In mid-October, Bowen Asset Management attended the annual financial conference in Las Vegas sponsored by the Lancaster County-based Emerald Advisers, Inc. It’s always a worthwhile and informative trip to the desert for this compact and intimate gathering of very smart money managers, featuring lively interactive panel discussions with top investment and retail analysts and research firm representatives. The event is a chance to discuss investment ideas, portfolio positions, and economic forecasts with some of the best and brightest people in the business, without canned sales pitches. And the timing of this year’s conference was notable, given the recent market volatility.
During technical discussion about the fears of a pending bear market, the consensus among the attendees was that the most recent market downturn is just a correction, not the beginning of a bear market. The bull market is not done. The high yield market has barely moved during the stock market decline and would have likely declined if investors were concerned about economic growth slowing and the fed tightening (raising fed funds rates). Historically, as the stock market drops money flows into the bond market as a flight for safety. Increases in interest rates as we have most recently seen, should cause a stock market sell-off as bonds become more attractive than stocks. The rise of interest rates after such a prolonged suppression of rates by the Fed is a clear indication from the Fed that the economy will continue to grow and heat up causing inflation to rise. Some believe that the equity market should be stable until the fed funds rate edges closer to 4.0 %.
As for the impact of mid-term elections, the conference consensus is that a Republican win will continue to drive the markets higher, while a victory for the Democrats will hit consumer confidence on the margin and could bring the equity market lower.
Coming out of this conference, we at Bowen Asset are remaining cautious. We think the fourth quarter will be similar to the third quarter, with no discernable definitive sense of market direction. We are concerned that in 2019 the earnings comparisons for the year will become more difficult than in 2018 because of corporate tax breaks inflating earnings. It is not that we are thinking that corporate earnings will come down; it is just that the corporate earnings growth rate will decline on a year-over-year basis. If wage growth continues to be offset by technological improvements and inflation from tariffs, consumer sentiment may not be as attractive as some of our peers think.
Rising consumer debt levels (which are usually variable interest rate debt, such as credit card debt) and the increasing explosive growth in outstanding student loans, along with rising interest rates, should siphon any excess cash gained as a result of the tax cut from consumer wallets and may impact consumer confidence levels. Consumers may not be spending more money, which will slow the economy. Even rising interest rates in housing impacts buyers in two ways: rising rates mean payments on any new mortgage will be higher, and since the interest rate is higher, buyers may have to look at less expensive homes; they might not qualify for a high interest rate mortgage.
Other discussions at the conference centered on a likely direction of government regulation in efforts to preserve customer data and anticipated renegotiation of leases and shipping costs in light of our over-retailed economy (see, for example, the recent Sears bankruptcy filing). The consensus was that increased governmental regulation safeguarding consumer information may be likely and imminent. However, the younger generation seems much more comfortable with their personal data being generally available than regulators may perceive.
Countermanding any negative feelings is the reality that there is more money flowing into a market that is substantially reduced in size. Fewer companies are going public because of the expense of maintaining that status and the regulatory burden that comes with it. Many of today’s public companies have opted to leave the public market either through acquisitions, mergers, or leveraged buyouts to private equity. As a result, the number of public companies has declined sharply as more and more money is invested in the market holding stock prices up in downturns that years ago would be even more severe and longer term. In 1996 there were 7,322 public companies; by the end of 2017 that number had shrunk to a little over 3600 ( see the Wall Street Journal, Nov, 16, 2017 article “Where Have All the Public Companies Gone?”) while capital inflows have ballooned exponentially. In short, the money really has nowhere else to go.
At the conference, one of Wall Street’s leading retail analysts presented her most recent stock purchases and noted the strength in apparel sales, with accessories stronger than usual. While commenting on the rising costs of advertising (where once retailers paid 4%-to-6%, the average is now 8%) she discussed the evolution of effective branding. As millennials’ wealth grows, social media speeds trends and make brands grow quickly and die quickly. For example, social media offers the advantage of simply paying a top-selling, perennial tabloid-fodder pop star $300,000 to carry around a particular handbag, thus driving attention to the product and boosting sales via her ubiquitous social media presence.
The analyst attributed recent improvements in consumer confidence to tax changes and the impact of tariffs. Her research focused on a shift in manufacturing from China to other low-cost sources for U.S. companies like Vietnam and Malaysia. She feels that though suppliers may be hit by the tariffs, retailers may be reluctant to pass through the effects to consumers, though the result may be price hikes up to one third. She did feel that furniture and flooring, in particular, will take a big hit.
At Bowen Asset Management, by contrast, we do not attribute a significant portion of the consumer confidence increases to the individual tax changes. Our data indicates that taxpayer attitudes may shift toward the negative when 2018 filings start in the beginning of 2019 and the impact on the middle class shows an impact different from the benefits touted by the current administration.
Online is still not profitable for most brick and mortar retailers. One cause is the impact of free customer shipping provided by competitive online retailers, which adds 3% to 6% of margin compression. The return rate for goods purchased online is close to 40%, since buyers can’t see what they bought until it is delivered. An analyst noted that Amazon, once averse to brick-and-mortar, was now seeking to establish physical spaces such as the Amazon 4-Star, featuring items top-rated by its customers. With brick-and-mortar stores losing profitable brands to online, retailers such as Target have taken to creating their own brands.
Bowen Asset Management met with some company representatives mostly related to the casino gaming industry (this being Vegas) but for us the main value was in interactions and discussions with others in our business, casino gaining insight into discretionary spending and potential of the future for American companies which provide goods and services to the casino gaming industry, specifically in Brazil where the country is voting to legalize gaming. The table game business has a very high margin, and the slot business is growing ferociously driven by slot machine cabinet hardware and lighting.
Oh, and it’s not all business. Among those we talked to were a visiting Welsh sheepherder and his wife at the hotel bar, who engaged us in a conversation ranging from Brexit to draught ewes to the U.S. midterm elections. It may not affect investing, but you never know when a sheepherder could come in handy.
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