Happy August!
Hope you are having a great summer so far! I was planning on waiting until September to write this update, but markets have been taking a beating these last couple of weeks and bear commenting on.
I am always unsure if highlighting market woes helps or hurts as there are many studies out there extolling the benefits of a “set it and forget it” type style of management. It is a balance in that I want to inure you to the volatility of markets without letting you think I am indifferent to the angst the ups and downs cause!
The current volatility index (VIX) is the highest since the pandemic in 2020 (when it hit an all-time high). The higher VIX Index indicates traders expect market volatility to increase. You can almost think of it as a fear signal.
Current stock valuations represent what investors and markets think a company will be worth in the short term. A company’s valuation is a number today multiplied by a story about tomorrow.
Today’s stock prices reflect where investors think the company will be next year. Some of that can be measured objectively, such as earnings, financial performance, market position, asset valuation, etc. Some of it surrounds the narrative of the company. Elon Musk is brilliant at consistently choosing the most appealing and exciting story to tell investors regarding Tesla. Don’t focus on sales; look at the potential of E.V.s, alternative clean power, autonomous driving, and robo taxis – all of which he has woven into the Tesla brand.
Sometimes, the narrative is macro in nature and has very little to do with the individual company itself. That is what is going on right now. The July U.S. jobs report was rather underwhelming. The report actually triggered what is known in economic signals as the “Sahm rule.”
Named after Federal Reserve economist Claudia Sahm, the Sahm rule states that a recession is likely if the unemployment rate (3-month average) rises by 0.5% from its low. The three-month average for the unemployment rate at the end of July is 4.1%, which is 50 bps higher than the 12-month low. This indicator has been triggered in every U.S. recession since 1970, with only two false positives (1959 and 1969) that were just premature by a few months.
The July jobs reports piles on to lowered guidance by a few of the Magnificent Seven stocks, (Google, Tesla, and Amazon), missing earnings, and that builds a lot of apprehension into markets. The volatility is being exacerbated by leverage and global trading.
Japan opened down 15%—the worst opening since 1987. This was not because of what was going on specifically with the Japanese economy, but mainly because of the unwinding of the “yen carry trade.” Essentially, traders were borrowing the yen at 0% interest and buying Nvidia and Microsoft (I’m oversimplifying it a bit, but you get the gist). What a great way to make money! At least until the yen dropped relative to the USD at the same time U.S. tech markets corrected. The unwinding of that trade means even more tech stocks are being sold to cover margin positions, amplifying the volatility.
I’m not sure how to measure its impact, but I feel pretty confident that the U.S. election coverage is not giving the world much assurance, either. It’s absolutely fascinating to watch, but I know I am not the only one wondering how the U.S. leadership race devolved into what we are watching right now!
What we see right now in markets is valuations multiplied by a fear that the U.S. economy is going into recession.
There is a lot to unpack there! Considering it is summer, I’m not even going to try. Here is what we need to remember. Corrections are a normal part of markets. Companies run up, get ahead of themselves, overcorrect, and bounce back. I’ve lost track of how many times I’ve written or told clients that there is no such thing as “upwards” volatility.
Considerable advances in A.I. and tech have caused an explosion in tech companies, specifically the magnificent seven (Google, Apple, Nvidia, Tesla, Microsoft, Facebook, and Amazon). They are leaders in A.I. and have a massive head start on everyone else. The growth curve is significant, but there is no way that they will continue to accelerate their earnings at the same pace they have in recent years. They cumulatively grew 73% in 2023. Adjusting their growth rate back down is not a surprise. That doesn’t mean their long-term business model is in jeopardy.
Recessions are a normal part of the economy. I’ve written at length on the fact that we’ve never gone through as significant a rate increase as we did in the last couple years and it not been followed by a recession. Now the triggering of the “Sahm rule” by the U.S. jobs report is further lending weight to the likelihood of recession in the U.S.
The warning that the US is heading towards recession reminds me a bit of Joey, the world’s unluckiest bear. According to the internet, Joey was a white albino grizzly. The story goes that Joey, because of his snowy white fur, a result of albinism, led to numerous cases of mistaken identity, often confused with a polar bear. Concerned for Joey’s well-being, conservationists had him airlifted from his home to the Arctic. He struggled mightily there until another group of conservationists recognized that he was not, in fact, a polar bear and brought him back. The reason why he was unlucky is that this happened five more times! The last couple of times after being tranquilized and woken up in the Arctic, he didn’t even try to survive; he just started walking back home!
Pretty sure this is an urban myth, but it sure makes a good story! I’m not saying that the U.S. economy isn’t going to touch recession territory, but I don’t see the U.S. jobs report as a significant red flag. I think of if as just a sign that A.I. is working. I don’t get the surprise here. Every chatbot you see online when ordering from your favourite retailer is replacing a customer service job. A.I. does a lot of jobs faster, more efficiently, and at a much cheaper rate than people. It is undoubtedly going to cause massive job displacement in the short term. The good news is that there has never been a piece of new technology that hasn’t ultimately created more jobs than it has replaced. It just takes time.
It isn’t a bad thing if we do hit recession. Recession is a culling of the herd—short-term pain but good for the economy’s overall health. Businesses must pay more attention to customer needs and servicing and offer real value to attract consumers again—no room for bad businesses or poor service. Workers have to lose that sense of entitlement and either learn to be productive employees or find another way to add value to the economy. Hopefully, there will be some incentive both ways. The ideal is a capitalism which rewards a company that offers value to its clients and takes care of great employees. Recession resets us back a bit towards that ideal.
My nephew got married a couple of weeks ago. It felt very different for Kristy and me in that all the help around wedding logistics was done by my kids’ generation, all of whom are in the 20-28 age group. The night before the wedding, my nephew had a planning session over at our house with all the people who had wedding day responsibilities around setup, takedown, and the ceremony. My wife and I had nothing to do! My kids and their peer group were handling everything.
My wife got a panicked call from my daughter on the day of the wedding. They were having some problems with unloading and setup coordination at the wedding place. She ranted for a bit about the “crisis” and then gave us a real chuckle when she ended with the proclamation that there were no adults there to help!
We assured her she and the wedding planning posse were fine, there were always going to be hiccoughs and they could handle everything. And, as they do, things turned out great – it was a beautiful wedding! The venue, food, music and weather were all fantastic, but even if they hadn’t been, it is the people themselves that make the wedding special. They are the only thing that matters!
Nothing has changed in the story behind the companies we own. They are good businesses today, they are going to be good businesses in two years. We may have to go through a recession, the unwinding of the “yen carry trade,” a U.S. election, or even a war. Those are all contributing factors that will affect short-term performance, but they are completely ancillary to the fact that we own companies because they are businesses with which we want to be long-term partners. When they go on sale because of factors beyond their control, we must “adult up.” Have confidence in the long-term viability of the business, hang on, and whenever possible, buy more!
Hope you enjoy what’s left of the summer! Happy to connect if you want to talk about your portfolio,
Stay safe, stay disciplined, stay positive!
Jeremy
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