Category Archives: Middle Class Squeeze

Weekly Issue: While Most Eyes Are on the Fed, We Look at a Farfetch(ed) Idea

Weekly Issue: While Most Eyes Are on the Fed, We Look at a Farfetch(ed) Idea

Key points inside this issue

  • The Fed Takes Center Stage Once Again
  • Farfetch Limited (FTCH) – A fashionable Living the Life Thematic Leader
  • Digital Lifestyle – The August Retail Sales confirms the adoption continues

 

Economics & Expectations

The Fed Takes Center Stage Once Again

As we saw last week, the primary drivers of the stock market continue to be developments on the U.S.-China trade front and the next steps in monetary policy. As the European Central Bank stepped up its monetary policy loosening, it left some to wonder how much dry powder it had remaining should the global economy slow further and tip into a recession. Amid those concerns, along with some discrepancy among reports that President Trump would acquiesce to a two-step trade deal with China, stocks finished last week with a whimper after rebounding Wednesday and Thursday.

We continue to see intellectual property and national security as key tenets in negotiating a trade deal with China. We will watch as the lead up to October’s next round of trade negotiations unfolds. Given the Fed’s next two-day monetary policy meeting that begins on Tuesday and culminates with the Fed’s announcement and subsequent press conference, barring any new U.S.-China trade developments before then, it’s safe to say what the Fed says will be a key driver of the stock market this week.

Leading up to that next Fed press conference, we will get the August data for Industrial Production and Housing Starts as well as the September Empire State Manufacturing Index. Paired with Friday’s August Retail Sales report and last Thursday’s August CPI report, that will be some of the last data the Fed factors into its policy decision.

Per the CME Group’s FedWatch tool, the market sees an 82% probability for the Fed to cut interest rates by 25 basis points this week with possibly one more rate cut to be had before we exit 2019. Normally speaking, parsing the Fed’s words and Fe Chair Powell’s presser commentary are key to getting inside the central bank’s “head,” and this will be especially important this time around. One of our concerns has been the difference between the economic data and the expectations it is yielding in the stock market. Should the Fed manage to catch the market off guard, odds are it will give the market a touch of agita.

On the earnings front

there are five reports that we’ll be paying close attention to this week. They are Adobe Systems (ADBE), Chewy (CHWY), FedEx (FDX), General Mills (GIS) and Darden Restaurants (DRI). With Adobe, we’ll be examining the rate of growth tied to cloud, an aspect of our Disruptive Innovators investing theme. With Darden we’ll look to see if the performance at its full-service restaurants matches up with the consumer trade-down data being reported by the National Restaurant Association. That data has powered shares of Cleaner Living Thematic Leader and Cleaner Living Index resident Chipotle Mexican Grill (CMG) higher of late, bringing the year to date return to 82% vs. 20% for the S&P 500. Chewy is a Digital Lifestyle company that is focused on the pet market serving up food, toys, medications and other pet products. Fedex will not only offer some confirmation on the digital shopping aspect of our Digital Lifestyle investing theme it will also shed some light on the global economy as well.

 

Farfetch Limited – A fashionable Living the Life Thematic Leader

In last week’s issue, I mentioned that I was collecting my thoughts on Farfetch Limited (FTCH), a company that sits at the intersection of the luxury goods market and digital commerce. Said thematically, Farfetch is a company that reflects our Living the Life investment theme, while also benefitting from tailwinds of our Digital Lifestyle theme. Even though the company went public last year, it’s not a household name even though it operates a global luxury digital marketplace. As the shares have fallen over the last several weeks, I’ve had my eyes on them and now is the time to dip our toes in the water by adding FTCH as a Thematic Leader.

 

 

Farfetch Provides Digital Shopping to the Exploding Global Luxury Market

Farfetch is a play on the global $100 billion online luxury market with access to over 3,200 different brands across more than 1,100 brand boutique partners across its platform. With both high-end and every-day consumers continuing to shift their shopping to online and mobile platforms, we see Farfetch attacking a growing market that also has the combined benefit of appealing to the aspirational shopper and being relatively inelastic compared to mainstream apparel.

