Some Common Cents for July 28th, 2017

Recently, on Mondays, I have been sending out a quick memo to our client advisors about the potential news items for the week. Here is what I out this week:

Gang:

The big news this week will be the FOMC meeting on Wednesday. FOMC is an acronym for ‘Federal Open Market Committee,’ which is the committee which sets interest rate policy at the Federal Reserve. All too often, the media mistakenly refers to the FOMC as simply “the Fed.” So, put that in the ‘for what it is worth file.’

In any event, the futures markets is currently putting a 0.0% likelihood the FOMC will raise the overnight lending target this week and a 0.1% chance it will cut. Essentially, the markets aren’t anticipating any real action out of the FOMC, but there will be a lot of interest in what the official statement will say after the meeting is completed. Specifically, folks will want to gain any insight into how, when, and how fast the FOMC intends to unwind a portion of the quantitative easing program(s). While this seems to be pretty straight forward to me: allow securities to mature, collect the money, fork over the profit to the Treasury, and delete the remainder through a keyboard strike. Shoot, if ‘they’ can create money out of thin air, they can delete it just as easily.

Typically, they release the statement around 1:00 central….so be looking for it if you have interest. For grins, the markets put the chances of another rate hike by the end of the year at a ‘coin flip.’  Perhaps the statement will give some insight one way or the other, but the markets aren’t expecting it to do so.

Also, we will get the first stab at 2Q 2017 Gross Domestic Product (GDP). The consensus estimate is the economy grew at a 2.5% annualized rate during 2Q, after a very pedestrian 1.4% rate for 1Q. Unless the headline is way off the mark, one way or the other, the GDP report probably won’t move the markets significantly, as it seems most folks don’t delve into the details of the report to get a true understanding of the health of things.

Finally, the Durable Goods Orders report and the sentiment gauges come out this week. Like the GDP report, these won’t move the markets if they come in somewhat close to expectations. The Durable Goods Orders report has the potential for the biggest vagaries, as the markets are estimating a pretty gaudy 3.7% for June. This HAS to be due to aircraft orders, as the auto industry has been slowing this entire calendar year. We shall see.

In the end: the FOMC dominates; GDP comes in second, and the Durable Goods Orders report comes in a distant third (but does have the potential to cause some problems).

Oh yeah….one more thing: Amazon releases its 2Q earnings on the 27th, and this will get a lot of press.

Take care, and have a great week.

Norris

As you can tell, this is somewhere in between travelogue and in depth academic analysis. However, I don’t intend for it to be the latter. Also, if you followed the economic reports and FOMC this week, you will see I was directionally accurate regarding, well, just about all of it. Full disclosure, predicting this stuff is almost like writing horoscopes: you make it broad and vague enough to be mostly right on most things. Unlike horoscopes, I rarely write about “meeting someone new in business,” or stuff along those lines.

What I got wrong or, better put, gave short shrift to was Amazon’s earnings release. I also failed to mention Alphabet’s (Google). The latter was a rookie mistake, and I am no longer a rookie. No excuses.

In case you have missed the headlines, both Alphabet and Amazon disappointed the markets with their 2Q 2017 earnings. I won’t mince words: Amazon whiffed and Alphabet didn’t, in my opinion. In fact, I have been kind of at a loss as to why the markets have treat Alphabet the way they have this week. After all, we ALL knew the company was going to take an earnings hit due to a recent EU ruling against the company, to the tune of, literally, $2+ billion. Apart from that, you know, the report looked pretty good or, worst case, within proverbial “spitting distance” of decent. I guess that is what happens when investors expect perfection, or close to it, as opposed to pretty good or spitting distance.

By comparison, Amazon’s revenue was slightly better than expected, slightly, but the company’s net income was well off estimates, well off. In fact, Earnings Per Share (EPS) were something like 72% less than what analysts had forecasted. The reasons for this are, not in any particular order: 1) an increase in sales & marketing expenses (second highest quarter); 2) a sharp increase in research & development (all time high by far), and; 3) a surprisingly high, to the point where it doesn’t make sense to the naked eye, income tax expense (again, another all time high).

Regardless of the reason(s), at the end of the day, the only thing that matters is what the company drops to the bottom line. Will the sharp increases in sales & marketing and research & development lead to increased revenue in the future? Probably, but we don’t know that right now. Is the 66% income tax rate for 2Q a “make whole” for previous quarters? While I haven’t read the official explanation, this undoubtedly something to do it. At the end of the day, a 72% negative earnings surprise will get folks’ attention, and it did.

