Enough With The Excuses!

As an investor, few tactics employed by company management teams annoy me more than making excuses for their failures. Unfortunately, this seems to be the norm rather than the exception in retailing these days. 

If you were to listen to some of the CEOs of major retailers out there, you would think that we were still stuck in a horrific recession where consumers are stashing their cash away and refusing to spend a dime. This type of rhetoric has been going on since the financial crisis, but the problem is that consumer data has done nothing but improve slowly over time. In many ways, consumers are better off today than before the crisis hit, which is a big deal for our economy since its health is dominated by consumer spending.

Bloomberg ran a great article yesterday on this very subject and pointed to a number of companies who continually cite a “weak consumer” as the reason why they continue to miss their numbers. Here is an excerpt that quotes several CEOs from leading brick and mortar retailers:

For Target Chief Executive Officer Brian Cornell, it was the “challenges we are facing in a difficult retail environment.” Gap sees it the environment as “tough,” said CEO Art Peck, while Abercrombie & Fitch Chairman Arthur Martinez has experienced the same conditions as “challenging.” The phrase has been adopted by dollar-store chains (Dollar Tree CEO Bob Sasser: “It is a fairly challenging retail environment”) and the parent company of Men’s Wearhouse (Tailored Brands CEO Doug Ewert: “The increasingly uncertain consumer and retail environment”). Barnes & Noble CEO Len Riggio has minced no words. “The retail environment is not good at this moment,” he said. “In fact, it’s terrible.”

When consumer confidence sits at all-time highs and unemployment sits at all-time lows with wage inflation creeping up, commentary like this is laughable. Just look at the data out there. Consumers are spending. There’s no question they are spending. The problem for these CEOs is that they just are not spending in their stores.

To me, it seems pretty obvious that many retailers out there are poorly positioned to compete in this new world of online shopping, which has exploded over the years (per the chart below).

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I believe this shift to online shopping has been so dramatic for three primary reasons.

  1. Price: Online merchants don’t have to pay insane rents and hire expensive labor, so they do not have to charge as much for the same good to be profitable. For example, warehouse space costs a tiny fraction of those fancy stores on 5th Avenue in New York City who pay an average $3,500 per square foot in rent.
  2. Convenience: Why lug heavy items from a store to your home when it can be shipped? Being a New Yorker who does not own a car, I will ship anything and everything I can to avoid carrying heavy bags all over the city.
  3. Comfort: The move to online spending was a slow start because it took consumers some time to become comfortable with the idea of buying from a web browser. Theft, fraud, and other concerns have gone away over the years as large online retailers have gained the credibility necessary to compete with traditional brick and mortar.

Case in point: My wife is remodeling our kitchen at the moment. We desperately needed a new sink and searched all over the city for a replacement that did not cost a fortune. After wasting an entire Saturday, we finally found one that fit our budget and time constraints. The problem is the store then wanted to charge us tax and over $200 to ship the sink to our apartment. In fact, each store we visited had a near similar policy.

Being incredibly cheap, I could not fathom wasting money like that so I pulled up the web browser on my iPhone (in the store) and found the exact same sink online for 30% cheaper with no tax, free shipping, and a return policy. Best of all it could be delivered in 3 business days versus this store’s shipping time of 2 weeks and no returns accepted. Before we even left the store, I clicked a single button on the website and confirmed that it would be there by Wednesday of the following week.

That’s not to say that traditional retail is doomed. Malls will continue to be a destination for families and friends, but the winners and losers will be defined by how well they can compete against the online shopping threat. For example, buying batteries online is easy whereas custom jewelry is tough to sell over the internet.

So when I hear CEOs whining about a weak consumer environment, I must assume that they are either (1) blind or ignorant to the economic data that is being released weekly, or (2) lazy and unwilling to accept the fact that they need to adapt to survive.

The bottom line is that the consumer is strong and spending is robust, but the way the consumer is spending money is changing dramatically. Don’t let these CEO excuses make you think otherwise.

Take five minutes to read the full article from Bloomberg. It’s worth it.

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I’m Back… With A MUST WATCH Interview

It’s been a while since I have been on the blog, but the time away was for good reason. Now that I am back, I wanted to kick things off with a MUST WATCH interview with Jamie Dimon, the no-nonsense CEO at JP Morgan. His insight on a myriad of subjects is not only entertaining but also insightful (to the point where I consider a video like this to be free research into the economy and global financial markets).

I am not implying that what he says is gospel but rather worth considering. We all have our opinions, but why I like Mr. Dimon’s style so much is because he backs up his statements with data. He’s also quite entertaining.