Part of what is fueling the global demand for luxury and aspirational goods is the rising disposable income of consumers in Asia, particularly China. According to Hurun’s report, The Chinese Luxury Traveler, enthusiasm for overseas travel shows no signs of abating, with the proportion of time spent on overseas tourism among luxury travelers increasing 5% to become 70% of the total. Cosmetics, (45%), local specialties (43%), luggage (39%), clothing and accessories (37%) and jewelry (34%) remain the most sought — after items among luxury travelers. High domestic import duties and concerns about fake products contribute to the popularity of shopping abroad.

It should come as little surprise then that roughly 31% of FarFetch’s 2018 revenue was derived from Asia-Pacific with the balance split between Europe, Middle East & Africa (40%) and the Americas (29%). At the end of the June 2019 quarter, the company had 1.77 million active customers, up from 1.35 million exiting 2018 and 0.9 million in 2017. As the number of active users has grown so too has Farfetch’s revenue, which hit $718 million over the 12 months ending June 2019 compared to $602 million in all of 2018 and $386 million in 2017.

Farfetch primarily monetizes its platform by serving as a commercial intermediary between sellers and end consumers and earns a commission for this service. That revenue stream also includes fees charged to sellers for other activities, such as packaging, credit-card processing, and other transaction processing activities. That business accounts for 80%-85% of Farfetch’s overall revenue with the balance derived from Platform Fulfillment Revenue and to a small extent In-Store Revenue.

New Acquisition Transformed Farfetch’s Revenue Mix 

In August, Farfetch announced the acquisition of New Guards Group, the Milan-based parent company of Off-White, Heron Preston and Palm Angels, in a deal valued at $675 million. New Guards will serve as the basis for a new business segment at Farfetch, one that it has named Brand Platform. Brand Platform will allow Farfetch to leverage New Guards’ design and product capabilities to expand the reach of its brands as well as develop new brands that span the Farfetch platform. For the 12-month period ending April 2019, the New Guards portfolio delivered revenue of $345 million, with profits before tax of $95 million. By comparison, Farfetch posted $654 million in revenue and an operating loss of $183 million over that time frame.

Clearly, another part of the thought behind acquiring New Guards and building the Brand Platform business is to improve the company’s margin and profit profile. And on the housekeeping front, the $675 million paid for New Guards will be equally split between cash and stock. Following its IPO last year, Farfetch ended the June quarter with roughly $1 billion in cash and equivalents on its balance sheet.

In many ways what we have here is a baby Amazon (AMZN) that is focused on luxury goods. Ah, the evolution of digital shopping! And while there are a number of publicly traded companies tied to digital shopping, there are few that focus solely on luxury goods.

Why Now is the Time to Add FTCH Shares

We are heading into the company’s seasonally strongest time of year, the holiday shopping season, and over the last few years, the December quarter has accounted for almost 35% of Farfetch’s annual sales. With the company’s active user base continuing to grow by leaps and bounds, that historical pattern is likely to repeat itself. Current consensus expectations have Farfetch hitting $964 million in revenue for all of 2019 and then $1.4 billion in 2020.

At the current share price, FTCH shares are trading at 1.6x expected 2020 sales on an enterprise value-to-sales basis. The consensus price target among the 10 Wall Street analysts that cover the stock is $22, which equates to an EV/2020 sales multiple of near 3.5x when adjusting for the pending New Guards acquisition. As we move through this valuation exercise, we have to factor into our thinking that Farfetch is not expected to become EBITDA positive until 2021. In our view, that warrants a bit of haircut on the multiple side and utilizing an EV/2020 sale multiple of 2.5x derives our $16 price target.

