Being Deeply Superficial
I am a deeply superficial person. – Andy Warhol
This past Thursday I took two of my daughters to see the great Andy Warhol retrospective currently on display at the Portland Art Museum. Most people are familiar with his work, the most famous of which consists of highly colorized sequences of reworked photos of Mao, Marilyn Monroe, and the Campbell’s Soup can series. We got lucky with our timing, as Jordan Schnitzer, the scion of a local real estate family who also happens to own all the works on display in the show (he owns the largest collection of works on paper in the country), was there to give a talk about the collection. I’ve heard Jordan speak on a number of occasions, and he always has some interesting insights into the lives and moitvations of the artists he collects, so I was excited for my girls to get a chance to hear him explain the backstory of the most famous of Warhol’s works (included in the show are 10 Maos, 10 Monroes, and a few dozen Campbell’s soup prints). Instead, I got a lesson in American commerce from the 1950s and 1960s that explains a lot of what we are seeing in today’s economy and global politics, but in reverse. Stick with me on this.
Briefly, Warhol’s works, especially the Coca-Cola and Campbell’s soup can pieces, were a commentary of the commoditization of culture in America that occurred in the late 1950s and early 1960s. Warhol started his career working in advertising as an illustrator. Before the widespread advent of television advertising, if you wanted to market a product across the whole of the United States, you had to place ads in about 150 local newspapers. There was no national culture in the sense we know it today. There were a series of local cultures, with local products, local tastes, local production, etc. With the rollout of national television networks during the 1950s, companies could now advertise nationwide. Culture became commoditized, via the Madison Avenue Mad Men. Now to reach everyone, you just had to sponsor a popular show on one of the big three networks and off you went. Hence, the growth in national brands like Coca-Cola, which could create a brand image that was consistent nationwide. It was this commoditization of culture that Warhol was critiquing with his art.
What's great about this country is that America started the tradition where the richest consumers buy essentially the same things as the poorest. You can be watching TV and see Coca-Cola, and you can know that the President drinks Coke. Liz Taylor drinks Coke, and just think, you can drink Coke, too.
– Andy Warhol
In a bit of a weird coincidence, later that same evening we decided to watch A Charlie Brown Christmas. I hadn’t seen it in awhile, but was immediately struck by its focus on the same themes that Warhol was skewering: the over-commercialization of American culture. (Ironically, the production was commissioned and sponsored by…Coca-Cola). Warhol’s first exhibition of the Campell’s soup cans was in 1962. The Charlie Brown Christmas special came out in 1965. This timing coincided exactly with the mass-adoption of television and the building of the interstate highway system. In 1946, only 0.5% of U.S. households had a television, in 1954 this was 55%, and in 1962, it reached 90%. For the first time, everyone in the country could see the same shows, be sold to by the same companies, and get the same products shipped to their stores. The significance of this for our culture and the nature of business for the next 50 years cannot be overstated – it literally reshaped the way companies were constructed, how products were produced, and the winners and losers in the battle for the consumer. And I think that era is over.
Today, we are experiencing the dismantling of a national culture. It is occurring not only because we have hundreds of TV channels instead of three, but because we can all choose which news media fits our worldview and only listen to the news we want to hear. Advertisers have a harder and harder time reaching everyone, which is why print advertising is dying and the only television advertising that has retained pricing power is for the Super Bowl, which may be the last truly national experience we share. While the recent presidential election made the echo chamber problem more visible to more people, it has been occurring for years, as power to influence tastes and desires has shifted away from Madison Avenue to Youtube influencers and organic, authentic marketing campaigns aimed at more subtle associative feelings of good, or bad, will. Culture is splintering in hundreds of mini-cultures, each insulated from the others. And it’s happening all over the world. The world is becoming more insular, more closed-off from other cultures, and more intolerant. The Silicon Valley version of the future had the internet at the nexus of a global culture in which everyone would finally love their neighbors, because they finally got to know them. (This was a lot of the thinking behind the European Union as well). But a funny thing happened along the way – the more people got to know their neighbors, the more intolerant of them they became. Familiarity bred contempt, not compassion. The vision of Twitter as a distributed information network has devolved into a sort of hellish hate-transmission vehicle for the radically intolerant on both the far-left and far-right, with the middle left wondering what the hell is going on and why are so many people apparently so angry all the time.
