The Times They Are A-Changin’

 Come writers and critics
Who prophesize with your pen
And keep your eyes wide
The chance won’t come again
And don’t speak too soon
For the wheel’s still in spin
And there’s no tellin’ who that it’s namin’
For the loser now will be later to win
For the times they are a-changin’

- Bob Dylan, The Times They Are A-Changin’

Earnings season gets into full-swing today, so I thought it would be a good time to go over some recent data that points to a potential changing of the guard in the global economy and what that means for earnings and stocks. 

We’ve had a few interesting pieces of news lately. First, Nike reported a few weeks ago, giving us a good look at what is working and what isn’t in the consumer space. In the U.S., women’s apparel and the sport-leisure trend there continues to grow. Interestingly, this same trend was seen in China, which despite the turmoil in their stock market showed strong growth for Nike. There appears to be a shift occurring in the Chinese economy. As it moves towards a more consumer driven economy, at least for those with good jobs and pay, the winners and losers are changing. Nike wins, while copper and coal producers lose. Expensive, flashy brands like Kors and Prada have had a rough time in China, as the anti-corruption push hit their gift-giving business. It appears that the less-conspicuous consumption dollars are flowing to athletic apparel, because, hey, who can argue with going out for a run?

Another interesting data point was that foreign currency translations (ie, the effect of the strong dollar) hit Nike’s earnings by 6%. That’s a number. I suspect that they will not be alone. Nike got a pass because their future orders were very strong, but I suspect that the markets will not be so kind to others that miss. While it is common for companies to try to gloss over the effects of currency moves on their income, at the end of the day, cash is cash, and the logical takeaway is that if currencies remain right where they are, the effect is permanent. You don’t get those dollars back. And our multinationals are valued in dollars, on U.S. exchanges. I have a feeling this earnings season could see a lot of volatility as people try to figure what “core” earnings power is going forward given the current level of the U.S. dollar.  That won’t be easy to do in 5 minutes, so this could be an interesting time for short-term moves in stocks.

The logical takeaway is to focus on domestic U.S. companies with small or non-existent foreign operations, as they should be immune to the currency problem, and may even benefit if they source their products overseas but sell them in the U.S.  In fact, that has been a popular trade. The problem with this thesis is that the U.S. economy appears to be slowing down dramatically right now. The most recent jobs report was not a pretty read unfortunately. The most startling statistic to me what that the Labor Force Participation rate has dropped to a level not seen since its inception in 1977. The U.S. wasn’t exactly booming back then either. The LFP dropped to 62.4%.  (What the other 37.6% are doing all day is an open question, but since one of the strong spots in the report was restaurant hiring, maybe they are hanging out in coffee shops more?)

Some parts of the economy are doing well. Food service continues to be a bright spot in the U.S., and hospitals also continue to hire. But these are generally not well paying jobs. Restaurants and bars added 349,000 people in the past year, but the mining industry, which includes oil and gas drillers, has shed over 100,000 since last December. I’d hazard to guess that the average oil drilling job pays at least twice a bartending gig, so it’s easy to see how wages are stagnating at up about 2%. Retailers added 24,000 in September, but again, these tend to be lower-paying jobs. And 6 million people are working part-time because they can’t find a full-time job, pushing the “real” unemployment rate to above 10%. More high-paying job losses are coming. Chesapeake announced recently that it is cutting 750 jobs at its headquarters in Oklahoma and Conoco is cutting 2,800 more jobs. Construction is weak in shale areas, with many projects stalled in places like the Bakken.

Come senators, congressmen
Please heed the call
Don’t stand in the doorway
Don’t block up the hall
For he that gets hurt
Will be he who has stalled
There’s a battle outside and it is ragin’
It’ll soon shake your windows and rattle your walls
For the times they are a-changin’

- Bob Dylan, The Times They Are A-Changin’

The stock market initially thought the weak jobs numbers were bad, and the stock market sold off 1.5% in quick order that Friday morning. However, after a few hours it reevaluated the situation and decided that this meant that the Fed wouldn’t be raising rates anytime soon. So banks got hit, but everything else ripped, and then market closed up 1.5%, for a big 3% swing intraday. Personally, I’d rather have a strong economy with good paying jobs so that consumers have more money to spend, but apparently I’m old fashioned.