  • Despite that multiple, there is roughly 60% potential upside to that target vs. downside to the 52-week low of $8.82.
  • We are adding FTCH shares to the Thematic Leaders for our Living the Life investing theme.
  • A $16 price target is being set and we will wait to put any sort of stop-loss floor in place.

 

Digital Lifestyle – The August Retail Sales confirms the adoption continues

One of last week’s key economic reports was the August Retail Sales report due in part to the simple fact the consumer directly or indirectly accounts for two-thirds of the domestic economy. Moreover, with the manufacturing and industrial facing data – both economic and other third-party kinds, such as truck tonnage, railcar loadings and the like – softening in the June quarter, that quarter’s positive GDP print hinged entirely on the consumer. With domestic manufacturing and industrial data weakening further in July and August, the looming question being asked by many an investor is whether the consumer can keep the economy chugging along?

In recent months, I’ve voiced growing concerns over the spending health of the consumer as more data suggests a strengthening tailwind for our Middle-Class Squeeze investing theme. Some of that includes the Federal Reserve Bank of New York’s latest Household Debt and Credit Report, consumer household debt balances have been on the rise for five years and quarterly increases continue on a consecutive basis, bringing the second quarter 2019 total to $192 billion. Also a growing number of banks are warning over rising credit card delinquencies even as the Federal Reserve’s July Consumer Credit data showed revolving credit expanded at its fastest pace since November 2017.

Getting back to the August Retail Sale report, the headline print was a tad better than expected, however once we removed auto sales, retail sales for the month were flat. That’s on a sequential basis, but when viewed on a year over year one, retail sales excluding autos rose 3.5% year over year. That brought the year over year comparison for the three-months ending with August to up 3.4% and 1.5% stronger than the three months ending in May on the same basis.

Again, perspective can be illuminating when looking at the data, but what really shined during the month of August was digital shopping, which rose 16.0% year over year. That continued strength following the expected July surge in digital shopping due to Amazon Prime Day and all the others that looked to cash in on it led year over year digital shopping sales to rise 15.0% for the three months ending in August.

Without question, this aspect of our Digital Lifestyle investing theme continues to take consumer wallet share, primarily at the expense of brick & mortar retailers, especially department stores, which saw their August retail sales fall 5.4%. That continues the pain felt by department stores and helps explain why more than 7,000 brick & mortar locations have shuttered their doors thus far in 2019. Odds are there is more of that to come as consumers continue to shift their dollar purchase volume to online and mobile shopping as Walmart (WMT), Target (TGT) and others look to compete with Amazon Prime’s one day delivery.

  • For all the reasons discussed above, Amazon remains our Thematic King as we head into the seasonally strong holiday shopping season. 

 

Going cashless may break the law?

Going cashless may break the law?

Here at Tematica, one of the things we like more than anyone of our investing themes is when two or more of them intersect as it forms a super-theme of sorts. We’ve seen numerous examples over the last several quarters, but there are also times when the tailwind of one of our themes presents a headwind for another. We are seeing that unfold between the cashless consumption aspect of our Digital Lifestyle investing theme and our Middle Class Squeeze and Safety & Security ones.

There are benefits to be had with the move by business to digital commerce…

Some retailers are cutting out cash to speed up transactions, reduce the risk of theft and accommodate the increased use of credit and debit cards, as well as digital wallets like Apple Pay and Google Pay, to purchase services and products.

… and there are times when having to pay only by cash can be a hassle, especially if you’ve gotten used to paying with a swipe or a tap. There are also those folks that are tapping their credit cards harder than others as they look to make ends meet. According to the Federal Reserve Bank of New York’s latest Household Debt and Credit Report, consumer household debt balances have been on the rise for five years and quarterly increases continued on a consecutive basis, bringing the second quarter 2019 total to $192 billion.

But as the below excerpts note, not everyone in the entire population is able to participate in cashless consumption be it because they lack a debit or credit card. Others have those but are wary about leaving a digital trail that could be exploited by cyber attackers and compromise their privacy.

