Annual Summer Update - Bobbo Jetmundsen
Innovation is running at a very fast pace and seems to be picking up momentum. In the past, to start a company, you raised some money from friends and family, maybe a venture capitalist, and then, as you were successful, you likely considered the option of selling shares to the public. Publicly traded companies, which is what we care about, are evolving, disappearing, showing up late to the party and are owned by shareholders that often know very little about the business because they just own them as an index investor. We have seen as many as 8,000 publicly traded companies in the past turn into about 3,600 today, and there is a lot more money around today chasing fewer and fewer companies.
This has been happening slowly, but now is being much more noticed, much like rising sea levels. New ideas are changing the way a consumer or business has been doing business. You see these ideas enter your life every day, from a new app helping you buy something, arrive somewhere, accomplish something, or find more efficient ways to make complex decisions quicker. Businesses are worried (or should be) about disruption, and for good reason. In a short amount of time, the retail companies like Macy’s, Sears, and JCPenny have been disrupted, partially because they ignored how WalMart, Target and Costco attacked their markets. What were they expecting? Then along came Amazon. The old guard was not immune to disruption and had no good answer. Who is next? Well, look at energy. We all use it every day, but we use less. Technology helps us use less. Coal is about done, natural gas while cheaper is quickly becoming higher in cost when compared to wind and solar. Look at banking. Loans are easier to get online for many of us than going to a bank, and Apple now has a credit card. The party is getting loud and it is getting late.
Exchange traded funds are great inventions with low fees that are run by computers. There are hundreds of billions of dollars in quantitative strategies with various names such as "momentum" or "risk parity" that tend to sell equity securities on weakness and buy them on strength, however illogical that may seem. The result is there are extreme swings in market prices of individual securities. How cheap can they go? Unfortunately for some, these can get very cheap, often deserved, but sometimes not. This makes value investors cautious and nervous. Value investors show up to buy when stock prices fall. But they are not showing up much anymore, and you really can’t blame them! They are often buying shares from computers that rebalance and rebalance with huge sell orders that seem to never end. Today, as investors often stay on the sidelines, the spread between value stocks and growth stocks are as wide as they mostly ever have been. This has us stubbornly committed to value investing even as growth investing seems unstoppable.
Bond investors are finding it difficult to get yield and are creating a bidding war for bonds that are forcing interest rates to historic lows. If you refinance your home, the investor (Bank or other Mortgage holder) that owned your mortgage gets their money back. They then are forced back into the market to buy more mortgage backed bonds. Buyers are everywhere. Low interest rates are good for the economy in general, but if you’re retired and expect a return on your income producing investments, that doesn’t help you.
Growth companies like Amazon and Google are amazing. Their overall market-cap valuations are extremely high, and they can scoop up emerging technology companies for huge prices that often don’t even make the news. This causes disruption from the way things were, as usually these companies would likely have been publicly traded and would allow investors to enjoy their success for a while. Oh, sure, some do go public. But take a look at how big these IPO company valuations are today. There are so many private VC investors ready to invest that they rarely need to consider becoming a publicly traded company. The regulation and added liability of being a publicly traded company has taken its toll.
The public is left to pay up for any highly priced public offerings. We Company, (WeWork), may have cracked this pattern because the public said NO to their high valuation and poor governance. Time will tell. The exchange traded fund computers put in orders along with the typical momentum money managers, (who likely are being disrupted by those very funds). A strategy without a conscious. A song without a chorus. A game without a playbook and all rules under review. Sky-high initial valuations keep us on the IPO sidelines most of the time.
The landscape is changing, but opportunity certainly lurks. Careful selection of companies that are ahead of the disruptor curve should prove to be savvy investments as they navigate their business to use technology to become very efficient, attract new customers, grow earnings, pay down debt, and build shareholder value. Bullish signs abound. Investors are nervous and there is a lot of dry powder (cash). We are eager to hold companies with dedicated management teams that provide their customers value by delivering products and services that are innovative and positioned for growth.
A few concerns:
1. We are in an election cycle, and this has often proven to be a volatile market environment. Note: more so when there is no incumbent on the ticket, and so far, Trump is on the ticket.
2. Corporate debt is rising.
3. Buybacks are at record levels. (Companies using their cash or raising debt to buy their own shares).
4. Recent Fed intervention in the Repo markets.
5. Military activity appears to be perking up.
Last year we warned of a correction and suggested it would be quick, and to sell now if you were not willing to hold if prices fell. The market fell (not as quickly as I would have preferred), and then recovered. Looking forward a year, I would expect the same advice seems appropriate.
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