October 16, 2019
Bill Miller 3Q 2019 Market Letter
“The world is in a mess
With politics and taxes
And people grinding axes
There’s no happiness.”
-“Slap That Bass”, George Gershwin
That refrain sounds a lot like today, but it comes from the 1937 musical Shall We Dance which starred Fred Astaire and Ginger Rogers. There are some economic similarities as well. In 1937, the bull market hit multi-year highs and unemployment was at multi-year lows, yet the country’s mood was grim, as it seems now. Dictators ruled in Germany, Italy, and the Soviet Union, and populism appeared on the rise everywhere. Ray Dalio has written often about the parallels between the late 1930s and today. They cannot easily be dismissed.
Still, things are just not all that grim. A year ago the market entered a fourth-quarter swoon that took it down 20% peak to trough, culminating in the worst December since 1931 when the world was sliding into depression. What was most remarkable about last December was it was worse than December 1941 when Pearl Harbor was bombed and World War II began. Last December nothing at all happened except the market went down. It did so because investors feared the Federal Reserve had over-tightened and the US economy was at risk of recession. It was an example of George Soros’s theory of reflexivity in action. Markets don’t just reflect and anticipate economic direction, they can also cause it or reverse it. In this case, the Fed stopped raising rates and began cutting them, and investors decided the US economy was actually doing OK. The result was an S&P 500 that was up around 20% year-to-date through the third quarter of 2019, the strongest performance in over 20 years. Still, the year-to-year gain was just over 4% and the mood of the market can hardly be described as euphoric.
The market’s worries now appear to be mostly politically based, and I think that is where the risk mostly resides. As the second week of October came to an end, the political concerns began to subside a bit and stocks rallied nicely. The US and China reached an accord on aspects of a trade deal, and the administration called off the next round of tariff increases, at least for now. With a Brexit deadline only a few weeks away, a newfound optimism about a potential deal also appeared and the British pound had a strong rally. A growing worry is the course of the impeachment investigation and its potential impact on the economy. If past is prologue, those worries are overdone. President Clinton’s impeachment in December 1998 did nothing to derail a powerful bull market. The impeachment drama, though, will certainly dominate the news cycle and likely overshadow, at least for a while, the presidential political cycle, though who might benefit or be hurt from that is far from clear.
A new book by Robert Shiller, the Yale economist who won the Nobel Prize in 2013, called Narrative Economics: How Stories Go Viral and Drive Major Economic Events appears to be particularly timely. In it, Shiller notes how conventional macroeconomic models, which are largely mathematical constructs, have no room for stories, but stories play a critical role in economic belief and behavior. As the poet Muriel Rukeyser said, “The universe is made of stories, not of atoms.” The market, of course, is a swirling cacophony of competing stories, and which ones an investor believes in and acts on determines investment results.
As was the case with President Clinton’s impeachment, what is most newsworthy bears no necessary relation to what is investment-worthy. The present trajectory of the US economy is positive, with modest economic growth of about 2%, inflation still well under the Fed’s 2% target, interest rates at levels that provide little competition for stocks, high returns on invested capital, and solid profit margins and free cash generation. Valuations are not demanding except in a few areas such as consumer staples, utilities, and technology stocks perceived as secular growers with large addressable markets. Cracks have begun to appear in all of those areas.
The first few weeks of September saw a powerful move into long-underperforming value stocks and out of the momentum names. The dominance of the latter over the former had reached extremes last seen at the end of the internet bubble of late 1999. I have no idea whether we are on the cusp of a regime change that will favor long-suffering value investors over the growth and momentum crowd, but there are signposts along the way (as in the Twilight Zone). The yield curve, whose inversion raised fears of an impending recession, has now de-inverted. If it continues to steepen, that will signal reduced fears about growth and support lowly valued names. A trade deal with China and a Brexit deal, or at least a Brexit that is less messy than feared, would also support more cyclical value names.
The US and certainly the global economy are not out of the woods and new risks can appear or old ones can resurface, but in the short run, it appears stocks are reasonably well supported. The US economy is driven by the consumer — 70% of GDP is consumption — and that is where the good news sits. Real wage growth is now firmly established, unemployment remains at generational lows, consumer balance sheets are strong and the savings rate is high. As long as those conditions persist, the path of least resistance for stocks remains higher.
Bill Miller, CFA
October 12, 2019
S&P 500 2970.27
Christina Siegel’s 3Q 2019 Market Highlights
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