This is worth watching from start to finish so carve out some time to give it the respect it deserves.

https://www.youtube.com/watch?v=AFFNWoJ2LOM

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What the U.K. Vote Means

Clearly a lot of volatility out there surrounding the U.K. voting to leave the European Union. Here’s a breakdown of what it all means by answering 5 questions. 

What happened?

The U.K. voted to leave the European Union and David Cameron has stepped down as Prime Minister as a result.

Why did they vote to leave?

Three reasons:

  1. Immigration: According to Bloomberg, roughly 500 people every day enter the U.K. and become eligible for employment and subsidies. The populist movement amongst many Brits wants this to come to an end.
  2. Cost: Britain can stop sending £350 million, equivalent to half of their entire school budget, to Brussels every week. This money could be spent elsewhere.
  3. Control: Leaving will return control over employment law, healthcare, and safety/security. They could renegotiate trade agreements and have a bigger voice in international affairs.

What is the timeline?

Most likely, this process will take at least two years. No country has ever left the EU before so they need to figure out how to do it.

Should I be worried?

No. I am not worried and do not expect this to cause any real problems for three reasons:

  1. There is no way that the UK separating from the EU can drive the world’s largest economy into a recession. This will have a very limited impact on the U.S.
  2. Several countries in Europe are already not members of the EU and are doing fine (Switzerland for example). We suspect that this outcome may actually be better for the U.K.’s economy because the money they were spending to be in the EU can be put elsewhere. Also expect the UK to sign new trade agreements in the coming years.
  3. The volatility has to do with trades unwinding and little to do with deteriorating fundamentals. Traders were betting on the direction of the vote and now they have to cover positions. Most of this will be done in the currency markets but since financial markets are interrelated these days, stocks will see some volatility as well.

A lot of the fear talk about the UK leaving is nothing more than self-interests playing out. For example, Jamie Dimon (CEO of JP Morgan) said it would be a bad outcome because he likely does not want to have to spend money to move an office from the UK to Europe. President Obama said it would be bad because politicians probably do not want to have to  spend time and money drafting new trade agreements. Simply put, be very careful what you read because many of the big names saying this is disastrous are nothing more than self-interested.

In fact, I am actually very excited to see such a great opportunity to go buy stocks and ETFs that may sell off. This is when money is made in markets. 

What does this volatility mean for investors?

Keep in mind that world equity markets fell over 20% in a matter of six weeks to start 2016, but then they (1) recovered, and (2) never drove the world economy into a recession. This is just another example of how emotions can take over for a brief amount of time but are never strong enough to derail large economies.

Read more on Brexit here: https://mikeonmarkets.com/2016/06/24/the-brexit-vote/  

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The Brexit Vote

The European Union (EU) is a political and economic union of 28 countries in Europe that spans areas including trade, security, migration, justice, health, and the environment. It began after World War II and was based on the notion that countries which trade together are more likely to avoid going to war with each other.

The EU has since grown to become a “single market” allowing goods and people to move around as if the member states were one country. Within this respect, it’s somewhat similar to the individual states in the U.S. For example, if I decide to move to California tomorrow, I can simply pack my bags and head west.

The Euro is the currency for the EU, which is used by 19 of the member countries, and it has its own parliament to set rules in a wide range of areas including consumer rights, environmental issues, and even the nitty gritty like mobile phone charges.

Like any club, all countries must pay monthly dues and are subject to its legislation. This centralization of power and capital has frustrated a few countries over the years, and arguably no member is more upset than the U.K.

A sizeable opposition group in Britain has always made its voice heard. This cohort of “Euroskeptics” prevented the U.K. from adopting the Euro currency and forced the country to maintain its own border control.

The Euroskeptics have garnered more power over the years due to public opinion surrounding the current state of the EU. These Brits feel that the union has morphed from what was supposed to be a trading zone into a force that has far too much control over British life.

To appease members from within his own political party and assist with his re-election last year, the Prime Minister, David Cameron, agreed to hold a referendum to allow U.K. citizens to vote on whether to remain in the EU or exit. The media has coined this potential outcome as “Brexit,” or Britain’s exit (Br + exit = Brexit) from the EU.

The country will vote on June 23rd, and the polls put the odds of a Brexit much closer than political leaders across the EU would prefer to see. Those in favor of leaving the EU cite three primary reasons:

  1. Immigration: According to Bloomberg, roughly 500 people every day enter the U.K. and become eligible for employment and subsidies. The populist movement amongst many Brits wants this to come to an end.
  2. Cost: Britain can stop sending £350 million, equivalent to half of their entire school budget, to Brussels every week. This money could be spent elsewhere.
  3. Control: Leaving will return control over employment law, healthcare, and safety/security. They could renegotiate trade agreements and have a bigger voice in international affairs.

