Common Cents on an Ugly Day in the Markets – Groundhog Day 2018

February 2, 2018, by John Norris

Section I

This morning, a client asked me whether I was nervous about the markets, particularly after the way they have behaved over the last week. He pointed out, correctly at the time, stocks were taking it on the chin here on Groundhog Day after a better than expected Employment Situation report. After all, this all but ensures the Federal Reserve will raise the overnight lending target at next month’s FOMC meeting, right?

As the color of my hair attests, I have doing this for a fairly long time. As such, I can overanalyze an economic release with the best of them, and make it say pretty much what I want it to say 80-90% of the time. Very few jobs reports are so bullish the bears can’t pull out a nugget therein to make their point, and vice versa. After all, folks that do what I do have been known to say: “on the one hand, but, then again on the other.”

I won’t belabor this morning’s number(s): it would give the report a C plus. If the Fed was/is so inclined to raise the overnight rate at the next FOMC, this report isn’t a stumbling block or obstacle. On the flipside, it certainly doesn’t suggest the need for a rate cut, and no one could sensibly argue it does. Where the rubber meets the road, out of all the Employment Situation releases I have read over the last quarter century, this morning’s was one of them. By Monday, if not by today’s end, ‘we’ will have likely forgotten it or, at the very least, pushed back into the furthest recesses of our brains.

It was the economic equivalent of a delivery cheese pizza. As Jon Bon Jovi might say: “it’s all the same, only the names will change.” Then, again, he is a cowboy who rides a steel horse…but I digress.

But if the economic data isn’t the reason for this week’s sell-off, what is? Fair enough.

What I am about to relay will be the most simplistic explanation of the market you will read this month, if not longer. Some of you will wonder: “Really, Norris, is that the best you can do? Of all the stupid…” However, here goes nothing.

Have you ever been to a children’s foot race, like a 1-mile ‘fun run’ at the local elementary school or charity event? If you have, you might recollect how the majority of kids sprint, and I mean with their hair on fire, off the starting line. Between my two children, I went to a number of these things when they were younger, and, without fail, this happened every single time. Do you want to know what else happened? After about 250 yards, some of the kids who started off as fast as their little legs could go were walking. By 500 yards, most of them were, and by 1,000 all had, let’s just say, moderated their pace a significant degree.

As we all know, the stock market had been on a torrid, unsustainable pace. There was absolutely no way it could continue, and no way the “all news is good news” could last much longer than it did. Whether we have entered an extended period of “all news is bad news” is anyone’s best guess as I type. However, I would submit, based on my past experience and current observations, that too shall pass in pretty quick order unless something completely unforeseeable happens…and I mean a bolt out of the blue.

Going back to the little analogy: we started the year at a dead sprint and walking at some point was inevitable. We did so this week. However, ‘we’ will eventually finish the 1-mile ‘fun run,’ even if we don’t threaten Sebastian Coe or Steve Ovett’s legacies in doing so.

How was that? I told you it would be simplistic. Take it for what it is worth, and use it at cocktail parties and coffee minutes until further notice.

Now, if you are truly a market fanatic, you might have noticed how the long-end of the yield curve has shot up a little thus far this year. That is a nerdy way of saying long rates are higher now than they were on December 31st. Is this a problem?

As I type, it isn’t. The ‘lending curve’ is still positively sloped. In fact, the pull back in the longer-end has increased the slope, which banks historically have loved. As such, there is nothing to tell me this increase in interest rates will threaten the extension of credit in the US financial system. Far from it. On the flipside of the same coin, there has NOT been a divergence in interest rates and inflation expectations which would/could/should alter consumer borrowing behavior.

To put this in perspective, the yield to maturity on the 30-year US Treasury Bond is now roughly where it ended 2016. What’s more, the trailing 12-month CPI (Consumer Price Index) is currently the same as it was then. In a lot of ways, we have gone around our backside to get to our nose.

Then I read this one in an article at CNN Money:

“Those rising rates are making it harder to say there is no alternative to stocks,” said David Kelly, chief global strategist at JPMorgan Funds.

Really? Okay. I have spoken to a lot of reporters over the years, and know full well sometimes you just ‘get on a roll.’ It happens, and sometimes slips out that might not be a 100% accurate reflection of how you actually feel. To that end, and I don’t know David Kelly nor mindset, I would be willing to bet a plug nickel what he really meant to say was: “While they are far from attractive, the recent run up in interest rates makes bonds less unattractive than they were at the start of the year.”

I will be blunt: if a 3.05% yield to maturity on the 30-year, a 2.1% trailing CPI, and an overnight lending target of 2-2.25% are going to wreck the US economy in 2018, it was going to wreck anyhow. Seriously. There is no need to develop a bunker mentality right now; there is no need to be nervous, particularly about ‘another 2008’ for a little while yet. Methinks the pull back in rates is a convenient excuse for some investors to realize some gains after a particularly robust January…one that was out of whack with the reality of the economic situation.