But with 6.5% of U.S. households in 2017 not having bank accounts, according to the FDIC, and 18.7% having accounts but also using financial services outside of insured institutions, some are pushing back on the trend

But it’s not just those without credit and debit cards who may balk at being told they can’t use cash. In an era when data breaches have occurred at institutions such as Capital One and credit rating agency Equifax, some consumers worry that cashless payments can infringe on their privacy.

“You do hear a good portion of people saying ‘Once we move to this cashless economy, there is a digital trail for every single one of my purchases, and I’m not entirely comfortable with that,’’’ Santana says. “And there’s a possibility there could be a data breach where your information gets compromised. The probability of a data breach happening is very low, but it is isn’t zero.”

Interestingly enough, despite these headwinds, the tailwind for cashless consumption continues to blow as evidenced by the continued decline in using cash.

Square Inc. found that four years ago, shoppers used cash for 46% of purchases that were less than $20. But this year, shoppers used cash for 37% of transactions in the same price range.

 And while there may be some overlap in the user numbers, earlier this year Paypal’s (PYPL) Venmo reported 40 million users that completed one transaction in the prior 12 months, while Square reported 15 million Square (SQ) Cash App users for “monthly actives (at least one transaction in the past month).” While those numbers are larger than some digital user figures at banks — Bank of America (BAC) reported that its active base of digital users was 37 million in the March 2019 quarter and for the same period Wells Fargo & Co. (WFC) had 29.8 million active digital users – during the June 2019 quarter Apple (AAPL) Apple’s Apple Pay completed nearly 1 billion transactions per month, nearly transaction levels in the year-ago quarter.

What those figures tell us is in today’s increasingly connected world filled with more consumers embracing digital shopping and mobile ordering, for both convenience and in many cases better affordable prices, we will likely see a continued movement away from cash usage… but we may not see the use of cash disappear just yet. In thematic speak, two powerful tailwinds may be impeded by one headwind, but that will likely only slow the impact, not eliminate it. 

As that shift away from cash continues, odds are we will see more companies embrace our Disruptive Innovators tailwind and bring new solutions to market. One such company is Tematica Select List resident USA Technologies (USAT) that is bringing mobile payments to vending machines and unattended retail.

Another is the cash to debit card ReadyStation kiosk found at the now cashless Mercedes Benz stadium in Atlanta. The kiosk by ReadyCard that converts cash to a prepaid debit card that can be used anywhere VISA is accepted. That is but one solution that could thwart regulatory headwinds, especially if like the ReadyStation kiosk the resulting debit card is fee free.

From Philadelphia to San Francisco, several cities and states have passed or are considering bills that prohibit retailers from refusing to accept cash, a policy they say shuts out the millions of Americans who don’t have a bank account, lack credit cards or don’t have photo identification. 

Another reminder that where there is a pain point, solutions tend to result.

Source: Going cashless? If you do in these cities, you’re breaking the law

More retailers are pivoting to capture the “thrift shift”

More retailers are pivoting to capture the “thrift shift”

When not just one company but a growing number of them make a conscious decision to pivot the merchandise they offer to consumers, to borrow a term from the game of poker, it’s a pretty big tell. The shift we are talking about is the move to selling used clothing, which takes a page right out of the Poshmark playbook and is in tune with our Middle-class Squeeze investing theme.

The more meaningful question is the why as in why are these companies doing this and doing it now?

We at Tematica have been sharing economic and other data that points to not only the continued climb in consumer debt levels but now banks ranging from Citibank to Bank of America, JPMorgan Chase and Capital One have announced rising credit card delinquency rates. We’ve long said that rising debt levels would sap consumer disposable income as interest costs associated with that rising debt level take hold.

At the same time, retailers of apparel and especially department stores remain under attack from digital commerce as well as private label brand initiatives at not only Amazon, but also Walmart and Target.

