January 6, 2019
“Whoever double-crosses me and leaves me alive, he understands nothing about Tuco”.
-- Tuco, from “The Good, The Bad and the Ugly”
Well, for better or for worse, the epic western drama of Good, Bad and Ugly, also known as the 2019 global capital markets showdown, is hard upon us. I will confess to waking up on Wednesday morning wondering whether or not I was up to the fight. I’ve been at this a long time, and there are elements of what I see on the horizon that rendered springing out of bed on 1/2/19 an iffy proposition at best.
But then I remembered Tuco; good old Tuco: The Ugly element of Sergio Leone’s 1966 masterwork. He was a stone-cold Mexican bad @$$, who, by my count, was murdered at least a half a dozen times in his unwavering and ultimately successful pursuit of The Gold. He paid a steep price, but in the end the prize was his. As a further element of inspiration, it should be noted that Tuco was portrayed by Eli Wallach – a Brooklyn-born Jew who lived to be nearly 100. He absolutely stole the show in tGtBatU (nearly dying himself on three occasions during the filming), and then pretty much disappeared.
But he got The Gold; that’s the important thing. He. Got. The. Gold.
And as such, I reckon it is incumbent upon us to follow his example, marauding our way through the treacherous terrain of this market, whose main inhabitants are desperados, banditos, snakes and other vermin, and try to grab that stash at all costs.
It didn’t take long for the action to begin in earnest, and a good deal of it ties directly or indirectly to the concept of Jobs. So, in typical mash-up fashion, I have chosen to review the recent proceedings through a Jobs-inspired filter that features The Good, The Bad, and The Ugly.
Ideally, I’d prefer to follow the flowing sequence of the film’s title, but for a number of reasons feel more strongly compelled to track these events in chronological order.
We thus begin with The Bad. Sometime around the close on the first day of trading, Apple CEO Tim Cook dropped an astonishingly negative pre-announcement on the market. Apple never does this, but chose, in this instance, to top even that unfortunate incident last spring, when Facebook’s management decided that >$4B of free cash flow per quarter and an embedded user base of >1B souls notwithstanding, it had no visible means to re-energize itself, and guided down for the subsequent three years. I reckon Mr. Cook had no choice; by all accounts, the company has missed Q4 numbers and missed them badly. He was therefore duty-bound to share these tidings with the investment world. As was perhaps inevitable, he placed most of the blame on our burgeoning trade war with China. I’ve no doubts that all of this is legit. However, I cannot help but wonder if there wasn’t something of a political element in terms of the timing. If so, if he wanted to begin the New Year with a message to Washington that this whole tariff thing has real consequences for the glittering board rooms of the Silicon Valley, which will devolve into sufferings for the great unwashed, then I’m OK with this.
But the smart guys I talk to had been expecting Apple to receive a Newtonian gravitational blow for the last several quarters. Their consensus is that the Company will need to come up with something not in its visible bag of tricks to regain its lost luster. And I can’t help wondering what Jobs, Steve Jobs would have made of all of this. After all, he was the wizard, and whether he might’ve been able to bring to market some bright shiny objects that would’ve changed the equation, we’ll never know.
Because he’s gone, he’s go-one and nothing’s gonna bring him back. So investors, already terrorized by factors too abundant and varied to inventory in this space, took for the hills. Global equity indices plunged in sympathy on Thursday, and, at that precise moment, all the key elements needed for a real crash were in perfect configuration.
But then came The Good: a December Jobs Report that played to the unmixed delight of any objective observer in its orbit. Non-Farm Payrolls blew the doors off expectations, the previous two months were revised upward, the Labor Force Participation Rate rose by several hundred thousand, Average Hourly Earnings surprised to the upside as well. Investors everywhere sucked in a huge sigh of relief.
But if market participants were becalmed by the Jobs Report, they were rendered positively giddy by Fed Chairman Powell’s remarks at that afternoon’s American Economic Association’s annual conference in Atlanta. As is widely known, Chair Pow used the opportunity to walk back the interpreted-to-be-hawkish comments that accompanied a rate hike at December’s FOMC meeting. Of course, we’re flexible here, he cooed, and, for the most thick-headed among you, this means that if the economy starts to take in water, we’re prepared to bail on both further rate hikes and balance sheet reduction.
Investors swooned like teenage girls at a Beebs concert. Equities surged, and suddenly, what began, after the first two days of trading, as the worst start to a new year this century, transformed to a point where all major indices are actually showing gains for the first partial week of ’19.
Well, I’m a little skeptical here. As prophesied in these pages, volatility surged in Q4, and I think that pattern continues for the next several weeks at minimum. In early December, and in the wake of a Bad/Ugly/Not Good rout this fall, our Fed Chair issued similar soothing set of comments, only to kill the buzz – rhetorically and unilaterally -- when the FOMC met later that month. Now he has reversed course yet again, and perhaps not, given the pattern he’s forming, for the last time.
