Musers’ Note: As always, our political commentary is intentionally non-partisan. We prefer no political party or candidate and assess political developments solely for their market impact or investing lessons inherent in media coverage. Additionally, MarketMinder does not recommend individual securities. The below merely represent broader themes we wish to highlight.
In this week’s edition of our we-swear-it-isn’t-weekly column, the media learns how to scale tariffs and shatters FAANG stereotypes, the potential Tesla buyout raises some philosophical questions, Brits prepare for a “no-deal” Brexit, craft beer gets accused of being a leading economic indicator, and creative capitalists tackle a certain public safety problem.
Media Finally Realizes New Tariffs Are Tiny
Last Saturday, President Trump tweeted a tweet implying revenue from his new tariffs would help pay down “large amounts” of US debt. Naturally, the media rushed to fact-check, and within days the Internet was riddled with well-supported articles explaining why tariff revenue would come nowhere close to the amount needed to actually start retiring debt, which The New York Times estimated at $800 billion annually (based on the CBO’s latest deficit projections). They went on to explain that according to Treasury Department projections, the president’s new tariffs (i.e., those brought into force this year and already in force as of August 7) would add just $5 billion to US tariff revenue this year. If all threatened tariffs came into force, they estimated additional annual tariff payments would rise to $140.25 billion, presuming consumers wouldn’t “switch their buying habits to favor goods not affected by tariffs,” an assumption they deemed “dubious.” (We agree!) Even then, tariffs wouldn’t come close to offsetting the deficit. Meanwhile, MarketWatch pointed out that the steel and aluminum tariffs generated just $110 million in June’s first two weeks and used straight-line math to estimate one year’s worth of steel and aluminum tariffs as just 0.0001% of total national debt. The Orange County Register helpfully pointed out that, according to the Tax Foundation, tariffs enacted so far amount to just 0.06% of US GDP. (Their estimate of all threatened tariffs is 0.45% of GDP). We highlighted these three because they topped our Google search, but there is plenty more where they came from.
That is all fine and dandy. But! Headlines have been warning for months that tariffs present a grave economic and stock market threat. If you accept that tariffs are far too small to put a dent in a projected $800 billion deficit, then it must follow that they are far, far, far too small to put a dent in a $20.4 trillion US economy. You can’t have it both ways.
Break Up the FAANGs?
As we noted last week, FAANG (Facebook, Amazon, Apple, Netflix and Google) may be the most popular acronym in finance. Yet it makes fairly little sense, as a Bloomberg commentator noted this week. The article delves into lots of technicalities, like factor analysis and such. But we think that is totally unnecessary to see the point. Consider: Facebook is in the Tech sector, but it makes almost all its money off advertising and data sales. (Yep, not in the business of breaking things and moving fast.) Google is somewhat similar, although not identical. Netflix? Subscription entertainment. Amazon is a retailer. Apple sells computer hardware and services. There is really very little overlap. But hey, the acronym is snappy and for that we award points.
That said, we point out the Bloomberg article for being not only the rare piece that points out the aforementioned differences,[i] but also for this:
Another questionable claim is that the FAANGs have hijacked the market. Yes, the FAANGs are giants, four of the five biggest U.S. companies by market capitalization in the S&P 500 Index (Netflix ranks a lowly 34). But they don’t take up an unusually large slice of the market. The five biggest stocks in the S&P 500 have accounted for an average of 12.3 percent of the index since 1990, the earliest year for which numbers [are] available. By comparison, the index’s allocation to the five FAANGs is 12.8 percent.
That is interesting, and cuts against the common notion of the FAANGs driving performance. It is further echoed by the S&P 500 Equal Weighted Index, which is up 5.1% this year.[ii] This gauge removes the impact of market cap weighting and, well, weights all the components equally. The fact it is up shows you markets aren’t all about the FAANGs.
