump in bullish sentiment still has the level below the long run average of 38.5%. The increase in the bullish reading came almost equally from a reduction in those investors indicating they were bearish and those reporting a neutral view of the markets.

This is a contrarian measure and remains at a fairly low level. On the other hand, the market continues to achieve record highs with very little downside volatility. A pullback of 5-10% would not be a surprise given the market's recent strength.

Source: AAII


Wednesday, July 05, 2017

Summer 2017 Investor Letter

Our Summer 2017 Investor Letter reviews the strong equity market performance thus far in 2017.  As of quarter end, the S&P 500 is up 9.34%, the Nasdaq is up 14.07%, and the MSCI EAFE Index is up 14.23% year to date. As investors become increasingly worried about the first significant market decline since early 2016, stocks continue to climb the proverbial “wall of worry.”


For more of our thoughts on everything from the FANGs to the Fed, see our Investor Letter available at the below link:


Monday, June 26, 2017

Market Pullbacks Should Be Expected

There have been plenty of reasons to sell stocks since the end of the financial crisis in 2008. The drumbeat seems to be getting louder as the postwar market advance approaches one of the longest on record.


Also contributing to some angst about the market's advance is the fact the last pullback/correction of greater than 10% occurred in February 2016. In other words the market has gone more than 16 months without a >10% pullback. As the below chart shows, market pullbacks of nearly 10% are a fairly common occurrence. The market's average intra-year decline equals 14.9%.


Sunday, June 18, 2017

Dogs Of The Dow Underperformance Gap Widening

The first six months of the year are nearly behind us so I thought it appropriate to provide an update on the performance for the 2017 Dogs of the Dow. As noted in the past, the strategy is one where investors select the ten stocks that have the highest dividend yield from the stocks in the Dow Jones Industrial Average Index (DJIA) after the close of business on the last trading day of the year. Once the ten stocks are determined, an investor invests an equal dollar amount in each of the ten stocks and holds the basket for the entire next year. The popularity of the strategy is its singular focus on dividend yield. The strategy is somewhat mixed from year to year in terms of outperforming the Dow index though. Over the last ten years, the Dogs of the Dow strategy has outperformed the Dow index in six of those ten years.

Since my last update a few months ago, the Dow Dogs performance has fallen further behind the Dow Jones Industrial Average Index. As can be seen in the below table, the average return of the Dow Dogs through 6/16/2017 is 4.9% versus the DJIA return of 9.4%.


Interestingly, in the top ten performing stocks in the DJIA index this year, only two are Dow Dogs, Boeing (BA) and Caterpillar (CAT). Boeing is the best performing Dow stock, up 28.3%. So far this year, energy has been a drag on the both the DJIA index and the Dow Dogs, while at the same time, industrial stocks have been performing well. In short, the sole focus on dividends in the Dow Dog strategy has yet to pay off this year.


Amazon: Selling And Delivering Groceries Is Not A High Margin Endeavor

Of course the big news last week was Amazon (AMZN) announcing it was acquiring Whole Foods Market (WFM) in a deal valued at $13.7 billion. The deal is an all cash one, but with Amazon's stock trading at a trailing price earnings multiple of 185 times one might think funding the purchase with stock might make more sense. Nonetheless, this acquisition announcement had ripple effects on many other consumer product companies and not just grocery retailers. One question that arises is whether Amazon's purchasing leverage will put downward pressure on prices for products manufactured by the likes of Procter & Gamble (PG), McCormick & Company (MKC), Kellogg (K) and many other packaged consumer product companies. Friday's stock market reaction to this broad category of companies suggests the AMZN/WFM merger will be a significant headwind for other companies in this space or to those selling into the space.


Selling and delivering groceries is not the same as selling and delivering books and non-perishable products. As the picture at the beginning of this post shows, consumers have had home delivery options historically. Home delivery of milk, for instance, was a common practice years ago before the popularity of large grocery stores. Still today, consumers have home delivery of grocery options. One firm that has been delivering groceries since 1952 is Schwan's. Schwan's website notes the delivery options it provides to consumers,
  • Personal Delivery: Our knowledgeable Route Sales Representative will deliver your food to your home at a time that is convenient for you.
  • Drop-Off Delivery: No need to be home for delivery. We'll drop off your order at your scheduled delivery time in a reusable freezer bag that keeps your food frozen for hours.
  • Mail Order: Mail Order delivery is available anywhere in the continental United States. It's a convenient option if our delivery service is not available in your area or if you want to send our food to family or friends.
More background on Schwan's can be found at this link.

At the end of the day, the success of any retail store is centered on the customer having a positive experience and the store or business executing on its business plan. And to this end, brick and mortar retailers need to make 'positive customer experience' an overriding aspect of their business model if they want to compete with the Amazon's of the world. I could, but won't in this post, list a number of procedures retailers have implemented that do not contribute to a customer having a positive experience.

I am skeptical of how successful the delivery of groceries can be. As I stated earlier, home delivery of groceries is not the same as leaving a non perishable package on the doorstep. A benefit Amazon is getting with the Whole Foods acquisition is access to 400 plus brick and mortar locations. Is Amazon then saying brick and mortar is a necessity in order to continue its growth?

And finally, much of what Amazon has been able to do in its pursuit of growth is a direct result of the profitability of Amazon Web Services or AWS. AWS accounts for less the 10% of Amazon's revenue but accounts for 74% of Amazon's operating income. AWS is made up of many different cloud computing products and services. The division provides servers, storage, networking, remote computing, email, mobile development and security. AWS's two main products are Amazon’s virtual machine service and Amazon’s storage system. AWS is now at least ten times the size of its nearest competitor and hosts popular websites like Netflix Inc (NFLX) and Instagram (a subsidiary of Facebook Inc.(FB))



So long as the market continues to give Amazon a pass on generating a decent profit from its businesses outside of AWS, AMZN's retail competitors could continue to face challenges. However, I do believe that the AMZN/WFM acquisition may not work out as well as AMZN anticipates. Selling groceries and adding delivery cost on top of a low margin business, is not a recipe for fast growth in my view.