I can think of few topics more over-discussed in the financial media than what the Federal Reserve is doing and what it is saying about what it is doing. Why, then, am I adding to this well-worn pile? Because the recent pivot to cutting rate cuts is important, and it’s importantly bullish. Further, it’s bullish for the consumer discretionary sector, which has underperformed, setting up some interesting opportunities.
A very quick and (relatively) painless recap on the boring topic of interest rates and how we got here: As you probably know, interest rates are a governor on the rate of economic growth. Raising rates slows growth. Cutting rates, you get it. Somewhere there is a level of rates that is neutral, but estimating that requires a Ph.D. Starting back in 2022, the Federal Reserve began a series of interest rate hikes. The objective was to slow economic growth, reduce demand for labor and goods with the expectation that it would stop prices from rising further (inflation).
Slowing the economy with higher interest rates without causing a recession is a neat trick, and initially few believed it could be done. The skeptics had history on their side. Most past rate hiking cycles had, in fact, provoked recessions. But not this time, apparently! Perhaps the offset has been spending and excitement around AI. Perhaps it is some combination of other things. The bottom line is that companies have not shed workers, nor have they canceled capital projects. Even in the sectors I follow closely, retail and restaurants, many of which have been hit by lower demand, almost none have pulled back on growth plans.
Higher rates have caused pain. Higher mortgage rates (directly linked to what the Fed is doing) have stifled the housing market. Consumers are paying more for auto loans and credit card debt. Elsewhere, the roll-off of programs enacted during Covid19 to aid consumers, notably elevated SNAP payments (previously known as food stamps) has hurt consumption. There is less money for arcade games at Dave & Buster’s, but it’s been great for Walmart.
Which brings me back to my point: Just as higher rates take money away from the consumer, lower rates directly benefit consumer spending (by lowering borrowing costs) and indirectly by stimulating other corporate projects that create jobs. Leaving aside the question of whether inflation has actually been subdued (restaurant prices were up 3% year-over-year in August and are about 30% higher than 2019 but who’s counting) it follows that lowering rates should benefit companies that service the consumer.
Crushed down retail stocks and consumer names get a fresh look. This has been a very odd cycle from the perspective that the consumer has weakened, but the cause has been higher expensesrather than lower incomes. In contrast, both the Great Financial Crisis and the dot.com bust featured significant job losses. The group hurt most by current conditions has been lower income consumers. They’ve kept their employment and even enjoyed wage growth but it has not been enough to absorb the inflationary pressures. Consequently, the stocks of many companies servicing this consumer group, with notable exceptions, have really suffered over the past 18 months. As I think about which consumer stocks could benefit the most from a change in interest rates and potentially easing inflation, retailers and other businesses serving the low-income consumer are high on my list.
Should you buy Facebook (META) at an all-time high?*
Back during my first job on Wall Street at Dean Witter we had a product call the “Dogs of the DOW”. This was a fund, created for individual investors, that offered the opportunity to buy the previous year’s worst names from the Dow Jones Industrial Average. It rebalanced each year, selling names that had outperformed, and buying again that year’s lousy stocks. I imagine that some lucky companies even got selected many years in a row! History had shown that the previous year’s losers often beat the overall market in the following year. At least that’s the sales line I remember being bandied about the office in the World Trade Center. There is some intuitive sense to this. Assuming all the stocks in the DJIA were high quality names, those that had underperformed were likely both cheaper and had negative sentiment, two conditions that often correlate with better performance in the future. However, it was also a silly strategy as it ignored any fundamental trends in the underlying businesses. I think the main reason the Dogs of the DOW fund existed was that it was easy for the brokers to sell.
Similarly, buying stocks off the 52-week low list or selling those on the 52-week high list is also a making an investment decision using a non-fundamental consideration. The price of the stock itself does not tell if the business is undervalued or overvalued. Nor does it tell you how the business will perform in the future.
Last week, META hit several new all time high prices. The market value is now pushing $1.5 trillion. However, based on my calculations, it is still one of the most undervalued names I’ve examined. I am coming to this conclusion with a simplistic intrinsic value calculation, which is one measure of valuation. This exercise takes the company’s recent free cash flows and uses its recent growth rate to forecast future free cash flows. I then discount the result back. (Email me if you’d like to see this in excel.) On this basis, META is trading at a discount to its intrinsic value. In contrast, most stocks I examine with this same approach trade at a premium, and many at quite a large premium.
Based on this and my other work, I think META is still very attractive. Whether the stock has been soaring with the seagulls or barking with the dogs is not that relevant.
Travel update: Last month, I attended the Cyprus Value Investor Conference. I gave a presentation on retailer Five Below (FIVE).* Please send me a message if you would like a copy of the slides. In October, I will head to Chicago to attend Ulta Beauty’s (ULTA) analyst day. I will then stick around a few days to attend Shoptalk, an industry event that brings together executives and employees from retail and technology companies. I then have a very important meeting in Green Bay, Wisconsin, when the Houston Texans come to meet the Green Bay Packers. It will be hard to make room in my carry on for the cheesehead, but I accept the challenge. Lastly, my October tour will take me to New Orleans where I’ll visit my daughter, a senior at Tulane University. If you’ll be attending Shoptalk or in any of these places in late October and would like to meet up, please send me a message. Thanks!
*This is not a recommendation. Please consult your advisor for investment advice tailored to your risk tolerance and investment profile.
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John Zolidis
President & Founder
Quo Vadis Capital, Inc.
John.zolidis@quovadiscapital.com
Mr. Zolidis has 25 years’ experience as an equity analyst. In 2017 he founded Quo Vadis Capital, Inc., a Registered Investment Advisor (RIA) offering investment management for individuals and an idea service for professional investors. He is a frequent presenter at value investing conferences around the world and a guest lecturer at Columbia Business School. Prior to founding Quo Vadis, Mr. Zolidis was a sell-side analyst following the consumer sector. 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. He started his career in finance in 1996 following degree studies in Philosophy at Kenyon College and the University of Oxford. Mr. Zolidis and works from New York, NY and Paris, France or wherever he has his laptop.
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The author of this letter and accounts managed by Quo Vadis Capital have a long position in shares of META.
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