As I type, Amazon is down a little over 1.5% in today’s trading, which is actually quite an improvement on where it opened the session, about $30 per share. Really? How can a company perform so much worse than expectations, and be down as little as it is at 12:30 CDT. While 1.5% in the red isn’t fun, the company reported net income was over $500 million less than Wall Street thought it would be. What’s more $197 million in profit on $37.995 in total revenue is so many peanuts, a net income margin of around 0.50%. I mean, investors would take just about any other ‘consumer cyclical’ stock behind the proverbial woodshed for a miss such as this.

Why aren’t they?

Obviously, you can’t get into the minds of every investor but I imagine it has to do with two things in particular: 1) folks believe Amazon is a ‘disruptive’ company which is fundamentally changing our lives and how we conduct business, and; 2) because of this investors don’t want to realize a significant tax bill over one quarter of disappointment, much of it due to things which could increase company performance moving forward.

Consider this: assume you bought 50 shares of AMZN on 12/31/2014, less than 3 years ago, at $310. You cost basis would be $15,500. As I type, again, a share goes for around $1,030. So, your investment is now worth $51,500. Congratulations on your $36,000 gain!!! If you own it in a taxable account and hit the 25% Federal marginal tax rate, you will pay at least 15% Federal tax and 5% state tax. So, expect to write checks totaling $7,200 or so. That would make your “beak even” share price on your Amazon holding equal to $886….or an extra 14% back from your sales price.

That is a hard call to make when you believe in the company, any company. What can you buy which will guarantee you a 14%, or higher, return than Amazon over a short period of time? Say 4% annualized over a 3-year window? Since we don’t guarantee anything in the investment industry, the answer is simply nothing. Therefore, lots of folks are taking their beating today, and maybe even into next week, because they will take a more severe beating next April IF they don’t.

Foolishness, this tax.

This is the problem with the capital gains tax. It inhibits the free flow of capital throughout the financial system. It penalizes you for making the right decision, or at least the right decision for you at any given time. As such, it is an incredibly punitive tax, and, quite possibly, my least favorite of the lot. Yes, I dislike the capital gains tax even more than the estate tax, particularly from an economic and investment perspective.

Basically, I would argue the capital gains tax encourages detrimental behavior. If I had a dollar for every person I knew who held onto dot.com stocks until it was “too late” between 2000-2002 and the folks who kept their ‘bank’ stocks during the worst of it in 2008, I would have a nice tidy sum of money. The story was always the same. Initially, they didn’t want to sell it and pay the tax. Then, they figured they had already lost so much money, on paper, they might as well hold onto it in the hope ‘it would come back.’ Some did and others didn’t.

A perfect example is the gentleman a co-worker of mine went to visit in Atlanta back when I was with another employer at the very start of 2000, the first week in January. His tech company had recently gone public, and his private banker invited us over to explore hedging options for him and his $25-30 million worth of stock and options. Since it was a new, small company, an exchange fund probably wasn’t an option, scratch the probably. Further, a derivatives market didn’t exist. So, buying a whole bunch of puts wasn’t an alternative; not that he had the cash to do so in any event. He was company stock rich, and that is about it.

What to do? Well, we had studied the company and had a pretty firm suspicion there wasn’t anything to it. There was NO way it would ever grow into its valuation with its business model and primary products. There were too few of the latter and not enough potential clients, period. It was a very finite target market. I forget the specific numbers, but it was losing something like $2.0 million on $1.0 million in revenue. However, it still had a market capitalization approaching $2-3 billion, if not more.

It was a completely ridiculous situation.

So, we recommended he sell as many shares and cash out as many options as he could as soon as he could. At the time, it was trading around $20/share, or thereabouts, and he looked at us like we had a 3rd eye in the middle of our forehead. Naw, he was visibly angry with us, as was his private banker (technically our co-worker). What kind of advice is paying, quite literally, millions of dollars in tax? If the dull memory serves, our advice would have netted him something like $8-9 million, with a tax bill of between $3-4 million (he couldn’t do all of it for legal reasons). Had we lost our blankety-blank minds? Who makes such a preposterous recommendation? Pay the government $3-4 million dollars? Brother, he was indignant

While he didn’t physically throw us out of his office, the meeting was over pretty soon thereafter, as in about 5 minutes. Unfortunately for the guy, so was his fortune. By the end of the year, the stock was trading at $0.66. I mean, it turned over fast, going from $22 on 1/7/2000 to about $6 on 6/30, then $2 at the end of 3Q 2000. Brother.

