Investing in 2023 | The Fed and the Economy | State of the Consumer | Stories of Note
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| With world economies now fully reopened (*cough* China *cough*), businesses are adjusting their strategies to better accommodate a less uncertain future- and a widespread return to the office [Original image ©BluePlanetStudio/ Adobe Stock. Modified for The Ignorant Investor: www.theignorantinvestor.com] |
Let’s wax philosophical for a minute. The stock market is a place where fortunes are made, and fortunes are lost; a place where the achievers are separated from the dreamers*; a place where our built-in belief systems are tested by fire as they collide with harsh, unforgiving realities. But this doesn’t have to be a scary place. A balanced approach to investing is a successful approach to investing, and diversification across – and some informed knowledge about – various types of assets is usually a big part of that success (the Stroh family certainly is a cautionary tale in that respect!). Now, onto the state of the market!
But what a difference a few short months make! In the late days of 2022, the stock market continued to march lower and lower. Analysts began making bleak assessments on the future of even quality names with solid businesses. Energy seemed to be the only safe place to hide. Yet, a few short weeks later, the market exploded higher- led by speculative, frothy stuff, it’s true – as beaten-up growth saw strong buying interest. This followed a few headline inflation readings and some resilient jobs numbers which showed that inflation may be tempering and the US economy was on solid footing. While technical indicators pointed towards potential for a market breakout, the fundamentals appeared to hint at some potential undercurrents which could derail the rally.
Fast forward to Friday’s close, the S&P 500 has given up most of its gains for the year, now settling up 0.6% YTD at 3,862. The tech-heavy Nasdaq continues to lead the major averages in 2023, up 6.4% YTD at 11,139. The Dow Jones Industrial Average has underperformed, down 3.7% at 31,910 points over the same period. Energy stocks, the safe space for 2022, have also moved markedly downward in recent days as oil and gas supplies remain ample for the near term and the Russian-Ukraine war remains a regional conflict. Meanwhile, the stock market remains surprisingly resilient in the face of continuous rate hikes and economic uncertainty. This comes as the Fed increases hawkishness to combat sticky inflation [more on this topic in the section below]. Despite these headwinds, The Ignorant Investor has seen quality growth names across his coverage rise 30%, 40%, and even 60% in the last several months while the broader market has floundered in range-bound trade. Some companies he follows even sit at all-time highs.
And talking about changes in sentiment, look at Tesla! Since the doomsday predictions of some analysts a mere three months ago, the stock has rebounded nearly 60% from recent lows. Competition with traditional automakers entering the space, oversupply of the EV market, and doubts about Mr. Musk’s business acumen – especially from TV pundits and online critics – led to sharply negative consensus around the stock. Then, suddenly, the story evaporated as the market decided that the consensus was in the wrong. As always, while The Ignorant Investor does not bet on Elon Musk, neither does he bet against him.
There are still plenty of places to put money to work these days. Treasury notes are quite appealing as virtually risk-free instruments generating near-4% yield (this was near-5% just a week ago). Investment advisors are also increasingly looking away from domestic uncertainty towards cheaper investment vehicles across Europe and further abroad. But The Ignorant Investor still considers a cautious approach to investment to be prudent (circling around to the philosophical start to this section): make sure that your financial advisor and you yourself know what you are investing in. And the US stock market remains a forward-looking thing after all- opportunities are still hidden in various corners of the equity market. As always, be sure to coordinate with your financial advisor and prepare a game plan to take advantage of potential market moves ahead!
Sailing Through Uncharted Waters
We’ve come a long way from that unfortunate point in time where the Fed stuck with its “inflation is transitory” thesis. Now, with inflation striving to embed itself in the US economy (energy prices no longer drive inflation), realistic discussions of a Fed willing to raise the Funds rate above 6% have become commonplace. Fortunately for the Fed and their limited toolset, employment remains quite robust (companies likely remain wary of the traumatic post-pandemic days when they couldn’t find workers) and the economy remains generally healthy- theoretically ideal conditions for the Fed to weed out inflation with minimal collateral damage. The dirty truth is that recession is still necessary, but perhaps it doesn’t need to be a particularly damaging recession, ceteris paribus.