I was encouraged by one element of his comments though. When asked if he would resign if requested by the President to do so, he responded with a resounding “No”. Good on you, Jay! You’re the Big Dog of the Fed, as appointed by the Bigger Dog at the White House, and the latter cannot justifiably play you as a political football. You were appointed to do a job, and, absent some palpable malfeasance on your part, you should do all in your power to keep it. I may not agree with the steps you take (and didn’t when you raised rates in December), but with the wearying prospect of yet another presidential election now taking form, your unimpeded presence and focus is vital to our collective concerns.
And speaking of elections, it was hard to miss the fact that the 116th Congress took their oaths of office on Thursday, and wasted no time in making spectacles of themselves. Within 36 hours, they had introduced Articles of Impeachment and bills for the elimination of the Electoral College. As indicated in recent columns, my biggest fear for the markets derives from the reality that of many of them believe that Job 1 for them is removing 45 from his current job. This, my friends, is The Ugly of this essay.
While the wizened heads that beat down the unhinged progressives for leadership positions are, wisely in my judgment, taking a wait and see attitude about how hard to attack The Prez, my guess is that they won’t be able to hold the discipline of their caucus. A lot of these folks were elected for the express purpose of taking Trump down, and one can forgive them any urgency they feel in starting the process. The time for them to attack, at least in my judgment, is now. If they don’t seek the removal initiative over, say, the next few weeks, then they may have lost their best opportunity to do so. Team Trump also wants to get the showdown under way, most probably as a better construct then allowing the removal forces to hold their fire until the 2020 election battle is fully joined.
Nobody can quibble over-much about the state of the economy, and the Trumpsters must use this to their advantage. But if Trump really wants to end this nonsense, he’ll move quickly and aggressively to cut a deal with China. This, in and of itself, will not solve intractable issues with them guys and gals; whatever we sign will likely be worth not much more than the paper on which it is printed. But it would be an enormous boon to the markets, offering the dual benefit of removing the specter of tariffs that have dampened down valuations, and tearing up key portions of track on the Impeachment Train.
Conversely, if those tariffs, set tentatively to be implemented in mid-February, do become the law of the land, I think the markets will be in full panic mode. Stock Prices will drop, companies will begin to shed Jobs, and the bonfires outside the White House will burn White Hot.
So I think the big risks for 2019 play out, in rather dramatic fashion, over the next several weeks. If we can get through to spring without having to deal with the Emoluments Clause, the 25th Amendment, or Impeachment proceedings taking form, if we cut a deal with the Chinese that has even optical teeth in it, then 2019 could be a very good year for the markets indeed. Stocks, against the backdrop of a strong economy with still-ridiculously low financing costs, are if anything cheap, as illustrated by the following chart, showing P/E’s below their 10-year averages for the first time since 2013:
Sharp-eyed readers will note that the last time these metrics resided below the 10-year Mendoza Line of ~14.5 it was on the way up; catalyzed by a recovery from the crash.
It doesn’t take the skills of a wizard technician to understand that piercing a 10-year time series average from below and above are very different constructs, and ones with polar opposite implications.
Again, I believe that if we can somehow muddle through this geopolitical mess, there are happy tidings for stock market gold hunters out there. And, again, I’ll point to one of my core premises for believing that significant rallies are any rate, plausible: the alarming and increasing shortage of investable names to trade in the equity complex. Case and point: while it drew scant notice, this past week, Bristol Meyers Squibb announced a $74B purchase of Celgene, combining the world’s two biggest cancer drug companies under a single ticker. Now, by my observation, nobody has traded or invested in Bristol for a long time, it missed the biggest part of the Bull Market and resides at valuation levels of a 2014 vintage. By contrast, everyone traded Celgene – long and short – that is until now. It will soon join the likes of Red Hat as an innovative company that is subsumed into a mushy global conglomerate.
And those companies that aren’t in acquisition mode are likely to continue their buy-backing ways. Consider, if you will, the case of Apple. With no Jobs to pull new rabbits from the product hat, but still generating >$60B of free cash flow, they almost have a fiduciary obligation to continue to buy back and retire their inventory of free floating stock.
So I say that The Gold is out there, but we will likely be compelled to channel Tuco to harvest it. Yes, we will pay a price, as Tuco himself discovered. SPOILER ALERT: Fans of the movie will tell you that Blondie (Clint Eastwood) left him hanging by a rope over bags of it, and then liberated him with the unfailing aim of his bullet. Tuco didn’t like this, but presumably took The Gold anyway. Perhaps a slightly easier path will light our ways in 2019. But I doubt it will be so by much of a margin. And whatever you do, don’t cross, Tuco. Unless you mean to kill him. Sound risk advice to start the year.
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