Now and then, someone would accuse me of being evil - of letting people destroy themselves while I watched, just so I could film them and tape-record them. But I didn't think of myself as evil - just realistic. – Andy Warhol
The increasing Balkanization of politics in western democracies is manifesting itself in incredibly intolerant micro-cultures on both ends of the political spectrum. The victimhood culture that relies on extreme reactions to perceived microaggressions only serves to reinforce this phenomenon and further isolate its proponents from mainstream society, while the rise of the “alt-right” for lack of a better term is a mirror-image manifestation of a similar victimhood culture that expouses violence instead of whining as a solution. Neither is useful for resolving societies problems, and both will continue to eat away at the foundations of western civil societies as the ability to only hear what you want to hear and only read what you want to read becomes increasingly prevalent. Facebook and Twitter really have ushered in an information revolution, but not the one they were expecting. The Balkanization of thought has turned out to be a very nasty thing to unleash.
I think we’re going to see this same Balkanization in the upcoming European elections. Brexit wasn’t an outlier, it was a warning shot. The danger is that Europe has a history of interstate warfare, and a rise of intolerance could quickly spiral into a shooting war if the migrant crisis and the rise of Islamic terrorism isn’t met with more action than words in the future. The risk is low, as Europe is steadfastly against action of any kind apparently, but a frustrated populace combined with a resurgent right could combine to create a push for military solutions to the problems that Brussels has created. Is this likely? I don’t know. But it’s possible. Especially when the clueless bureaucrats running the ECB and EU are more upset about Italy bailing out its banks than about the complete inability of the German intelligence service to monitor a terrorist suspect because they didn’t have the resources. Where are their priorities? Apparently not on public safety, which throughout history has been an extremely costly mistake to make by those in power. I literally read back to back articles in the FT last week that demonstrate the blindness of those in power to what is happening in the world. In the first, a German functionary at the Bundesbank was “aghast” and “appalled” that the Italians were considering breaking the EU imposed limit on debt issuance to preemptively backstop a bank in which tens of thousands of depositors stand to lose their savings if it fails. In the second, Merkel said she was going to “seriously look at” the shortcomings in intelligence that allowed Amri to go unmonitored after he was known to German intelligence to be a terrorism risk because of a lack of resources. Think about those two statements for a bit and then ponder the Warhol quote above. Sometimes life does imitate art.
I always like to see if the art across the street is better than mine. – Andy Warhol
What does this Balkanization of thought and culture have to do with investing? Everything. The same forces that are making splintering our national culture are making it increasingly harder for big brands to create a connection with their customers. You can see this in any number of industries, where the concentration of market share is declining. Look at microbrews taking significant market share from Budweiser (BUD), or the multitude of specialty waters and teas taking share from Coke (KO), or the locally sourced hip restaurants stealing share from McDonalds (MCD) and Applebees (DIN). Today’s buyers want authenticity, and they think they can find it in local, small-batch products. I think this fracturing of markets is just starting, and it’s going to make sales gains for the large brands difficult. This is a big versus small battle, and while no one small producer will make an impact on a Budweiser or McDonalds, collectively, I think they are going to be quite meaningful. Just like one red ant is a nuisance, but a swarm can be deadly, I think this continual pecking away at the big brands is going to be an inexorable headwind for years to come. I think a wave of disaggregation is coming. It will be like the creation of General Motors (GM) 100 years ago, but in reverse, as smaller becomes better. This will reshape the investing landscape, and management teams that engage in insular thinking will destroy value. I’ve seen it happen over and over, where a management team is so emotionally and financially invested in the status quo that they can’t see the secular decline that is eviscerating their industry. Sometimes making the best buggy whips isn’t enough. A secular decline is incredibly hard to fight. I met with the CEO of Peabody Energy (BTU) a few years ago. He was a nice guy. But he was too “inside” the industry to see that coal was done no matter what he did. I kept asking about solar, wind, and natural gas all getting cheaper every year, and how he could fight that, and he said he’d make it up by exporting to China, which was growing demand rapidly. I replied that eventually the shipping costs would kill the cost advantage, they’d dig their own or find cheaper alternatives, and then what? He just couldn’t see it. Peabody filed for Chapter 11 in April of 2016.