As we like to say, a pain point generally gives rise to a solution. Sometimes that solution arises quickly and other times not so much. But in the case of the apparel and our Middle-Class Squeeze investing theme, we are seeing several solutions unfold.

Above we mentioned Poshmark, a company that sits at the intersection of our Digital Lifestyle, Digital Infrastructure and Middle-class Squeeze investing themes and while it has garnered a significant user base and following it isn’t the only company looking to attack the market for monetizing one’s wardrobe. Online marketplace Depop counts more than 15 million users that tap into its marketplace to buy and sell clothes. And for those thinking the used clothing market isn’t for higher-end and luxury items, offerings from TheRealReal (REAL) and Farfetch (FTCH) should get you to think again.

Aside from the business pivot, Macy’s, JC Penney and others could also be looking to get a valuation multiple bump by wading into the used clothing market. Shares of Farfetch are trading at more than 3x expected 2019 sales, multiples ahead of the 0.2x price to sales valuation currently accorded to Macy’s shares. And for those wondering, that valuation is even lower at JC Penney. In order to get that multiple pop, Macy’s and JC Penney will both have to cross the digital shopping chasm, something Macy’s has been far more successful at than JC Penney.

Macy’s Inc. and J.C. Penney Co. this past week unveiled partnerships with resale marketplace thredUp Inc. to sell used clothes and accessories in some of their stores. Outdoor brand Patagonia plans to open a temporary store in Boulder, Colo., this fall dedicated to selling pre-owned goods, its first such location.

Thrifting is gaining traction as shoppers have grown more bargain conscious and concerned about the environmental impact of fashion, particularly the throwaway clothing model popularized by fast-fashion chains.

“We looked deeply at Generation Z consumers, and recommerce came up over and over again,” Macy’s Chief Executive Jeff Gennette said in an interview, referring to theburgeoning resale market. “It’s not a downside that something has been preowned.”

Thorsten Weber, chief merchandising officer of Stage Stores Inc.,

Other chains, including Bloomingdale’s, which is owned by Macy’s, Urban Outfitters Inc.and Ann Taylor, are taking a slightly different approach by launching services that let shoppers rent clothes instead of buying them. Customers can even rent home décor at West Elm, which has partnered with Rent The Runway Inc. for the program.

Source: On Second Thought, Traditional Retailers Make Room for Used Clothes – WSJ

Almost one-third of Americans say they can’t afford a vacation

Almost one-third of Americans say they can’t afford a vacation

While more than a few GDP forecasts for the current quarter were lifted by the July Retail Sales report that came in ahead of expectations, we’re seeing other signs indicating that not all is well in consumer land. Odds are consumers feeling the pinch of our Middle-class Squeeze investing theme are having to choose what and where they can spend their disposable income dollars.

This is nothing new for some, but it does explain consumer spending strength across certain categories, while others, such as appliances, clothing, sporting goods and vacations, have been declined year over year. The larger issue is in order to make ends meet or to have funds to meet a portion of their spending needs consumers continue to take on more debt. The newest Federal Reserve Bank of New York’s Household Debt and Credit Report shows that exiting the June quarter consumer household debt was  1.2 trillion higher than the peak of $12.68 trillion in 2008.

That’s bound to be a headwind on consumer spending as more discretionary dollars are eaten up by debt servicing. This doesn’t exactly bode well for the year-end holiday shopping…

Americans, crippled by debt and seeing signs of a slowing economy, are sitting out on pricey vacations and everyday leisure activities.

A new Bankrate survey found 42% of Americans decided not to take a vacation over the past year because of the cost. Nearly a third said they can afford a vacation less now than they could have five years ago, though 26% said they can afford to do so more now. More than two-thirds of U.S. adults opted out of a recreational activity due to the cost at some point in the past year, the study found.

You can’t blame them. Trade tensions have economists projecting the likelihood of a recession in the next 12 months at 35%. U.S. student debt is over $1.5 trillion. Almost 40% of Americans think the economy is “not so good” or “poor.”

