Fading Momentum

Team Trump can talk all that it wants about “the greatest economy ever,” but even after the tax cuts which mostly went to corporations, consumers are not doing that great.  With job growth slowing in recent months, this situation is not likely to get better.

The Fed can ease, but it has no control over the dynamics of certain industries like surveillance marketing, cloud computing, online retailing, social media, software-as-a-service, or the smartphone industry.  Importantly, the stocks in these sectors that drove this cycle like Apple, Google, Facebook, and Amazon don’t represent the same future growth potential they did five years ago.  Warts are beginning to show.  The regulators are going after some of the major tech companies that drove much of the rally the last few years as privacy and competitive concerns have become mainstream.  Team Trump has raised antitrust concerns regarding the digital market in recent months. 

Leading the charge in growth stocks were companies involved with the gathering of consumer data. It will go down as one of the greatest heists in U.S. history.  All those “free” services and apps weren’t so free as these companies made hundreds of billions of dollars by monetizing the private information of consumers who now might rather have it all back.  Surveillance marketing and the related ad growth were crucial to a lot of tech stock’s performance.  Regulation is coming and with that profitability should decline. 

Chipmakers are experiencing rapidly falling revenues. The smartphone sector’s big growth phase is in the past.  The major players in cloud computing have been fighting over the same customers for a while now as that sector matures, crimping future margins and growth.  Software-as-a-service is getting frothy and crowded as well. Incredibly, multiples of 15-20 times revenues are common in the sector even as growth slows. 

Numerous growth stories like Tesla and Uber are losing fans as the realities of their business models become exposed.  Uber drivers are now talking about how they don’t make as much money as they thought once they factor in auto maintenance costs. Uber loses money on every ride.  Demand for Tesla’s is being called into question as its debts mount.  Netflix is facing new competition from media giants like Disney. Pressure in the once booming financial technology sector is becoming more pronounced as lenders are beginning to question the credit quality of new borrowers after years of reckless lending.

The point is that key sectors are losing momentum.  The law of large numbers is coming into play for many.  Broadly speaking, high growth names are reporting slowing revenue growth, but many participants have yet to notice.  This happens in every cycle, but investors can’t help but make decisions based on past growth until it becomes obvious that the glory days are over.  After the 2000 tech boom, even those tech companies that continued to show good growth failed to avoid the fate of declining stock prices as sentiment simply became less euphoric and multiples contracted.

Meanwhile, the debt boom of recent years has exhausted a lot of future demand. Housing activity has yet to respond to lower rates in recent weeks based on purchase applications.  The growth engine of oil fracking is slowing as investors are demanding producers exhibit a more disciplined approach to generating free cash flow.  Retailing has taken another turn down based on dismal quarterly results from many in the group.  Store closure numbers are mounting. 

Growth in China is fading once again after an enormous lending binge to start the year.  Factory output there is the weakest in about 17 years.  Those that have been reading our letters over the years know that we think the willingness of China to take on $30 trillion in debt over the last decade has been responsible for an inordinate amount of total global growth.  The fading of this impetus cannot be underestimated. The closely linked economies of South Korea and Australia are reporting data that seems to suggest recessions may be in place.  European data has turned demonstrably weaker as key trading partners for China are seeing fewer new orders.

Investors want to keep playing along in mega-cap U.S. stocks because the Fed encourages that, but they don’t seem to realize or care at present that they are already paying over two times normal multiples of the overall economic output of the underlying economy.  Meanwhile, many individual stocks and other asset classes continue to sound warning signs about economic prospects as they fall completely out of favor. 

In a significant flight to quality, cash is flowing into Treasuries and precious metals, taking them to multi-year highs. Something has to give.  Based on a broadening list of stocks being treated with enormous disdain, it appears participants are waking up. Maybe the indices will begin to reflect this.

The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.