If you don’t have teenagers in your household perhaps you can’t appreciate the TV show 24. It takes Kiefer Sutherland 24 hours to assess the landscape, identify both the problems and opportunities, develop a plan to win, and execute upon it – all while tackling volatile changes in the day-to-day operational climate. Keith McCullough does it for our clients in one hour. The Research Edge morning meeting is scheduled to last one hour (but with diatribes it can easily turn into more), with Keith using the first 20 minutes to create a mosaic of how the world is intertwined from an investment standpoint. Appreciating the Research Edge Trend vs. Trade mentality, Keith is clearly more constructive recently on the US than most strategists. His note on 11/12/08 “Beware of the Squeeze” had nine factors that work the bullish scenario and he increased his weighting in the US market. At Research Edge, we now stand at US Cash 67%, US Equities 14%, and International Equities 19%…
As a consumer analyst that is the only hour in the day that I feel better about the market and the direction we are headed. I don’t need to patronize Keith, but for the first 20 minutes his Marco narrative as the facts stand today can actually make you feel much better about where we are in the cycle, and that the worst of the destruction in the market is behind us. As an aside, 99% of the people reading this note don’t get the benefit of that hour, but it can happen if you so desire (I’ll save those details for another forum).
Coming out of the morning meeting I’m determined to find some name in my group that is going to work on the long side. Unfortunately, it does not take long before reality starts to set in – the consumer is in real trouble. I end up looking for companies where the news flow is “less bad” and all I can hope for is a short squeeze. That is no way to invest and a great way to lose money. Unfortunately, basic Graham and Dodd analysis is not holding up, it does not matter if you are buying a stock on the basis of asset value, free cash flow yield or an EBITDA multiple; no metric seems to be working. The root of the problem is that sales continue to disappoint and margins are being squeezed to levels that are impossible to model. But Keith would say “US Consumer Discretionary stocks have been crashing for longer/further (peak to trough decline from 07’ is now -55%), and now the Street is bearish on spending!” I know I see that every day, but when is the consumer going to start spending again?
In my lifetime, changes in economic activity have been closely related to growth in consumer credit and the biggest driver of incremental consumer credit has been the growth in residential mortgages. Those days are over. Given the actions the government has taken it’s easy to argue that the appropriate steps have been taken to stabilize the financial system, which should invigorate the credit markets and allow businesses to lend so consumers start spending again – but when? Where are they going to get the money? If consumers have equity in their homes today, the last thing these people are going to do is borrow more to spend! In fact the opposite is happening as more banks are requiring consumers to put more equity in their homes.
I know gas prices at the pump are approaching $2, which will put more money in the consumer’s pocket, but job losses and higher mortgage rates can eat that benefit up in a heartbeat. I can easily give you a list of 10 companies that need to see an immediate reversal (next six months) in consumer spending or they will need to shrink significantly in order to survive. As more companies shrink to stop the bleeding, more consumers will be out of work and the further we get from the bottom of the economic cycle. It’s hard to paint a picture on how we get out of this destructive downward cycle.
Yes, my day-to-day conversations with companies, suppliers and industry insiders are downright depressing. I realize, however, that most industry executives lack the foresight to see an inflection point when business will turn – for better or for worse. This is when marrying a Macro process with Micro analysis matters most.
I really want to be wrong this time on my industry outlook and I’m looking forward to 8:30 am so I can get out of this funk even if it’s only for an hour!