Source: Americans Say They Can’t Afford a Vacation – Bloomberg

Keys to July Retail Sales and Walmart Earnings Results

Keys to July Retail Sales and Walmart Earnings Results


Plus the Biggest Threat to the German Auto Industry

On this episode of the Thematic Signals podcast, we’re digging into the July Retail Sales and quarterly earnings results from Walmart as both confirm the hard-blowing tailwinds associated with our Digital Lifestyle, Middle-Class Squeeze, Aging of the Population and Cleaner Living Investing themes.





We also breakdown a recent article in The Wall Street Journalthat discusses how one aspect of our Cleaner Living investing theme — electric vehicles — could threaten the German economy. It’s the same structural shift that should have folks more than a little concerned about Tesla, both its business as well as its shares. All that and much more on this episode of the podcast. 

Have a topic or a conversation you think we should tackle on the podcast, email me at cversace@tematicaresearch.com

And don’t forget to subscribe to the Thematic Signals Podcast on iTunes!

Resources for this podcast:

WEEKLY ISSUE: Mismatched Economic Data, Earnings and the Fed

WEEKLY ISSUE: Mismatched Economic Data, Earnings and the Fed

Key points inside this issue

  • Did you notice the June quarter GDP depended on the consumer?
  • Earnings, earnings, earnings and what it may mean for the market
  • Waiting on the Fed and what Powell says about what’s ahead

Did you notice the June quarter GDP depended on the consumer?

While last week’s corporate earnings included the usual mix of better-than-expected and weaker-than-expected results, we also saw mismatched economic data. The IHS Markit July Flash US manufacturing index hit a reading of 50.0, while the initial second-quarter GDP print came in warmer than anticipated at 2.1% vs. expectations for 1.8% – 2.0% it was down from 3.1% in the first quarter. Parsing the GDP data, the quarter was all about the consumer, with personal consumption expenditures rising 4.3% (annual rate), the strongest performance in six quarters.

Given rising debt levels, I continue to have concerns over the consumer’s ability to spend at such a vigorous rate given rising debt levels. We’ve seen rising delinquency rates reported by American Express (AXP)and Capital One Financial Corp (COF). If you’re thinking this meshes with our Middle-Class Squeeze investing theme that has propelled the shares of Middle-Class Squeeze Leader Costco Wholesale (COST) by more than 37% this year (head and shoulders above all the major market indices), you would be right.  And the fact that personal consumer expenditures contributed 2.85 percentage points to the initial GDP print of 2.1% isn’t lost on us here at Tematica.

The upcoming economic data will be critical to assessing the vector and velocity of the domestic economy, in part because it will tell us if the consumer is able to sustain the economy at a time when it relies most on him and her – the year-end shopping season.  In the very near term, however, the market will be fixated on the Fed and the degree to which it uses monetary policy to attempt a “Goldilocks” move for the U.S. economy. Once we are past today’s expected Fed rate cut, odds are investor will get back to business breaking down economic and other data. We hear at Tematica will continue to do that as well as ferret out the latest signals for our investing themes.

Earnings, earnings, earnings and what it may mean for the market

Coming into this week, 220 or 44% of the S&P 500 group of companies had reported their earnings for the second calendar quarter, and among those more than 1,050 reports coming at us this week will be another 168 S&P 500 companies. When the stock market closes on out this week, 78% of the S&P 500 will have reported.

From a statistically significant perspective, this gives us a very hard look at how the second half of 2019 is shaping up from an earnings expectations perspective. As of Friday, July 26 afternoon this is what the picture looked like:

You’ll notice there really isn’t any earnings growth year over year for the first three quarters of 2019, leaving all of the expected over year 2019E PS growth for the S&P 500 that now stands at just 2.6% to come during the December quarter.