The US economy is a confusing puzzle in and of itself these days. Are we in recession? The answer is a strong yes for various arenas. Other sectors are experiencing strong – and in certain cases, historic – demand. Inflation is rampant in some places while disinflation is demonstrably present in others. The job market in general is quite strong, while those Big Tech companies have been laying off people by the tens of thousands (granted, these same Big Tech companies largely overhired in the past, a practice that was aggravated in the immediate aftermath of the pandemic; see some great graphics in this article on the hiring pandemic hiring spree at CNN). Technical assessments of the economy also remain convoluted: the Treasury yield inversion sits at multi-decade highs (typically considered a reliable recession indicator), yet corporate yields generally sit somewhat near Treasury yields (ie recession not yet broadly anticipated). Most importantly, consumer spending – the primary driver of the US economy – remains strong. Yet there is also plenty of evidence that consumers are also spending beyond their means [more details further below in this article] and some are even shifting towards recessionary spending behavior.
And it’s through this haze of uncertainty that the Fed steers the US economy. The Fed has done a great job with its strong response to rampant inflation, yet this is the same Fed that failed to perceive growing inflation as a problem for quite some time in 2021. Small tremors hit the financial world in the last several days as regulators moved rapidly to seize and shut down Silicon Valley Bank and Signature Bank; sensible moves to protect depositors and stem potential contagion to the wider financial system. Considering these recent events, perhaps the best course of action may be for the Fed to hold near current levels of tightness until the real effects on the economy – and inflation – can be better understood. However, an argument can also be made that these are isolated incidents which demonstrate that the Fed rate hikes are working. In the meantime, The Ignorant Investor recommends coordinating closely with your financial advisor and focusing on quality companies with real businesses and strong balance sheets- companies that can afford to wait out the current uncertainty.
The State of the US Consumer
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| Ever-increasing prices of necessities (remember eggs in January, anyone?) have forced the average family to closely watch their budget and adjust day-to-day spending. Yet rampant travel and vacation expenditures continue unabated. Who can read this riddle? [Original image ©NinaLawrenson/ Adobe Stock. Modified for The Ignorant Investor: www.theignorantinvestor.com] |
Worrisome cracks have formed in the investment thesis that drove much of early 2023’s short-fueled rally. As the Fed continues raising the funds rate and inflation remains stubbornly embedded in portions of the economy, attention has shifted beyond this institution, headline inflation, and the labor market to assess the bedrock of the US economy: the US consumer.** For example, in January, continued strong consumer spending surpassed income growth - indicating that consumers were dipping into savings or other resources to fund their lifestyles (this is, for now, somewhat offset by elevated levels of savings). Some of that spending was also fueled by credit card use. Credit card balances for the fourth quarter of 2022 rose 15% year-on-year. This happened even as interest rates on these credit balances skyrocketed because of the Fed raising interest rates (30% annual fees can also be a thing these days- rates that near extortion if this were a bank offering a personal loan!), resulting in a double whammy for consumers carrying credit card balances. All these words simply mean that while headline January consumer spending was strong, it is also unsustainable and must, ceteris paribus, trend lower.
The most recent wave of earnings reports also showed another interesting trend: consumers are changing spending habits for essential goods and other items used on a day-to-day basis by switching to lower cost alternatives or waiting longer to replenish supplies. This can be an early indicator of economic difficulty for the average person and family. Walmart cautioned investors in their February earnings call that despite solid results, they expected considerable pressure on the consumer this year. It’s worth noting that strong results for Walmart’s grocery business may have been partially attributable to shoppers who moved away from pricier supermarkets. Yet the average consumer isn’t necessarily frugal- spending continues at a record pace on leisure travel as evidenced by hotel, cruise, and airline reports (take your pick of earning reports ranging from Delta to Booking Holdings of Priceline fame). This may be a carryover of that “revenge travel” mindset of 2021 and 2022, or it may be a larger shift in mentality towards “experiences instead of stuff."*** In the meantime, many companies have been able to raise prices with little pushback from these same consumers (hey, Disney theme park prices were just hiked to all-time highs, but the parks remain overcrowded!).
One possible driver behind a portion of changing spending habits may be post-pandemic lifestyle changes. Let’s theorize for a moment. Yes, life is settling into a new normal, but the way the labor force participates in the economy has changed. Most workers are fielding calls for a return to the office, but work-from-home (WFH) and work-from-anywhere (WFA) remains an option for many employees (firsthand observation here!). Spending looks radically different for The Ignorant Investor in a WFH scenario versus a day in the office, with transportation and expensive restaurant costs evaporating. And if WFA is an option, then of course I would take full advantage of that flexibility- working from a seaside room at the Hotel Punta Regina is always preferable to a drab Manhattan office, for example. But enough of the speculation! This theory merely illustrates that we are still observing potential structural changes in the labor market that may reflect some aspects of changing consumer spending. As companies continue to recall workers to office environments, or in some cases go the opposite route and offer more flexible work from anywhere policies, we can get a better feel on exactly how this shakes out.
