Post-Election Humility and a Vulnerable Market

We ask you, gentle reader, after indulging in some well-earned schadenfreude, to print this epistle, burn it and let its incense waft heavenward to be inhaled by St. Thomas More, the patron saint of politicians, who, among other achievements, was beheaded for dismaying Henry VIII.  We should be so lucky.

This sacrificial rite is called for, we believe, after our premise on election eve was neatly defenestrated by the stunning victory of Donald Trump and the upending of our expectation that divided government would persist in these United States.

The upshot in financial markets has been a rout in debt on expectations of a Trumpian agenda that includes more spending on infrastructure and defense, meaning more bond supply; fewer workers via mass deportations, meaning wage inflation; and, perhaps more importantly, the expectation of significant tax cuts for corporations and the one-percenters.  Stocks, meanwhile, have climbed ever higher, anticipating brisker economic growth on the back of the aforementioned government outlays, tax cuts and business-friendly government.

The irony in all this, of course, is that the hot-under-the-blue collar class (no snarky ripostes, please; we’re a working man ourselves) is likely to cede even more slices of the pie to capital.  If you’re a lefty, you should be happy; after all, to paraphrase Lenin, “It has to get worse before it gets better.”  How much worse (or better, if you’re so inclined)?  As the network correspondents say, only time will tell, but Trump’s recent selections for the Labor and Environmental Protection portfolios suggest coddling for capital and nose-thumbing for workers.

We all live in the meantime, though, and we are reminded of a line from our favorite Christmas movie, It’s a Wonderful Life.  When Clarence the angel remarks no money is needed in heaven, George replies, “Comes in pretty handy down here, bub.”

With the warning that the cake that Trump bakes will be heavily salted with surprise, we attempt to reconfigure our outlook.

• Obamacare is dead! Long live Obamacare!  Republicans will not return healthcare for the poor back to the emergency room.  Neither will they get rid of the pre-existing condition guarantee or parental coverage for young adults.  They’ll just call it something else.
• With Trumpian inflation on the way and the U.S. economy at full employment, the market expects the Federal Reserve to ratchet up the Fed Funds rate another quarter to one-half percentage point at the Open Market Committee’s meeting in five days. Indeed, futures contracts assign a 97% probability of a rate hike.  But don’t expect another unless the Fed wants to pop the equity bubble.
• And a prodigious bubble we think it is. The ratio of stock market capitalization to gross domestic product is over 125%, significant overvaluation by historical standards.
• Which means we believe that it’s wise to focus on individual trees, not the forest.  We pick two consumer retail names at opposite ends of the income target spectrum.  We still like J.C. Penney (JCP), despite its recent rapid run-up, believing it undervalued at a price-to-sales ratio of 0.25 compared with 0.50 for flailing Macy’s (M).  And more disposable income for the wealthy should favor luxury names.  We recommend Coach (COH), the handbag, shoes and fashion house. Superior operating margins and a safe dividend that yields 3.49% justify its trailing 12 months’ price-to-earnings ratio of 22, in our view.

Meanwhile, gentle reader, we pause in this season of light to count our manifold blessings and, at the risk of squandering our remaining brain capital, cogitate in peace about the year ahead.  We called the election of Trump last year (albeit as a jape), so we’re confident of your attention to our 2017 predictions.  Coming soon.

We Have No Angst On Election Eve

Where have you gone, H.L. Mencken?  You are much needed in this year of “Hamilton” ascendant on Broadway, Trump triumphant with your “booboisie” and Clinton winning the hearts of all who have told cops or spouses: “That’s my story and I’m sticking to it.”

Now, hip-hop “music” not being our cup of tea, we confess we have not rushed to see the runaway hit, and thus are at a cultural disadvantage to our more with it peers.  So, we are left to wonder if its creators and players captured the contempt with which Washington’s aide-de-camp so full-throatedly held full-throated democracy.  “Your people, sir — your people is a great beast!”  In other words, Hillary’s basket of deplorables; or Donald’s Mexican Muslims.  We have met the enemy and he is us! Pogo declared from the comic pages of the Sixties.

On second thought, that old scold Jeremiah put it best: “The harvest is past, the summer is ended, and we are not saved!”

But enough of sages profane and sacred.  You, dear reader, come to us, for practical wisdom this weekend before the election.

Those of you anxious about domestic policy under either candidate should not be so – anxious, that is.  With little chance of either party controlling executive and legislative branches, changes to tax policy or healthcare are unlikely.

Far from perfect, Obamacare is here to stay.  Though premium increases have startled and high deductibles mean you’re really only covered if hit by a bus, it has not proven the job destroyer its critics foretold.  Indeed, labor has become scarce enough to force wages to finally respond.