Those who favor staying in the EU comprise a powerful group. Nearly every major political and business leader has publicly stated that leaving the EU would be a terrible decision for three reasons:

  1. European Trade: Europe accounts for roughly 45% of all U.K. exports, and any damage to the relationship between Britain and the rest of Europe could dramatically impact their economy.
  2. External Trade: Membership with the EU has its privileges. For example, the EU has established trade agreements with other countries like the U.S., and all members get access to these trading partners. Leaving would require striking new agreements, and these terms could end up far less favorable.
  3. Fear of The Unknown: No country has ever left the EU, so it’s nearly impossible to predict what will happen if they do leave.

Simply put, the decision comes down to a battle between the economic ramifications of leaving versus the immigration concerns if they stay.

Implications for Investors

As much as political leaders may fear the unknown, markets despise uncertainty far more than any politician ever could. If the Brits do vote to leave, three legitimate risks could eventually impact investors:

  1. Retaliation: If the U.K. were to leave, other member countries may retaliate by refusing to trade with Britain. Egos are at stake, and logic may get thrown out the window.
  2. Employment: Jobs could be lost both in the U.K. and in the EU if the Brits choose to close their borders. The instability from further job losses could risk the already fragile economies across southern Europe.
  3. Herd Mentality: If the divorce ends up working out better for Brits, then other European countries may also leave and ultimately force a collapse of the EU.

But who knows for sure? Maybe exiting the EU and even an ultimate break-up of the union would be a better outcome for Europe. It’s hard to say at the moment because it’s still far too early to be able to predict possible scenarios.

Europe is our largest trading partner, so portfolios that own U.S. companies who sell to Europe could have some exposure to a Brexit. However, the benefits of global diversification far outweigh any risk associated with the potential for trade agreements to be rewritten.

Lastly, even if they do leave the EU, the process will most likely take two or more years, which is more than enough time to prepare for any negative externalities that could arise along the way.

The bottom line is that the impending Brexit vote carries risk, but any real impact to investors won’t be known for quite some time. Therefore, it’s best to be patient and resist the urge to make any major changes to an investment strategy until after the outcome is better understood.

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Puerto Rico Defaulting

Puerto Rico is making headlines this morning with their decision to default on a $433 million payment due to its bondholders. Making matters worse, the island is also signaling that it is a near certainty that they will also default on a $2 billion payment in July. 

These defaults are just the tip of the iceberg for Puerto Rico’s financial problems. Although a combined $2.4 billion in defaulted debt may sound like a lot over the span of a few months, this island actually owes over $70 billion that has been accumulated over the past several years. That’s a big number (only California and New York have a bigger debt load), and more defaults in the future could easily happen unless they find a way out of the mess that its leaders have created.

Puerto Rico debt is broadly owned in several mutual funds and other bond funds because of its attractive yield, thanks to a law that shields investors from paying taxes on income generated from these bonds. Hence, investors want to know just how much exposure they may have and downside risk they face. 

Before panic takes over, here are three important facts regarding Puerto Rico that should alleviate some of the concern over the impact of this default:

  1. Defaults are Telegraphed: Although defaults catch headlines, as in the case with Detroit, they are actually known well in advance. Professional investors have expected for over two years that this day would come, and the institutions who own the majority of Puerto Rico debt have been building hedges in their portfolios for protection. Therefore, this is coming at no surprise to any professional investor who has exposure to its debt.
  2. Debt is Insured: Most mutual funds, bond funds, pension funds, and other large institutional investors typically own “investment grade” debt, which is rated by one of the major bond rating agencies (Moody’s, etc.). The only way Puerto Rico debt can receive this rating anymore is if it is insured against losses. Therefore, the only way most institutions can have material exposure to Puerto Rico debt is if they own the insured portion of its debt. The uninsured portion of Puerto Rico’s debt can only be owned by junk bond funds and “distressed debt” funds, and these investors are the ones who are at risk of any major losses.
  3. Insurers are Fine: Fears are circling around in media outlets that those companies who are on the hook to pay claims in the event that Puerto Rico defaults cannot cover all the losses are inaccurate. The debt insurers with the most exposure to Puerto Rico, specifically MBIA and Assured Guarantee Ltd., have all publicly stated that they are more than capable of paying claims, so this concern should be dismissed. Furthermore, the ratings agencies maintain AA- or better ratings on the companies who have insured this debt, which is a further sign of confidence that these insurance companies can withstand even the most dire outcome for the island.

This is not to say that Puerto Rico will be fine. The island cannot declare bankruptcy without approval from Congress, and the odds of this happening appear to be low. There is pushback from both Democrats and Republicans for different reasons. For example, permitting bankruptcy is akin to a government bailout, and many politicians don’t like the idea of forcing taxpayers in Texas, Florida, and other states to be on the hook. 