While the company never went completely under, it was touch & go for long years, before selling to another company for $1.85 in 2008. At worst, he would have been around $6 million better off had he listened to what we said. According to the banker, which we called late in that year, he rode that bad boy all the way down. So much so, he was no longer even a prospect for the bank. Craziness.

I am certain you can think of other examples, and I have digressed mightily this afternoon.

In the end, this week largely went as anticipated, with the possible exception of Amazon’s earnings release and Alphabet’s… to a lesser degree. However, I would stop short of calling either worrisome, at least at this time.

So, there you have it. The predictions can be  pretty vague by design, just as the explanations are boring for the same reason.

 

John Norris: Fundamental flaw in minimum wage debate

A group of economists recently released a research paper that suggested Seattle’s increase to a $15/hour minimum wage has had a negative impact on the lowest skilled workers. It would seem the market clearing rate for unskilled labor out there is around $13/hour. Up to that level, hourly workers largely benefited from the gradated rate increases, in aggregate. Past that, the report implied the well-intended $15 minimum wage has had some ironic consequences on a decent segment of the local unskilled workforce.

Intuitively, this makes sense.

A major problem with the debate about minimum wage laws is it assumes companies pay workers for their time. They don’t. They pay them for the economic value of their labor, and time is simply a way of measuring it. We can legislate an hourly price floor all we want, but we can’t dictate the actual hourly value of individual workers. If someone is worth, say, $12/hour to an employer, the government can mandate $15/hour all it wants. That person will eventually be out of work, because no business is going to continually pay them more than they are worth.

(Read the full article as previously published in the Montgomery Advertiser on July 10th, 2017)

Norris: Get ready for massive changes in Alabama’s economy

In a recent letter to clients, I wrote how the investment industry will likely have to reassess how it defines industry sectors. For instance, Google (Alphabet) is obviously, and correctly, classified as a technology stock. However, Tesla gets lumped in with the rest of the automotive group, and Amazon is considered a consumer discretionary company just like, say, Tractor Supply Co.

We can discuss the merits of these classifications, but do investors really buy Tesla because it makes cars? Or because Amazon sells stuff which you used to buy at the store? Perhaps, but I would counter there are companies which are incredibly disruptive forces in their respective industries, and investors love them primarily for that reason. The three I mentioned are simply low-hanging fruit.

Intuitively, there will be a small number of true disrupters in any economy, which means there were be a lot of base companies. The former will develop new products, services, and technologies which will change how we live our lives and conduct business. The latter will battle it out for market share in what is left of any one economic sector. By the time the dust settles and the smoke clears, a large segment of current corporate America will be, as Charles Dickens might have said, “without a situation.”

The trick will be choosing the likely winners and avoiding the losers, but make no mistake about it: unless the government gets involved and/or there is an evaporation of capital in the global economy, there will be an enormous amount of consolidation in the U.S. economy over the next decade as corporate Darwinism weeds out those “stuck in the middle” firms.

Historically, this would suggest there will be an enormous amount of merger and acquisition activity, and there might be. However, I believe it is more likely the healthier firms in an industry will be far more apt to simply let lagging firms fail on their own, as opposed to buying their capacity. Why? Because there is already “too much” capacity in much of the economy.

While the auto industry is increasingly dear to the Alabama economy, how much capacity does it need in the United States and how much does it have? Would you say cars are still in a growth stage? Or would you think, overall, it is a relatively mature sector, which will grow more proportionately with the population than it did decades ago? At least in terms of units sold over a multi-year period? Yep, that would be my vote.

(Read the full article as previously published in the Montgomery Advertiser on June 12th, 2017)

John Norris: Value is in the eye of the beholder

Recently, I was at my parents’ house, and my father pointed to a smallish watercolor on the wall. He said that it had been a wedding present for my grandmother during the Great Depression, and that it could possibly be the most valuable thing in their house. That certainly piqued my interest.

Frankly, the painting seemed pretty pedestrian to me, but I am admittedly no expert. So, I googled the artist’s name on my phone, and found there to be no shortage of their work available for sale for about the cost of an oil change. Apparently, these had been somewhat mass produced back in the day, and popular with young homeowners and newlyweds.