Um, So, About That Tesla Buyout (This Isn’t a Recommendation)
Silicon Valley’s biggest Twitter celeb was at it again this week. The co-founder of PayPal, The Boring Company and SpaceX, a free-thinking visionary named Elon Musk, set the twitterverse on fire Tuesday by announcing he may take his other company, an automaker named Tesla, private. At a share price of $420, which is nearly $80 higher than Monday’s closing price.[iii] And lest you doubt his ability to find a bank or investor group willing to support the biggest leveraged buyout of all time, he added two little words: “funding secured.”
We’ll leave it to others to ask the obvious questions, like whether that bit about having funding lined up is actually true and how Musk plans to raise money for his cash-bleeding enterprise when it doesn’t have a very large, publicly traded market cap to leverage. And the SEC is reportedly already on top of the “Is this securities fraud?” issue, as some suspect Musk’s motivation went beyond simply informing shareholders and the investing public of a potential corporate action. Our interest is much more philosophical.
You see, in an employee memo later posted on Twitter’s website, Musk explained his reasoning for going private: Shareholders of publicly traded stocks are too focused on quarterly results, incentivizing execs to make short-term focused decisions that might not be the most beneficial long-term moves. This is a viewpoint we are sympathetic to, in principle. We are also sympathetic to anyone claiming a CEO of a privately held firm has more time to focus on their actual job, rather than all the public appearances and media relations that come with being a high-profile CEO of a publicly traded firm—another point in Musk’s memo. However, we could point to some flamethrowers and an abandoned submarine that suggest taking Tesla private might not materially change how Musk spends his time. Musk also claimed that, since Tesla employees are shareholders, the constant focus on near-term (and somewhat arbitrary) benchmarks of success is a counterproductive distraction. Which is maybe true, but Musk’s spurring a media firestorm and The Mother of all Distractions this week doesn’t help his case.
As for the whole “shareholders are too short term” thing, we sort of think this is backward in Tesla’s case? This is a stock whose price has gone up about 2,000% since its June 2010 IPO, despite never having turned a profit and shouldering a high cash-burn rate.[iv] It doesn’t have a P/E ratio because dividing its high stock price by its negative earnings would look very weird. Its price-to-book ratio is a hefty 16.2, nearly five times higher than the S&P 500’s 3.3.[v] To reiterate the above disclosure, we are not in the business of recommending for or against (or anything else) individual stocks, but it seems fair to say Tesla’s shareholders are wholly focused on the super-duper long term, not the cash-burning making-cars-in-a-tent short term. They are paying a premium for a distant future where government subsidies never run out, charging stations are on every street corner, the power grid is beefy enough to cope with an electric car in every garage, and Tesla has somehow survived even though it can’t subsidize its money-losing green cars with high-margin gas guzzlers. None of this is to say that future can’t happen. It could! But we think it destroys logic to say investors with their eye on the very long term are somehow obsessed with the next quarter’s earnings.
Brexit Doomsday Prepping
After the UK’s trade minister told reporters he sees a 60% chance the UK Brexits without an EU trade deal, speculation about the impact of a “no-deal” Brexit hit fever pitch. The National Farmers’ Union (NFU) warned Britain could run out of food within six months of the Brexit date, defying the UK government’s prior pledge that it would have “adequate food supplies.” Drugmakers have started stockpiling medicine, and apparently some citizens have started hoarding canned food and tilling plots for victory gardens. Meanwhile, UK stock markets have drifted sideways and the pound has tumbled anew.
To us, this seems like a classic overreaction to good old-fashioned politicking. Last we checked, appearing pessimistic about trade negotiations was a classic tactic to create urgency and jumpstart talks. Additionally, we also have seen hyperbolic industry warnings used to great effect to motivate politicians toward a desired outcome. The farmers’ and drugmakers’ proclamations seem like more visible iterations of the finance industry’s long-running warnings about the potential impact on banks and capital markets firms if UK and EU officials don’t hammer out a services trade deal. We aren’t saying there is zero merit to their claims—this is far from our area of expertise—but we think it is important to consider a situation from every angle.