Stories of Note
Now that The Ignorant Investor isn’t posting as often, there remains a significant amount of ground to cover here! Some of these topics could easily been six-page articles in and of themselves.Ghosts of 2008: When banks fail
Reverberations were felt throughout the financial world after Silicon Valley Bank (SVB), the bank for startups and venture capitalists in both the US and abroad, was taken over by regulators on Friday. The Ignorant Investor was caught somewhat offsides and surprised at the amount of exposure some companies had to the bank (hey, Roku had almost $500M parked in cash accounts?!?). Keep in mind that Silicon Valley Bank had at least some $400 billion in client funds and loans before collapse, and a huge percentage of those deposits were uninsured. This bank’s failure is just sad and apparently a consequence of an entirely avoidable series of missteps on the part of the executive team, with problems starting around the time the Fed began hiking rates (the seeds for the collapse were arguably sown during the heady cash-rich days of pandemic stimulus funding; read a quick run through on the SVB board’s potential risk management missteps creatively pieced together from dry proxy statements at Forbes). Yes, regulators could have asked more questions of SVB over the last several years too, but the takeaway point here is that banks can and do fail. Thankfully, the US government stepped in and backstopped deposits over the weekend (and decided to take over high-risk Signature Bank, cutting the crypto industry off from mainstream financial markets in the process), ensuring payrolls will be met this week and minimizing contagion effects. Companies shouldn’t need this type of massive government intervention, however. Hopefully they learn from this experience and put some financial planning behind their decisions for managing their cash stockpiles. In the meantime, the US government is in the odd position of appearing to back the entire banking industry (“not a bailout” appears to be a repeated mantra emphasized on the talking points for officials). Stricter regulations and oversight (and less profitability) are on the horizon for mid-size banks.
An era of efficiency
Meta Platforms, more widely known for “Facebook” and “Instagram”, set the firestorm trend for Big Tech, small tech, “non-tech” earning calls alike when Zuckerberg was proverbially brought to heel and used the term “efficiency” more than 30x in his company’s earnings call. This follows a brazenly dismissive earnings call in November of 2022 that briefly sent Meta’s stock down to lows last seen in July of 2015 (high $80/share range). Gone was the extensive discussions on the “Metaverse”. Gone was the surprisingly cold indifference to investor concerns about business focus and runaway spending. A new Zuckerberg had arrived, announcing a dedication to the business “core” and a dedication to trimming the fat to make the company leaner and more efficient. True, speculative Metaverse spending remains rampant, but this new commitment to efficiency was enough to allay investor concerns (for now). Since that time, company after company has made similar pronouncements, also met with similar investor enthusiasm. And yes, The Ignorant Investor had taken positions in Meta across the selloff and was very encouraged by this new Zuckerberg- and the new tech sector in general. Tech, it seems, has finally gotten religion. Now let’s see how well they all can execute on this commitment to efficiency.
AI and Chat GPT – the next big thing?
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| Artificial intelligence is here to stay- just not in its present over-hyped form. [Original image ©pinkeyes/ Adobe Stock. Modified for The Ignorant Investor: www.theignorantinvestor.com] |
Briefly continuing with Meta’s earnings call, while Zuckerberg did emphasize “efficiency” more than 30x, he also made use of another key word about 30x: artificial intelligence (also interchangeably referred to as “AI”). AI has been on the scene in various industries for many years. It’s also the catchall phrase that board members like to throw around when trying to apply the next big thing to their business, even if it doesn’t simplify things or help with the process (first and secondhand observation here!). However, a small startup took the world by storm in November of last year by releasing their now-ubiquitous conversational AI ChatGPT to the public. General interest online was immediate. And since late November, The Ignorant Investor and his tech-savvy friends have been experimenting with this AI. ChatGPT is amazing- able to create literary works****, summarize and make logical conclusions from information sets, and help write computer code – when correctly prompted – with a surprising degree of accuracy (it’s also relatively easy to intentionally trip up, but we prefer to focus on the positive side of things). In fact, it was impressive enough that The Ignorant Investor even used it as a party trick to embellish a portion of his annual Christmas letter sent to family, friends, and colleagues across the globe.
The release of Chat GPT sparked early tremors even in such lofty places as the Google – erm, excuse me, I mean Alphabet – board room (you know, that company where employees go to retire?) and more recently formed a cornerstone of the Nvidia investor presentation, since the AI world (as the next big thing) largely runs on Nvidia chips. While Microsoft (now a champion of Chat GPT after incorporating the AI in Bing search) and Alphabet face off in the search world (following a hasty announcement and release of Bard, Google’s own conversational AI), other companies across industries are also closely looking at how their own products could benefit from AI. Of course, as investors, the big question is whether this is a temporary craze or meaningful advancement? After all, we had the “pot” stocks of 2018 (and portions of 2019). The crypto craze of 2021. The meta-everything of 2022. And is this now the AI frenzy of 2023?
