It may seem strange to think about this today, but there was a time not so long ago (such expressions are an indication that I am over 50) when the stock market would take a nosedive whenever economic news turned out to be stronger than expected. The market's obsession then (back in the 1990s, really) was that an economy that was too "hot"--or a labor market that was too robust--would lead the Federal Reserve to raise interest rates in an effort to keep inflation in check. This was often referred to as the Fed "taking the punch bowl away from the party." More recently, the worry du jour has concerned economic weakness. Last summer investors focused on the possibility of a double-dip recession, and that concern was followed by worries about a financial crisis in Europe spreading to our shores. The market does not need an economy that is firing on all cylinders to do well, but it does need an economy where there is at least modest, positive growth--in other words, an economy that stays out of a recession. Like Goldilock's preference for porridge, the economy can't be too hot or too cold--at least for the stock market, it has to be just right.
The Federal Reserve brought the mother of all punch bowls to the party with their recent announcement that they would keep interest rates near zero through 2014 (the Fed had previously pledged to keep rates near zero through the middle of 2013). They are essentially saying to us that our money won't earn anything in the bank or in money market funds for three years, so we'd better invest in riskier assets like the stock market.There are at least two other interpretations or implications of the Fed's accommodative stance, and they are not mutually exclusive. First, the commitment to easier monetary policy signals that the Fed is concerned about the sustainability of the economic recovery, that even with some good economic numbers of late the recovery is still fragile and needs all the help it can get in the form of low interest rates. Unemployment, although showing some improvement, is still elevated at this stage of the recovery, and that remains a concern for policymakers. Second, the Fed's easy money policy is viewed by some as sowing the seeds of future inflation, and this is why we have seen strength in gold prices. When the price of gold goes up, that really means that the dollars used to buy gold are worth less--inflation erodes the purchasing power of a dollar. On balance, the Fed is saying that they are more worried about unemployment than they are about inflation.
Of course, the biggest punch bowl in the world is not going to liven up the party if nobody drinks the punch. If you are a business owner and don't see growing demand for your product or service, then you are not likely to invest in expansion even if interest rates are at historic lows. And if you want to buy a new house but think you may be in danger of losing your job in the next few months, rock-bottom mortgage rates are not likely to spur your enthusiasm about making such a long-term financial commitment. Lower and lower interest rates do not guarantee an immediate boom in investment and spending, but the perception that rates will remain low for an extended period is good for stocks in general, especially when the economic numbers are improving. That could very well be the "Goldilocks" spot for stocks.
Someone asked me recently if the improving economy would temper my positive view of the discount store stocks such as Dollar Tree (DLTR, $86), Ross Stores (ROST, $52), and TJ Maxx (TJX, $34). The short answer is no, for a few reasons. As I have said before, I am intrigued that many people who don't need to save the money actually love finding the deals at these stores. This is anecdotal evidence, but I think it has become trendy and chic to shop in the bargain bin. Also, these companies are growing and opening more locations. One measure that investors follow closely is the growth in sales, and here we need to distinguish between same-store sales growth and total sales growth. Companies that already have saturated the market with plenty of store locations aren't going to show the additional sales growth that comes from opening up new outlets. For the discount stores, and for a restaurant chain like Chipolte Mexican Grill (CMG, $374), the added boost to sales growth comes from their continuing penetration of new markets with additional locations. When total sales growth approaches and comes to rely on same-store sales growth, that is a signal that the rapid growth phase is coming to an end.
The big issue here, the proverbial elephant in the living room, is the "Tale of Two Cities" investment thesis that we've looked at before. We are seeing the economy improve on a cyclical basis, but there are structural factors that aren't going to improve dramatically with the upswing in the business cycle. Wages, for example, have been stagnant for years, and there is a tendency to blame this on the fact that many manufacturing jobs have moved overseas. That is really a vast oversimplification, just true enough to linger on in a world that seeks simple answers and scapegoats. (And I don't know what is more disturbing, the tendency of politicians to exploit such misconceptions, or the sad truth that so many people don't know enough about basic economics to see right through the deceptions.) Manufacturing is not dead in the United States, but the relatively low-skill jobs in the sector have moved to countries where labor is less expensive. Companies have to seek out the lowest costs for all aspects of the manufacturing process, because if they did not their competitors would put them out of business--and that would mean the loss of even more jobs. The better-paying and higher-skilled jobs are still here in the U.S., but there are fewer of them. Companies have invested heavily in technology, and today there aren't as many workers on the factory floor. The ones who remain, however, are those with the skills to operate the technology. The resulting productivity gains have been flowing to the bottom line as profits, and that has been very good for stocks. This is really all about efficient supply-chain management, so it really doesn't make sense to talk about "bringing manufacturing jobs back to the United States." The better solution would be to focus on making it easier for businesses to create jobs and ensuring that tomorrow's workers have the training needed to fill those positions.
Two of the more insightful articles on these topics are Thomas Friedman's column, "Made In The World," from the January 28th, 2012, New York Times and Adam Davidson's piece, "Making It In America," from the January/February 2012 issue of The Atlantic. The links are as follows:
http://www.nytimes.com/2012/01/29/opinion/sunday/friedman-made-in-the-world.html?scp=5&sq=friedman&st=cse
http://www.theatlantic.com/magazine/archive/2012/01/making-it-in-america/8844/
From an investment perspective, we need to be on the lookout for companies that can help consumers and businesses save money. Some examples for future research include Perrigo (PRGO, $93), which makes the over-the-counter products that sell under a store's private label (generics). The company reported a positive earnings surprise this past week, offered upbeat guidance, and said it will launch more than 45 new products in the coming year. The average age of the automobile on the road is now about 10 years as consumers delay buying new cars, and that can benefit a company like Autozone (AZO, $353) that operates in the after-market. As health providers seek to lower costs by moving more towards electronic health records, a company like Cerner (CERN, $69) should see more business.
Much of the political talk may focus on jobs that are lost as companies become more efficient and reduce expenses, but the other side of this trend is that we all pay less for a host of different products and services. I have never liked the way a new WalMart can lay waste to locally-owned, Mom-and-Pop businesses, but the benefit here is that many basic items we buy are cheaper. Price competition leads to a higher standard of living for the majority of the population. I'm not going to buy more laundry detergent if the price goes down, but I will spend less of my income on what I do buy, and that means more money to spend on a nice Valentine's Day gift for my wife. I'll give it to her when she gets home from the Dollar Tree.
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/ or I own shares of DLTR, ROST, TJX, CMG, PRGO, AZO, and CERN. Stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing here should be construed as investment advice or the recommendation to buy or sell any security.
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