In all honesty, the future does not look great for Puerto Rico without some major political reform. The island’s leaders put themselves in this situation, and the unfortunate outcome is that its citizens are now paying the price. The result of years of fiscal mismanagement has led to a 45% poverty rate and an exodus to the U.S., where roughly 1,500 citizens are leaving the island every day. Statistics like these are throwing gasoline on an open flame, as the tax base and ability to collect revenues for government services falls each time someone leaves.

I have no idea how all of these problems will get resolved, or if they ever will, but I am much more certain that the impact to those investors who own insured Puerto Rico are going to be fine as long as they don’t panic.

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Where’s The Love?

Gallup recently published the results from a poll that gauged the interest level from Americans in owning stocks. Three results from the survey are worth observing.  

First, just over half of the American population, or 52%, say they currently have money in the stock market. This number matches the lowest ownership rate in the 19-year history that Gallup has conducted this survey (chart below).

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Despite the massive rise in the S&P 500 since the depths of the financial crisis, there appears to be a large percentage of Americans who missed out on the gains.  

Second, back in 2007, nearly two-thirds of Americans were invested in stocks, which shows the real impact of 2008 on the mindsets of Americans. Confidence in the stock market was crushed and has yet to return in any material way.  

Third, those younger than 35 are the ones who saw the largest drop since 2007 (see below).

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This trend is concerning since this is the cohort that should have the highest allocation to stocks. They have a long time horizon and can withstand the volatile nature of equities. Furthermore, stock returns compound over time, which can transform single-digit annual returns into phenomenal long-term returns. 

In any event, the survey is interesting but frankly not overly surprising. The Great Recession left scars that will likely take much longer than a few years to heal. 

Click Here to read the full article from Gallup.

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Yet Another Empty Threat

A recent article in the New York Times has suggested that Saudi Arabia is threatening to sell up to $750 billion in U.S. treasury securities if Congress passes a bill that would allow their government to be liable in American courts for their accused role in the September 11, 2001, attacks.

This story goes all the way back to a 2002 Congressional inquiry, which cited evidence that Saudi officials living in the U.S. at the time of the attacks were involved. Here’s an excerpt from the article:

“Adel al-Jubeir, the Saudi foreign minister, delivered the kingdom’s message personally last month during a trip to Washington, telling lawmakers that Saudi Arabia would be forced to sell up to $750 billion in treasury securities and other assets in the United States before they could be in danger of being frozen by American courts.”

I won’t go into the details of the legal components to this article because I have nothing to offer. I am no lawyer, and I know more about the migratory patterns of bald eagles than I do international law. 

Where I can offer some insight is into this threat of dumping such a large amount of U.S. debt and any ramifications to the global financial system. The short answer is that this is about as much of an empty threat as when I tell my wife that we are moving to Singapore if the U.S. government raises our taxes again.

The long answer forces us to first believe that Saudi Arabia is not bluffing and they actually will sell $750 billion in treasuries. This is a pretty big leap of faith given their history of saying one thing and doing the exact opposite. 

Unloading such a large amount at once would be incredibly challenging. For every U.S. dollar they sell, there must be a willing buyer, and finding entities to buy in bulk to this degree may be pretty tough.

But let’s give them the benefit of the doubt and assume that they did find buyers. Selling dollars equates to buying some other currency (in the same manner as swapping dollars for foreign currency when traveling abroad). So the question is what would they buy?

At the moment, the second and third largest currency bases utilized by central banks (Euros and Yen) are both offering negative yields. Saudi Arabia would be swapping a positive yield for either zero to negative yield for a large portion of the securities that could even replace their treasury stockpile.

Realistically speaking, they won’t be able to unload their entire position quickly, so let’s continue down a more probable path where they sell over time. The government would need to move slowly or else they risk flooding the market with supply. 

The concept is similar to selling condos in Miami. If a builder puts thousands of condos on the market in a matter of a year, and buyers see plans for future supply to increase even further, the price will ultimately fall because condo buyers are smart enough to wait. The same applies to buyers in the currency market. 

If they were to exert too much pressure on the dollar, their actions could potentially destabilize our currency. Although this outcome may appear to be precisely the form of punishment/retaliation they seek, the kicker is that the riyal, Saudi Arabia’s currency, is pegged to the dollar.

Hence, any destabilization in the dollar would inflict a similar result on the riyal. Given Saudi Arabia’s current financial and economic stresses, such a move would just cause more problems than solve. 

The bottom line is that this is nothing more than an empty threat and will most likely go nowhere. 

Click here to read the full article.

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