Stock buybacks and the “economically illiterate”
In Buffett’s most recent letter to shareholders, he states that only “an economic illiterate or a silver-tongued demagogue” would say that all share repurchases are damaging to shareholders or solely beneficial to company executives. The Oracle of Omaha certainly came out swinging! And he’s very right- share buybacks avoid the double-taxation (yes, in the broken tax code of the United States of America, double taxation is very much a thing) of dividends while providing value to all shareholders, retail trader and executive alike (read an older article by Harvard Business Review outlining the case for stock buybacks here). It should be stated that the Ignorant Investor holds Warren Buffett in very high regard. I mean, what’s not to like about someone who remains so down to earth that they stay in the same home they purchased before they became successful? Someone whose personality and character remains relatively humble and unaffected by their success (especially this level of success, as the world typically measures success)? An executive that fulfills his fiduciary duty to stakeholders with as much passion and dedication as this man? But we digress. Even the critics of share buybacks likely realize their benign nature. The message against stock buybacks may well be the language of politics: the soundbites play to the itching ears of the populace while politicians cement their (projected) positions ahead of reelection campaigns. That’s how the game is played, and we should expect more of such rhetoric as elections approach.
The Russia-Ukraine Conflict and Elevated Geopolitical Risk
As the Russia-Ukraine conflict moves beyond the twelve-month mark, investors must sadly resign themselves to an elevated geopolitical risk that has the potential to spread into broader Europe (let’s continue to hope and pray for peace in the region). As the US and NATO continue to pour weapon systems into Ukraine and China seriously considers helping Russia, there is always the potential for a misstep in an arena that has already rewritten segments of global supply chains (wheat, anyone?) to say nothing of rewriting the entire energy market regime. Winners and losers are found across the global economy, with some nations benefiting more than others, some industries benefiting more than others. This trend will likely continue as long as the status quo remains. For now, Russia, the US and NATO have been navigating a remarkable balancing act. However, any misstep from either side could result in an escalation of violence and end in global catastrophe. There is no real way to prepare for this type of black swan event, but we can expect things to get more difficult before they get better in that region!
The X-Files: 2023 Edition
In late January, the US shot down a Chinese high-altitude balloon that it claims was surveilling sensitive sites across the North American continent. Shortly afterwards, as the US turned its attention skywards, the air force shot down a number of floating and flying objects across North America. For a few days there, the government remained silent about what exactly it had shot down, driving conspiracy theories on UFOs and flying objects that felt like a throwback to the 1990’s hit show The X-files. Fun times. Nothing much from an investor focus here, but it does demonstrate how elevated geopolitical tensions have spread to other geographical arenas (something of a continuation of the last paragraph).
* The beauty of the stock market is that the achievers and the dreamers can both win big. Buying quality names and holding them over time has historically been a certain way to grow wealth. This rule does not hold true for those who try to trade the market, especially without frequent consultation with financial advisors and at least a considerable investment of time and study.
** As a recap, the US economy remains largely insulated from international events since it is self-driven, with about a high sixty-something percentage rate composed of US consumer spending. In contrast, a mere forty percent of the Chinese economy is driven by Chinese consumer spending (and this following sustained decades-long efforts to transform into a more developed economy).
*** There are never enough hours in a day for all the wonderous things to experience and learn about in this short life, and therefore The Ignorant Investor gladly identifies with this lifestyle- a novel experience is nearly always preferable to more stuff.
**** The Life of an Investor, a somewhat bleak poem written by ChatGPT in November 2022. The content seems quite fitting for the average investor that year! Prompt: Write a poem that rhymes about the perils of life as an investor, in short sentences
“Life as an investor, oh so fraught
With risks and perils, never a thought
Of steady returns, no easy feat
Always a gamble, always a cheat
The market can crash, stocks can fall
Leaving us broke, no money at all
But still we invest, with hope and faith
Praying for success, no time to waste
So we take the plunge, into the fray
Hoping to win, but knowing the pay
Could be high or low, depending on luck
But still we try, no time to duck [?]
For the thrill of the game, the rush of the trade
Is something we crave, never to fade
So we persevere, through thick and thin,
Hoping for riches, but never to win.”
- OpenAI ChatGPT