When I showed him the results and suggested the real value of the painting was sentimental, the old man wasn’t thrilled. However, I wasn’t trying to be difficult. I simply had access to pertinent information in the palm of my hand with very little effort. At a yard sale, I would put a $25 price tag on the thing, but I would never do that. (Read the full article as previously published in the Montgomery Advertiser on May 16th, 2017)

John Norris: Alabama has two economies

Over the years, readers have asked me to be more of a homer in my columns, meaning I should accentuate the positive to a much greater degree than I do. When I respond, I typically say I can rah rah with the best of them. However, in my opinion, we get enough of that already. Besides, ignoring problems doesn’t make them go away.

We know our state lags the national averages in a lot of economic measures. There is little reason to list all of them here. Still, the data suggests Alabama basically has two economies: one for our metropolitan areas and another for everyone else.

If you happen to live in one of the five largest metro areas in our state, life is actually pretty good. These are: Birmingham, Huntsville, Mobile, Montgomery, and Tuscaloosa (the Big 5). According to the data I could glean from the Census Bureau and the Bureau of Economic Analysis, the Big 5 represented 53.9% of the state’s population and 67.8% of its economic output in 2015.

That year, if my math is correct, the Big 5 had a per capita Gross Domestic Product (GDP) of $46,238 in constant 2009 dollars. This would have ranked somewhere between Kansas and Wisconsin, which aren’t our normal comparisons, and be good enough for 28th place nationally. Further, it would be well above Georgia, Tennessee, Florida, and, as you might imagine, Mississippi. Rah rah, right?  (Read the full article as previously published in the Montgomery Advertiser on May 9th, 2017)

Some Common Cents for April 7th, 2017

You would think 60 Tomahawk missiles into a Syrian airbase might cause some consternation in the world’s financial markets. I certainly thought so last night when the news came across the television. In fact, the first thing I did was look at stock futures and the Asian exchanges to see how they were responding. At the time, they wobbled a little, but not as much as I would have thought. This morning, it would appear as though “God is in His heaven and all’s right with the world.”

Outside of the anticipated condemnations from Syria, Russia, and Iran, it appears the rest of the world, those countries which matter at least, is okay with United States wiping out a sizable chunk of the Syrian Air Force. Certainly, not everyone will be in personal agreement with the Administration’s decision, but if actions speak louder than words, the global response has been: so what? At least up until 9:37 CDT on April 7, 2017, that is.

As an aside, in today’s political correct society, I am frankly kind of surprised we still call these intermediate-range missiles Tomahawks. It seems this nomenclature would offend someone, somewhere. I suppose “one-handed ax used as a tool and weapon by pre-contact Native Americans in the United States” doesn’t have the same ring. It would certainly take up more space on the side of the thing to no real effect.

The real story today is the Employment Situation report for March 2017. The Street had been looking for an increase in non-farm payrolls of around 180K, with a range in the official estimates being 100K to 267K. Back when I was at Regions Financial Corporation, I used to participate in this survey, and others. So, I know the work that goes into concocting the numbers. As a result, I don’t put too much faith in them. Ha. While a fun thing to do when I was younger, it really is kind of a waste of time. …Read More…

The opinions expressed within this report are those of John Norris as of the initial publication of this blog. They are subject to change without notice, and do not necessarily reflect the views of Oakworth Capital Bank, its directors, shareholders, and employees.

Some Common Cents for March 27th, 2017

This week, you might think investors are agonizing over the particulars of the proposed healthcare legislation. Some might be; however, I would argue the details aren’t as important as the Administration’s ability to get legislation through the Congress. After all, the markets assume President Trump has a pretty aggressive pro-growth agenda, and this is the first major test of his actual political clout in Washington.

If this fails, what will happen when the tax reform proposals hit Capitol Hill? That is what really interests investors, and for good reason.

At this time,  it is difficult to imagine a sudden surge in corporate earnings, at least one which would engender another significant ‘leg up’ in the stock market. Sure, increased business owner and consumer sentiment might drive an increase in economic activity. However, I would counter with much of that increase in sentiment has to do with the prospect for meaningful tax reform. If it doesn’t happen, or is so watered down in the sausage making, it could be a more tricky year than it would currently seem.