To see this better, consider the finer points of the NFU’s warning. They calculated that if the UK had to feed its entire population with home-grown food, supply would run out by August 7, 2019. Thing is, that is a big IF, as it presumes the UK imports zero food from non-EU trading partners. But according to the Office for National Statistics’ latest data, a little less than half the UK’s food and livestock imports come from outside the EU. Two of its top five food sources are the US and China. So, even in the very bizarre event that the EU cut off all food exports to the UK in the event of a no-deal Brexit—potentially angering France, Germany and Holland, which round out the top five food exporters to Britain—then the UK could import more from the rest of the world. But in all likelihood, it could probably also keep importing from the EU, as the trade relationship would default to WTO rules.
Anyway, as we have written in MarketMinder’s “Headlines” section, the benefit of all this no-deal Brexit handwringing and prepping is that markets are now quite familiar with the possibility and all the associated worst-case scenarios. The bar is really, really low—and it should be quite easy for reality to clear.
Does the Proliferation of Craft Breweries Show the US Economy Is Frothy?
We mean, no, of course not, there is always room for more beer. But even on further consideration of this Washington Post article, still, umm, no.
The article argues craft brewing was really, really booming in 1990 before a US recession, and it is booming today. We agree! To a much greater degree! (Which we love!) According to the Brewers’ Association, there are over 6,500 microbreweries in the country, and a graph on their website resembles the (trigger warning!) hockey-stick pattern of climate charting lore.[vi]
But our take on this is a little different. Drawing macroeconomic conclusions from an industry that amounts to an estimated $67.8 billion in impact is almost certainly overstating reality. We mean, the US economy is $20.4 trillion, so this is just 0.03% of GDP.[vii] (But it is a truly lovely 0.03%.)
As for writing a whole article that posits craft breweries face stiff competition and may struggle to survive a recession, when lending dips and spending slows? That is a fair enough point, but it is basically like writing the Foundational Story of Capitalism as though it is somehow news. We mean, this whole growth/boom/overinvestment/bust thing has been going on a couple hundred years. So, yes, there will be, in all likelihood, a shakeout in the craft beer biz whenever the next recession hits. The likely result: Poorly run businesses and those that can’t compete on quality will fail or be absorbed by others. For those who like to quaff an IPA or stout, this is good news, not bad, as quality brewers would stand to grow. And, though some prefer the micro-businesses remain micro, we are of the view that to the victors should go the spoils. Growth of good beer is, well, good.
Capitalism Saves the World: The Sequel?
As Frank Zappa reminded us all once upon a time, necessity is the mother of invention. In recent years, highway patrolmen have increasingly needed a way to field-test cannabis impairment, thanks to the recent raft of state laws legalizing recreational use. Colorado has experienced a spike in the percentage of drivers in fatal crashes testing positive for marijuana. Yet officers have had a hard time proving drivers who seemed stoned were actually chemically impaired, making it difficult to win DUI convictions. You see, there was no breathalyzer for pot. There are hair and urine tests, but because THC lingers in users’ systems for quite a while, positive drug tests aren’t much use in court.
Enter an Oakland gentleman named Mike Lynn—a trauma physician, SWAT team deputy reserve and CEO of a company called Hound Labs that has pioneered the world’s first-ever marijuana breathalyzer, which some police departments will soon begin field testing. Other companies are hard at work on competing products in a great race to improve public safety. Note, this didn’t happen because state or local governments threw buckets of money at labs and directed scientists to find a solution. It germinated among smart, compassionate people who smelled a public safety need and a new business opportunity. At the risk of sounding like a kid in a Disney movie, faith in markets is really all about faith in your fellow man to find a creative solution for what ails the world. Which means faith in the stock market, over the very long run, is all about having faith your fellow man’s constant problem-solving will translate to new technological frontiers, companies, industries and profits. That sure seems like a striking case for optimism to us.
Enjoy your weekend!
[i] Which we mostly categorize as a whole lotta duh.
[ii] Source: FactSet, as of 8/10/2018. S&P 500 Equal Weighted Index total return, 12/31/2017 – 8/9/2018.
[iii] Source: FactSet, as of 8/8/2018.
[vi] This statement is not meant to wade into the climate change debate, which we want no part of.
[vii] Source: US Bureau of Economic Analysis, as of 8/10/2018.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.