Thus, as far as the home front figures into it, the expansion will continue, only vulnerable, as it always has been, to a Federal Reserve pulling the tightening trigger too soon and too often.  We think it a mistake to raise rates in December, as the Fed has indicated it will do; if it continues to squeeze money supply in 2017, recession will follow no matter who’s in the oval office.  In our forecast for 2016, The Happy Few of 2016, we japed that Donald Trump would win. It remains a jape.

Among the names we cover, we remain buyers of J.C. Penney (JCP), which we believe is taking share in a smaller pie for brick-and-mortar retail chains.  We still like Amazon (AMZN) because, well, it doesn’t sit still and has no significant challenger on-line.

On the avoid side, we still think Whole Foods Market (WFM) won’t command a premium PE again.  There’s just too much competition to expand margins much beyond a regular old grocery store.  Other retail and fashion names we’ve told you to avoid or sell – Michaels Kors (KORS), Under Armour (UA), L Brands (LB) and Macy’s (M) – remain unappealing to us on a long-term outlook.

We still think, as we explicated in “The Happy Few,” that there are few home runs in a market that is fairly to over-valued.

Neither Trump nor Clinton will have the power to affect market valuations either way.  For all Trump’s bluster, a Smoot-Hawley like return to protectionism would likely be allowed by the corporate interests that rule us for better or for worse.  And Clinton’s late-hour critique of the Pacific trade pact is an obvious pose.

Indeed, the real threat to prosperity is something we think both candidates would avoid – another military adventure as misguided as W’s fiasco in Iraq.

Rest assured, gentle reader, something bad is bound to happen, but political fortune or misfortune for those who want to be the big dog won’t matter. 

These Times

We were recently shocked – shocked! – to discover there are men and women running the world who don’t remember watching the Beatles on the Ed Sullivan Show.  They don’t remember, it turns out, because they weren’t alive. 

As you can imagine, gentle reader, this has discombobulated your correspondent, who has been much bewildered as 2016 charges ahead without him.  Much as Brian Wilson felt 50 years ago, “I guess I just wasn’t made for these times” (Pet Sounds, The Beach Boys, 1966).

We hear you, Brian.  Consider these irruptions on the usually smooth felt of our space-time pool table:

• Outrageously low interest rates.  The republic has never been held in such high regard by creditors.  The 10-year U.S. Treasury note yields just 1.58%, which is pretty darn low.

• Stubbornly high U.S. stock prices.  The market capitalization of U.S. equities is 119% of nominal gross domestic product, which is pretty darn rich.

• Striking correlation of oil prices and stock prices in 2016, which is pretty darn (pun alert) crude.  See the charts below:

Oil

                                                                           ’16

Wilshire 5000

                                                                           ’16

Now, these phenomena are not without explanations.  A global savings glut and central bank largesse are keeping interest rates depressed, we are told.  With fixed-income yields so low, investors are forced into equities, boosting stock prices even as corporate earnings decline.  

Brexit proved a brief scare, even though Great Britain is the world’s fifth largest economy, but recent employment and retail sales data have made the case that the U.S. can resist the drag from sclerotic Europe and a slowing China.

All this leads us to believe it could be different this time.  This, we hear you say, is the bell rung at the top, a sign that the final fool has rushed in and all must be spanked vigorously by a market god that cannot be mocked for long.

Nevertheless, as we have sighed before, we can’t call a top, so we can’t let go.  Given the apparent spending propensity of the American consumer and signs in the latest jobs numbers that wages are at last perking up, we still like two disparate retail names – Amazon (AMZN), the online velociraptor, and J.C. Penney (JCP), the undervalued brick and mortar dinosaur.

As a disclaimer, we confess to remaining one bewildered baby boomer.  Just the other day we drove our golf cart to the first tee without loading our clubs.  However, once we retrieved the sticks, we sweetly striped our Titleist, splitting the fairway and convincing us we were infallible -- until we four-putted for double bogey.

J.C. Penney Can't Rebound? Of Course It Can, Old Sport

Can't time the market? To quote Jay Gatsby when "old sport" Nick Carraway tells him he can't repeat the past: "Of course you can." In fact, those who say they don't try to time the market do it anyway. What else is buying low and selling high but timing? Well, OK, maybe not the market, but timing sure comes in handy in finding the stock of a company on the cusp of surprising the crowd.
We've been JCP bulls for some time (click here for our last article on JCP) and put our money where our mouth has been the other day, buying a stake in the company at $7.50 per share ahead of tomorrow's fiscal fourth quarter earnings release.
Here's why:

• Holiday comps came in 3.9% higher, way better than competitors, which makes us think...
• JCP will continue to take market share from competitors like Macy's, which should help convince skeptics and short sellers that...
• JCP will achieve its EBITDA and free cash flow goals in 2016.

We'll be back with a deeper analysis after the fiscal fourth quarter results are released.