The reason is simple: economic conditions suggest the need for a higher overnight lending target. Put another way, historically, the overnight rate would not be as low as it has been, and currently is, given the overall level of economic activity and expectations for inflation. On the flipside of the coin, in a simpler time, the Fed probably wouldn’t be ‘raising interest rates’ given, again, the current overall level of economic activity and expectations for inflation.

The Fed apparently believes conditions are strong enough to warrant a more ‘normalized’ interest rate environment, and is behaving accordingly. Obviously, this will raise borrowers’ debt service on floating rate obligations, both individual and corporate. Without a corresponding increase in revenue, this will have a compressing effect on earnings. Period. …Read More…

The opinions expressed within this report are those of John Norris as of the initial publication of this blog. They are subject to change without notice, and do not necessarily reflect the views of Oakworth Capital Bank, its directors, shareholders, and employees.

Column: Norris: Federal Reserve doesn’t have all the answers

Recently, a reporter buddy of mine in Birmingham asked me for a quote about the Fed’s recent rate hike. Did I think it adequate? Was it premature or overdue? That sort of thing. I have known him for long years, and know he is typically looking for a quick soundbite. Of course, funny is always nice.

I pretty much gave him what we have been telling clients for the better part of a year now. The Fed wants to normalize the yield curve, but not invert it. The national data has been strong enough to support a higher overnight lending target for quite a while. This past rate hike, plus the next two, really aren’t data dependent. Finally, Fed Chairman Janet Yellen wants to do what she can before Trump fails to reappoint her at the beginning of next year. That sort of thing.

No, it wasn’t funny, but monetary policy normally isn’t hilarious. (Read the full article as previously published in the Montgomery Advertiser on March 20th, 2017)

Some Common Cents for January 27th, 2017

This morning, the Bureau of Economic Analysis (BEA) released its first stab at 4Q 2016 Gross Domestic Product (GDP). Since the BEA estimated the economy grew at a 3.5% annual rate for 3Q 2016, no one was expecting a huge number (or shouldn’t have). However, the 1.9% figure the BEA gave us was less than the so-called ‘consensus’ estimate of 2.2%, but it wasn’t surprising.

In fact, it was the somewhat gaudy 3Q estimate I found a little, well, head-scratching. Sure, the headline looked great, but how in the world did our trade deficit improve so much in one quarter as to add 0.85% to the 3.5% estimate? Sure, the US dollar fell a smidgeon, a smidgeon, during 3Q, but enough to engender a 14.4% annualized surge in exports (goods) and essentially no change in imports (goods)? That seemed a bit much to me, even if the various governmental agencies could support it in some form or fashion.

Historically, there tends to be some volatility with the trade data in the GDP report, if volatility is the right word. As a result, a large surge in either exports or imports in one quarter ordinarily results in a swing the opposite direction the next. Such was the case this morning. To that end, exports (goods) reportedly fell at a 6.9% clip and imports (goods) surged 10.9%. As a result, the worsening in our trade deficit during 4Q shaved a full 1.70% off the GDP equation.

In so many ways and words, the 3Q number (headline) probably overstated domestic economic growth, just as the 4Q number understated it. For the year as a whole, the BEA currently estimates GDP grew 1.6% when adjusted for inflation. This means the US economy has not grow at a 3.0% or greater clip for 11 years, as 2005 was the last turn of the calendar when we had such ‘august’ economic activity. …Read More…

The opinions expressed within this report are those of John Norris as of the initial publication of this blog. They are subject to change without notice, and do not necessarily reflect the views of Oakworth Capital Bank, its directors, shareholders, and employees. 

Column: Will Bitcoin craze last?

bitcoinWhenever I write anything about Bitcoin, I receive a number of emails from, um, well-wishers calling me any number of colorful names, to put it politely. It seems people have really strong opinions about their cryptocurrencies. Anyone who isn’t completely onboard with them is a Luddite, or worse, as I found out in no uncertain terms.

I have a friend who knows my general opinion on Bitcoin, and he has been quick to tell me how much it went up in price in 2016. Surely, this must be the start of something wonderful for his two-coin investment, and I hope it is for his sake. However, I still can’t wrap my head around cryptocurrencies as generally accepted mediums of exchange. If for no other reason, there seems to be few barriers to entry, outside of the brilliance of a handful of people smart enough to write the necessary algorithms. What are their parameters? How do we keep them from adhering to them?  (Read the full article as previously published in the Montgomery Advertiser on January 18th, 2017)