And if you’re thinking like me that expected 11% EPS growth forecast for the S&P 500 group of companies in 2020 looks a little bit much, well, here’s some perspective:

The point to that last graph is that for some reason the investing herd seems to start out with a +10% or more EPS growth assumption for the coming year. I’m not sure why that is, I merely comment on the data being presented. Given the vector and velocity of the global economy today, it seems that forecast is more likely to move lower than higher. And odds are rather high we’re not going to see yet another tax cut like we did exiting 2017 that goosed corporate EPS in 2018.

The last time we saw back to back years of little to no earnings growth for the S&P 500 was 2015-2016, and the S&P 500 peaked around 18.4x earnings. If 2020 EPS expectations for the S&P 500 continue to fall toward 2019 levels near $165 per share, it could mean we are seeing a market ceiling near the 3,040-3,060 range for the S&P 500.

No doubt there are some moving pieces in that analysis, but I find it is a smart move to keep a bead on how real earnings expectations are as well as their likely directionality vis a vis the global economy when charting what to do next with one’s investments.

Again, this is not a snapshot kind of a thing, but rather an evolving story. Yeah, I may sound like the Fed hear, but it shouldn’t come as a surprise the evolving nature of the market. So… I guess this means more on this as the story continues.

Waiting on the Fed and what Powell says about what lies ahead

Just after 2 p.m. ET today, we’ll hear from the Federal Reserve following its much-anticipated July FOMC meeting and the prevailing expectation is for a 25-basis-point rate cut. We do not expect an update to the Fed’s June economic projection materials, but what Jerome Powell says during the press conference will likely set expectations for the Fed’s three remaining monetary policy meetings in September, October and December. Odds are the central bank will remain on message, saying it will continue to be data dependent.

Weekly Issue: Several thematic bright spots among  2nd Quarter earnings disappointments

Weekly Issue: Several thematic bright spots among 2nd Quarter earnings disappointments

Key points inside this issue

  • Boosting our stop loss on Middle-Class Squeeze Thematic Leader Costco Wholesale (COST) to $240.
  • Safety & Security Thematic Leader Axon Enterprise Inc. (AAXN) catches a TAZR win.
  • Housekeeping: The next issue of Tematica Investing will be published during the week of July 29th. Why? Because next week I will be on vacation. Even though I’ll be catching up on some reading and thematic thinking, I’ll be kicking back and recharging for what lies ahead.

Last week, we started the June-quarter earnings season. While there were only 20 reports, what we heard from BASF SE, Fastenal (FAST), and MSC Industrial (MSM) served to remind us that, even though the Fed will likely cut interest rates, odds are the current earning seasons will be a challenging one. That view was reaffirmed this week with results from JB Hunt (JBHT) and CSX (CSX) that confirmed the slowdown in freight traffic, an indicator that we here at Tematica watch rather closely as a gauge for the domestic economy’s health.

Given the declines in the Cass Freight Index over the last seven months, the results out of JB Hunt, CSX and other shippers should hardly be news to the investment community. On the other hand, what is somewhat concerning to me is that these declines in freight are coming in even as June Retail Sales surprise to the upside and e-tailers, like Thematic King Amazon (AMZN), Walmart (WMT), Target (TGT) and others, are embracing one-day and same-day shipping from the prior table stakes that were two-day shipping. The growing concern that I have is that despite the tailwind associated with our Digital Lifestyle investing theme, continued declines in the Cass Freight Index and other freight indicators could signal that the domestic economy is moving from one that is slowing into one that is in contraction territory.

Despite the upside surprise in the June Retail Sales report, it was counterbalanced by a revelation contained in the June Industrial Production & Capacity Utilization report. What we learned yesterday from that report was that domestic factory production fell at an annualized rate of 2.2% in the June quarter. Paired with the slowing freight-related signals mentioned earlier, there is little question over the vector of the domestic economy. Clearly the June quarter will be slower than the March one, but the real question we need to face as investors is, how slow will it be in the current third quarter, as well as the fourth quarter this year? That speed along with the degree of the expected July Fed rate cut and the continuation of the current US-China trade war will influence business spending and earnings expectations for the back half of the year.