The market’s needed a pause, and it is getting one this week. We have not changed our forecast for 2018, and do not intend to do so because of one week’s price action. With that said, we are going to be diligent in ensuring the bond market doesn’t ‘tell us’ more than what we think it is here on Groundhog Day.

 

Section II

This week, a co-worker, I will call him Jim Williams, sent me an email with all kinds of futuristic predictions in it. A few years, it would have seemed like so much science fiction. These days? Not so much. Let me give you a few of them. These focus on the automotive industry, and I didn’t write them:

  • Auto repair shops will go away. A gasoline engine has 20,000 individual parts. An electrical engine has only 20. It’s incomparable! Electric cars are sold with lifetime guarantees and are only repaired by dealers. It takes only 10 minutes to remove and replace an electric engine. Faulty electric engines are not repaired in the dealership but are sent to a regional repair shop that repairs them with robots. Essentially, if you’re electric “Check Motor” light comes on, you simply drive up to what looks like a car wash. Your car is towed through while you have a cup of coffee and out comes your car with a new engine.
  • Gas stations will go away. Parking meters are replaced by meters that dispense electricity. All companies install electrical recharging stations.
  • Autonomous cars: In 2018 the first self-driving cars will appear for the public. Around 2020, the complete industry will start to be disrupted. You don’t want to own a car anymore. You will call a car with your phone, it will show up at your location and drive you to your destination. You will not need to park it you only pay for the driven distance and can be productive while driving. The very young children of today will never get a driver’s license and will never own a car.
  • It will change the cities, because we will need 90-95% fewer cars for that. We can transform former parking spaces into parks.
  • Most car companies will doubtless become bankrupt. Traditional car companies try the evolutionary approach and just build a better car, while tech companies (Tesla, Apple, Google) will do the revolutionary approach and build a computer on wheels.

 

What to make of this?

I won’t make any bones about it and haven’t. The North American auto industry isn’t a growth market. However, paraphrasing Mark Twain’s famous quip: “The reports of industry’s death are greatly exaggerated.”

We will always have cars or, better put, some form of personal transportation. My friends in the auto industry will scoff at this analogy, but it wasn’t so long ago so-called experts were seriously forecasting the end of physical books. They haven’t gone away, even if the number of book stores have. In fact, personally, I now actually buy MORE books than previously. Go figure.

However, automobile ownership rates across the country will fall. ‘We’ will buy fewer vehicles moving forward, as more and more consumers become comfortable subscribing to car services…whether they be electric, driverless, or not. Secret? They will be. This will be the trend in DENSELY populated areas. Notice I didn’t say heavily populated.

It is the same basic principle as public transportation: how far does the bus have to travel to pick up a fare paying passenger? The closer the better. That is the reason why it doesn’t work in a far flung metro area like Birmingham-Hoover. But New York? San Francisco? Chicago? Boston? Any other metro area with a population density of at least 500 persons per square mile, at least? Predicting a continued slide in car ownership rates in those areas is almost as easy as forecasting the sun will come up in the East tomorrow. However, this is more of a continuation or acceleration of an existing trend, as opposed to a new one.

What about all those suburb-heavy MSAs in the country, particularly those in the South and Southwest that don’t have many/any geographic impediments to growth? This trend will take longer to meaningfully develop. It boils down to convenience. The further one has to travel to the grocery, the less likely one is to opt for a car subscription service. Why? The further the local population has to travel to, say, conduct errands, the longer the wait for the car.

Pretty simply really, but what does it all mean for the industry?

The headline numbers will not be as catastrophic as the local impact will be in some areas. In fact, it might be hard to see the problem nationwide unless you are sensitive to it. For some reason, and it might not be fair or scientifically accurate, the following parable comes to mind. This version is from a pop-out box on Wikipedia:

If you drop a frog in a pot of boiling water, it will of course frantically try to clamber out. But if you place it gently in a pot of tepid water and turn the heat on low, it will float there quite placidly. As the water gradually heats up, the frog will sink into a tranquil stupor, exactly like one of us in a hot bath, and before long, with a smile on its face, it will unresistingly allow itself to be boiled to death.

With that said, I would be looking to sell my chain of oil-changing places, gas stations, or car washes in San Francisco or Seattle if I owned one/them. However, the good proprietors of such businesses in places like Macon, Montgomery, or Sevierville probably won’t need an Ambien at night for a little while longer yet.

In the end, the auto industry ain’t going away. It is just going to look a lot different, in some areas more than others.

 

 

Take care, and have a great weekend.