Being good in business is the most fascinating kind of art. Making money is art and working is art and good business is the best art. – Andy Warhol
At this point you’re probably wondering if I’m going to do the usual New Year predictions thing where a pundit makes a guess where the stock market will be in twelve months. Well, sorry, I don’t do that, because I don’t know. Stocks are fully-valued, but shorting on valuation is notoriously difficult to time right. Bonds are the clearer play, with high-yield spreads quite tight to a treasury yield that is still quite low by historical standards. Yes, U.S. treasuries have fallen sharply since the summer, but with global rates still near 500 year lows, do you think a 10% drop is all that we’re going to get? Yeah, me neither. If we ever get a recession again, high-yield will crater, but right now, it’s a painful short. I’m sticking with it. How about instead of looking at stock market pundits’ guesses in order to place a big macro bet, we instead make many smaller ones on companies we know well? That’s what I’m doing. If you want some specific stock ideas, my StockPicker newsletter is coming out this week and its free to try for awhile. Just reply to this email and I will send it to you when it’s ready. The themes I think will move markets in the years ahead are being driven by the increasingly fractured nature of society, and therefore small will beat big, authentic will beat artificial, and craftsmanship will beat mass production. As people become more and more afraid of each other, I think a search for safety and comfort is taking hold, with a nesting instinct manifesting itself in more cooking at home, less eating out, more Netflix and HBO binging, and a focus on safety and security. The problem, besides the obviously negative implications for society as a whole, is that most of the beneficiaries of this trend are private and the losers are public. Good for a long-short portfolio, but bad for the overall market. Invest accordingly.
My positions haven’t changed much since the last letter. Right now I’m market neutral, with small bets via options on a SPX decline. I am still short international sovereign debt, along with small shorts on the Italian and Chinese stock markets. I’m leaning long in some tech companies, consumer discretionary stocks, and defense in the U.S., with a number of shorts in other sectors offsetting that.
This week’s Trading Rules:
SPY Trading Levels:
In our last letter we said resistance was about 229. The market stopped at 228.34 before retreating to 225.66 on Friday. That has created some overhead just above here. This week’s levels:
Resistance: With the pullback there is now a lot between 226 and 228. Then its moved up to 229.50. Not a lot above that.
Support: 219/220, then a lot at 214/216. After that it’s 212.50, then a little at 210.
Positions: Net neutral stocks (both long and short stocks). Short XLU, SPY, and BWX. Long options on SPY, KRE, XLF, HYG.
Miller’s Market Musings is a free bi-weekly market commentary written by Jeffrey Miller, who has been managing money through various market environments for over 20 years. You can subscribe here. If you no longer wish to receive this letter, simply hit reply and put “Remove” in the subject line. Prior posts can be found at www.millersmusings.com.
Mr. Miller has been quoted in financial publications including the Wall Street Journal and New York Times, and he has appeared on Fox Business News, PBS and CNBC. More information and past articles can be found at www.StockResearch.net. Sharing and quoting from this letter is permitted with attribution.
Do I Feel Lucky?
Uh uh. I know what you're thinking. "Did he fire six shots or only five?" Well to tell you the truth in all this excitement I kinda lost track myself. But being this is a .44 Magnum, the most powerful handgun in the world and would blow your head clean off, you've gotta ask yourself one question: "Do I feel lucky?" Well, do ya, punk?
Harry Callahan, Dirty Harry, 1971
The Trump Trade has been in full effect since election day, with very few pauses. Anything domestic and regulated or geared to the economy has been on fire, while the stocks that either had their own growth (FANG) or were “safe” havens have fared poorly. In the U.S., Banks (BKX) are up 23.5% since election day, and Industrials (XLI) are up 12.5%. Regional banks are up even more than their large cap brethren, with the biggest determinant of performance being whether or not the company was a member of a regional bank ETF. Those in an ETF are significantly outperforming those that are not. This has been a massive allocation trade, based, as I wrote in my last note, on expectations for higher interest rates, regulatory reprieves and tax relief.
