Behind the Shiny Objects and Gloss, the View is Less Wonderful
US markets have geared themselves to decelerating inflation, relatively stable economic figures and a fascination with the possibilities related to advances in artificial intelligence. But bottom-up signals from companies are increasingly concerning.
Skepticism, ironically, is often a feature of sustained upward movements in stock prices and markets.
How did we get to a 17% YTD gain in the stock market? It’s the baby of negative investor psychology (the year started with the consensus thinking we’d have a 2023 recession), low stock prices and very modest sustained economic performance. When expectations are low, it doesn’t take much to make prices go higher.
Eventually, however, the market narrative shifts to “explain” what stock prices are doing.
Professional investors are supposed to be coldly discounting the future into current stock prices, but when “the consensus” has been wrong, psychological pressure builds to fit the forecast to the observed trend in stock prices.
| To put it another way, in a rising market eventually there is an inflection point when investor skepticism turns to acceptance that good times are here to stay. For some investors, it just proves to be too difficult to anticipate bad news that does not arrive, watch prices go up, and miss gains in the market. This is compounded by the financial media, which typically amplifies the narrative that appears to have the best short-term explanatory power for stock prices. In this case a positive one. Basically, as your friends and frenemies get rich, you feel more and more like an idiot. A poor one. And this chips away at the conviction for the cautious view. I think we have arrived at this point. |
An inconvenient truth: consumer behavior will make or break the U.S. economy, and by extension, the performance of U.S. stocks
I am not an economist but I know that consumer spending represents 2/3 of US economic activity. Accordingly, it is nearly impossible to have economic growth without growth in consumer spending. Employment, wage growth, and population growth are the biggest factors in U.S. consumers’ ability to spend. On the other side of the leger, expense growth, ease of accessing capital (availability and cost of getting a mortgage, for example) and consumer psychology are among the items that determine where and how freely consumers spend.
And here’s the issue: the long tail of distortion from Covid on consumer activity is still playing out. These lingering effects include the draw-down of excess savings (from a combination of reduced activity during lockdowns, government stimulus checks, enhanced tax credits, reduced rent payments, etc.) the past ability to borrow at ultra-low interest rates, and paused student-loan repayment, among other factors. As I look into the near-term future, it is a lot easier to see consumer spending retrenching than growing. Generative AI and shiny Nvidia chips are not going to whip up a solution, of that I am also sure.
Bottoms-up data already shows plenty of consumer weakness.
| As I mentioned, I am not an economist, but in my role as an equity analyst following retail and the restaurant industries, I speak to management teams in the consumer space every week. The signal from these companies is unambiguous. Things are getting worse. Consumer visits to restaurant chains have fallen every month with the exception of two since the start of 2022. In other words, declines are compounding on top of declines in the prior year. Retailers are reporting reduced spending on discretionary items. Traffic to Walmart (WMT), which is seen as cheap, is growing, while more upscale Target (TGT) is suffering. But perhaps the biggest tell is that retailers specializing in selling leftover items priced at a discount such as Ollie’s Bargain Wholesale (OLLI) or Grocery Outlet (GO) are doing bang-up business. To describe these store environments as no-frill would be an insult to a frill. Most people don’t shop there because they want to. They shop there because they need to. My point is, there is already abundant evidence that the consumer is stressed at the individual company level, even if it hasn’t yet percolated up to the glossy macro data or dented demand for stretchy pants at Lululemon (LULU). |
Curiously, my observations around the Chinese economy are exactly the opposite.
It seems like there is a negative article about the Chinese economy nearly every day in the Wall Street Journal. Granted, the Chinese economy is not a consumer driven economy like the U.S. However, just this past week, Lululemon reported a 61% increase in sales in the Chinese market. The operator of Domino’s Pizza in China (DPC-Dash HK:1405) said that sales at existing stores saw an 8% increase on top of a 13% gain in the prior year. In fact, I can’t think of an example of recent weakness reported from Chinese consumer company. I am highly skeptical of this media narrative about China. In any case, I am going there myself next week (see below) so I’ll see what I can learn from first-hand observation.
How I am managing investments* in this environment.
Higher stock prices, and a soft-landing consensus narrative, together with obvious signals of consumer weakness suggest tougher times ahead. My strategy is focus on the long-term (and avoid this whole debate about the near-term economic outlook) to stay nearly all invested all the time. This has been a good strategy (so far) in 2023 and I am not altering my approach. That said, I recently trimmed positions in one widely held name, Apple (AAPL) considering its nearly 50% move YTD and the massive company’s modest growth profile (revenues are falling YOY). For new positions, I am looking for companies with idiosyncratic growth (IE not economically dependent), strong management (as evidenced by a history of execution) that can be bought at an attractive price relative to their future earnings and cash flow.
*This is not a recommendation to buy or sell any security. Please consult with your investment advisor for advice tailored to your investment objectives and risk tolerance.
Feedback and commentary welcome. Would you like to learn more about how we invest in the markets? Please click here to get in touch.
John Zolidis
President & Founder
Quo Vadis Capital, Inc.
John.zolidis@quovadiscapital.com
Mr. Zolidis founded Quo Vadis Capital, Inc., a Registered Investment Advisor (RIA) and research consultancy, in 2017. He started his career in finance in 1996 following degree studies in Philosophy at Kenyon College and the University of Oxford. He has followed U.S. consumer companies as a senior analyst since 1999, mostly on the sell-side, writing research for institutional investor clients. He also managed money in a buy-side role at a long-short equity fund over 2013-2014. He was named in the Wall Street Journal’s Best on the Street list in 2005. Mr. Zolidis and works from New York, NY and Paris, France or wherever he has his laptop.
Travel update: Flying to China and Cyprus in September.
I am ramping up the frequent flyer miles generation this month. First, I am returning to China for my first visit post-Covid. I will start with a few days of meetings in Shanghai where I will visit Luckin Coffee (LKNCY), Tim Horton’s China (THCH) and will visit stores of Shake Shack (SHAK), Lululemon (LULU) and others. Then I will continue on to Xi’an, where I will attend the YUM China (YUMC) analyst day. YUM China is the Chinese franchisee of YUM Brands (YUM) the operator of KFC, Pizza Hut and Taco Bell. YUMC is the largest restaurant operator in China with over 10,000 locations. Xi’an is also the location of the famous terracotta warriors, so I am looking forward to checking those guys out.
Later in September, I will attend the Cyprus Value Investor Conference where I will present an investment idea and take in a few last swims in the extended summer of the Eastern Med.
I recently was honored to record a podcast on investing, decision making, mental models and the problems of Wall Street as an industry, among other topics with Dr. Chris Stout who has published 38 books, founded a school in Tanzania, and accrued accolades too numerous to list here. He has an incredible 450k followers on LinkedIn. (I thought 450 was a lot.) If you have time, please check it out here on SoundCloud but also available on Spotify and all the other platforms, let me know what you think!
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