Combine all these data points and you have economists cutting their estimates for U.S. GDP growth to 1-2% for the third quarter of 2015 from 3.9% in the spring from a combination of weaker trade numbers and lower energy activity.  This earnings season, we will be very focused on the outlooks coming from corporate America, as the companies on the front line of this shift will provide us with the best insight into what is happening in the economy in real-time. Given the changes in global markets this quarter, their conference calls will be mandatory listening.

There is another aspect of this quarter’s reports that makes them very important: the third quarter is when outlooks for the coming fiscal year are adjusted. This is due to the timing of budgeting. Companies typically budget for the coming year in the late third and early fourth quarters, in order to have the process finished before the year-end bonus review work begins. I think this is why you see estimates come down the most in the third quarter each year – left to their own devices, Wall Street analysts default to making growth assumptions that tend to be too optimistic. As the companies themselves face the reality of actually putting a budget together for the next fiscal year, they release this guidance to the Street, which often has to adjust down their expectations. I believe that this reason, more than anything else, is why September and October tend to be the worst for stocks – this is simply when the companies finally acknowledge that their long-term goals are not short-term reality.

The line it is drawn
The curse it is cast
The slow one now
Will later be fast
As the present now
Will later be past
The order is rapidly fadin’
And the first one now will later be last
For the times they are a-changin’

- Bob Dylan, The Times They Are A-Changin’

The U.S. consumer (and the Chinese one too) seems to be resilient in the face of a weaker job market. Clearly lower oil prices have helped a little (hence the strength in restaurants). The problem area will be multi-nationals, particularly those with large foreign sales. There, we’re going to see a lot of “adjusted” earning for currency changes, but I think the right investment play will be to continue to focus on predominantly domestic companies and avoid those levered to the previously fast-growing Emerging Markets. For the times they are a changin’.

The upcoming StockPicker newsletter will be focused on Nike and valuation. During earnings we will shift from a bi-weekly schedule to more frequent, brief notes on actionable items. Email me for a free trial. 
______________________________________________________________________________
This week’s Trading Rules:

• The calendar matters. October can be volatile because it’s when companies face reality.

• Accept that risk, probability and uncertainty come every day; manage the chaos.
• Look for core simplicities in complex situations.
   

Last time we said we thought the S&P 500 was deeply oversold and “could easily trade back to 1950.”  It shot past that and is now struggling at resistance. October earnings period can be a tricky time to trade. Play small ball and be patient.

SPY Trading Levels:
Support: 199, 195, then 188/189.
Resistance: 201/202, 205/205, then 208.

Positions: Long and short U.S. stocks and options, Long SPY Puts.

For more ideas and interesting reading, Email me for a free trial of my bi-weekly StockPicker newsletter. No credit card or other financial information is required.

Millers Market Musings and StockResearch.net are not making an offering for any investment. It represents only the opinions of Jeffrey Miller and those that he interviews. Any views expressed are provided for informational and entertainment purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest and is not in any way a testimony for Miller's other firms. Jeffrey Miller is a Partner at Eight Bridges Capital Management and a Member of Eight Bridges Partners, LLC.  Eight Bridges Capital Management, LLC is an exempt reporting advisor with the SEC.  Eight Bridges Capital Management solely manages the Eight Bridges Partners, LP investment fund and does not provide any advice to individual investors in any capacity.  This message is intended only for informational purposes, and does not constitute an offer for or advice about any alternative investment product. Past performance is not indicative of future performance.

Any views expressed herein are provided for informational purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest with any manager, fund, or program mentioned here or elsewhere. Any opinions about any individual stocks, commodities, or other securities expressed in this article or any linked articles or websites are solely for informational purposes only and are not an offer or inducement to buy or sell any securities.  The author and/or funds he manages may hold positions in the securities mentioned and his positions may change at any time without an obligation to update this disclosure. 

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Opinions expressed in these reports may change without prior notice. Jeffrey Miller and/or funds he manages may or may not have investments in any securities cited above as well as economic interest. Jeffrey Miller can be reached at 503-333-9725 or jmiller@stockresearch.net.