The KBW Regional Bank Index (KRX) hit a new all-time high on December 9th before pulling back a bit. Since bottoming out from a six-week free-fall on February 11, 2016, both the BKX and KRX are up about 65%. That is quite a move. In fact, according to KBW, it is the second-best trough-to-peak move on record for them both. Only the 164% BKX rally from March 9th, 2009 through October 14th, 2009 beat this year (that was a fun time). For the KRX, its best year-to-date trough-to-peak return came in 2008 surprisingly, when it advanced 88% from July 17th to September 23rd (inauspicious timing, that). So after what is pretty close to a historic move in banks, you have to ask yourself: Do I feel lucky?
Well, before we talk luck, maybe we should look at the terms of the bet first. In an earlier note, May the Odds Be Ever in Your Favor, I wrote “The bond market is, probabilistically speaking, an underdog to perform well over the next 2-3 years.” Since then, the 10-year US treasury bond yield has risen over 83 basis points from 1.75% to 2.58% as of the close today. An investor in the 10-year bond has lost nearly 9% of their principal in the 5 months since rates bottomed in July. Investors in a 60/40 stock/bond portfolio are not doing nearly as well as the headlines on CNBC would suggest.
At the same time, U.S. banks have risen on expectations that the Fed is going to keep raising. But remember, they said the same thing last December, before global tummy troubles made them change their mind. If you recall, the Fed is very afraid of “uncertainty” and is quite enamored of its own power to cause it. The market has already priced in at least 4 more Fed hikes, along with a healthy dose of tax and regulatory relief. How much is priced in the banks here? Well, if your average bank pays a 35% Federal Tax rate, and that goes to 25%, earnings go up 15.4%. These rate hikes add another say 3% to 8% depending on the bank. So, after a 23% move, most of this is already the stocks. What are the odds that we get more than the 4 hikes that are already baked in? That’s what you are betting on happening from here if you stay long the group. I don’t think I feel that lucky. This past week I closed out my long KRE and XLF call positions and am now market-neutral in financials.
So what about the rest of the market? What can take the overall market higher from here? Again let’s examine the terms of the bet. The broader market is moving up on expectations that Trump is going to be able to get a massive infrastructure package through Congress and get tax reform done. Except Mitch McConnell said last week that any package would be “revenue neutral” – which means it’s not a stimulus package, it’s a reallocation package. Recall, your traditional Republican Senator is not a big Trump fan, so just because he won, doesn’t mean he’s going to get what he wants. I think the odds of some more gridlock in Congress over taxes and spending are coming. Everyone wants tax reform, but if you’re cutting taxes and want to increase spending by say a trillion dollars AND the head of the Senate wants it all to be revenue neutral? Good luck with that.
Let’s Play a Little Poker. The Terms of the Bet, i.e., Your Hole Cards:
U.S. Stocks: Valuations are near all-time highs. Only higher on a number of measures in a few times in the past 100 years, including 1929, 2000, and 2007. See Steve Blumenthal’s excellent piece for the details. Odds: Not good. Timing? Hard to game. 9 of hearts.
U.S. Bonds: Valuations are also near all-time highs, although they have dropped nearly 9% for the 10-year and about 19% for the 30-year treasury already. Cheap yet? I don’t think so. This move can continue. Rising rates at some point may impact stocks that aren’t banks. 10 of hearts.
You have suited connectors. Not the best hand, but not terrible. I’d play it.
5 cards to come on the flop, turn and the river.
China: Just today China halted trading in “key bond futures” according to the Wall Street Journal. Its 10-year bond is now at 3.4%, a 16-month high. After halting trading, do you think yields are poised to go higher or lower? Me too. This is after the Chinese government has been doing everything it can to stem the trillion Yuan and counting exodus from its currency. So far it has cracked down on moving money to Macau, cross-border deals, and companies with operations in China moving their profits out of the country. That’s right, if you operate in China and make a profit there, it’s become nearly impossible to move the money out. So, what are profits in China worth if you can’t ever bring them home? If you said $0, you and I agree. This is a bad card. 5 of clubs.
Italy: Quick, what is the third-largest issuer of government debt in the world, at $2.5 trillion Euros? Since this is the Italy card, you guessed right. In case you let your FT subscription lapse, the situation there is “not good,” and not just because the country voted no on a referendum. It’s not good because most of its banks are insolvent (if your bad loans are 20% of assets while your equity is about 10%, you have a problem – it’s not rocket science). How can Italy resolve this problem? If it was back on the Lira and out of the Euro, it could devalue and recap its banks with government cash. If it stays in the Euro, Draghi and the Dreamers (hey, new name for a band?) in Brussels will have to do some form of extend and pretend again – but that just delays the inevitable, while saddling the Italians with a stagnant economy and massive unemployment. Remember, before the advent of the Euro, Italy was a manufacturing powerhouse with an economy and stock market that outperformed Germany. Since the joining the Euro, it has badly lagged. How hard will it be for the “leave” candidate in Italy to make that point? Another bad card. 4 of spades.
France: Not too dissimilar to Italy, but it isn’t as acutely aware of its issues yet and its banks are in somewhat better shape than Italy’s. They have elections on April 23rd, 2017, and the incumbent is already out. Marine Le Pen has a very good chance of doing well in the election, and if she gets significant power, you could easily see a push here for cutting ties to Brussels as well. This is a neutral card – say the Jack of diamonds. Now we have 3 to a straight.
Keep betting? At this point I’d fold. But say it’s a friendly game, and the company is good. You call knowing you’re probably going to lose.
U.S. Politics: Looking out say 6 months, what are the odds that nothing weird, strange or dangerous happens here? Right now in the U.S. there are high hopes for a Congress that can roll back some of the most harmful regulations stifling business, simplify and streamline the tax code, and get business investing in the U.S. again. A lot of that actually happening is already in stocks. In addition, there are a lot of unhappy voters making all sorts of noise about being obstructionist, as well as questions about the DNC hack and other issues. But will they meaningfully impact stocks, enough to derail the momentum it has right now? I don’t think so. Queen of hearts.
Geopolitics: Chinese military aggression (South China Sea), Russian military aggression (Baltics) and the likely breakup of the Eurozone. Any of these things would be a negative for stocks. The odds of all of them happening are low, but the odds of at least one of them happening are pretty good, and if any of these happen, stocks will be down 10% fast, if not more. 3 of clubs. We lose.
What cards do we need to hit to make a winning hand? All of these are needed for stocks to go significantly (10% or more) higher:
The Eurozone abandons its austerity measures and moves to fiscal stimulus, not just monetary accommodation. With the Germans running the show, odds are low. But if it hits, Europe could actually show some growth. Absent that, continued stagnation.
The U.S. passes a $1 trillion or more infrastructure package without offsetting spending cuts or tax increases, while reducing the top corporate tax rate to 25%.
China doesn’t implode under its massive debt burden.
A strengthening dollar doesn’t create another emerging market debt crisis (recall, since most emerging market debt is denominated in US dollars today, a stronger dollar makes it harder for those countries to repay their debts.)
Oh please, I scare easy.
The Killer, Dirty Harry, 1971
If all that makes it seem like I scare easily, I guess I’d argue that I like to be aware of my surroundings. When stocks were at valuations that were extremely attractive in 2009, I was buying hand over fist. As they have become fairly-valued and then overvalued recently, I have definitely become more cautious. Right now I’m market neutral, with small bets via options on a SPX decline. I am still short international sovereign debt, along with small shorts on the Italian and Chinese stock markets. I’m leaning long in some tech companies, consumer discretionary stocks, and defense in the U.S., with a number of shorts in other sectors offsetting that. For more specific ideas, please email me for a free trial of my new StockPicker newsletter, where I will be discussing specific stock and sector picks in more detail. Just reply to this email for more information. The next one comes out this weekend.
This week’s Trading Rules:
SPY Trading Levels:
Resistance: The market is just off its highs, so there isn’t much resistance. The top of the Bollinger Bands is at 229 – look for some resistance there. The market is overbought but can still trend higher in the near-term.
Support: 221/222, then a lot at 219. After that it’s 216, 212.50, then a little at 210.
Positions: Net neutral stocks (both long and short stocks). Short XLU, SPY, and BWX. Long options on SPY, KRE, XLF, HYG.