As far as the June Retail Sales report goes, while I am all for consumers spending, I’m not in love with the fact that it is increasing credit card debt that is likely driving it. According to data collected by the FDIC and published by MagnifyMoney, “Americans paid banks $113 billion in credit card interest in 2018, up 12% from the $101 billion in interest paid in 2017, and up 49% over the last five years.” And as we’ve seen in the monthly Consumer Credit Report issued by the Federal Reserve, revolving consumer credit, which includes credit card balances, has only grown year to date. In other words, consumers are using credit card debt to fund their spending and rising interest payments will squeeze disposable income levels.

While increasing consumer debt is not exactly an uplifting thought, and certainly a headwind for the economy in the coming quarters, these development are a tailwind for Middle-Class Squeeze Thematic Leader Costco Wholesale (COST):

  • Year to date, COST shares are up some 37%, and we are only now heading into the seasonally strongest time of the year for the company’s business. We should continue to hold COST shares, but we will also increase our stop loss to $240 from roughly $225.

Thematic Leader dates to watch

With investor attention turning to corporate earnings, here are the announced reporting dates for the Thematic Leaders:

  • Netflix (NFLX) –  July 17
  • Chipotle Mexican Grill (CMG) – July 23
  • Amazon (AMZN) – July 25
  • AMN Healthcare (AMN) – August 6
  • Dycom Industries (DY) – N/A
  • Costco Wholesale (COST) – N/A
  • Alibaba (BABA) – N/A
  • Axon Enterprises (AAXN) – N/A

Not all of the Leaders have shared the reporting dates for their latest quarterly earnings, but no worries as I’ll be filling the calendar in as the missing ones announce them. And it goes without saying that as the June 2019 earning season continues, I’ll be sifting through the sea of reports looking for thematic data points to be had.

Safety & Security Thematic Leader Axon Enterprise Catches a TAZR Win

As I was putting this issue of Tematica Investing to bed, I saw that Safety & Security Thematic Leader Axon Enterprises (AAXN) announced a big win for its business — a significant order for its TASER Conducted Energy Weapons from agencies across the United States. These orders, which were landed during the first half of 2019, will ship in multiple phases in the coming quarters.

Why are we only hearing about this now?

Partly because Axon needed permission from the agencies make the announcement, and even with such permission granted, the company still needed further permission to name those agencies as customers. A full list of those announced orders can be found here.

Of course, this news is a positive for Axon, and it serves as a reminder that even though the headline story for Axon is the company’s ongoing transformation into a digital security company as it grows it body-camera and digital subscription storage business, the steadfast TAZR business remains a firearm alternative.

We’ve enjoyed a nice run in Axon shares since they were added to the Thematic Leader board, and year to date the shares are up more than 46%. I see no reason to abandon them just yet and our long-term price target of $90 remains intact. For now, our stop loss on the shares continues to sit at $51.

And for what it’s worth, as impressive as that year to date gain is for AAXN shares, it still trails behind Cleaner Living Leader Chipotle Mexican Grill (CMG), which as of last night’s close was up more than 76% year to date.

Central Bankers’ New Clothes

Central Bankers’ New Clothes

In this week’s musings:

  • Earnings Season Kicks Off 
  • Central Bankers’ New Clothes 
  • Debt Ceiling – I’m Baaack
  • Trade Wars – The Gift that Keeps on Giving
  • Domestic Economy – More Signs of Sputtering
  • Stocks – What Does It All Mean

It’s Earnings Season

Next week banks unofficially kick off the June quarter earnings season with expectations set for a -2.6% drop in S&P 500 earnings, (according to FactSet) after a decline of -0.4% in the first quarter of 2019. If the actual earnings for the June quarter end up being a decline, it will be the first time the S&P 500 has experienced two quarters of declines, (an earnings recession) since 2016. Recently the estimates for the third quarter have fallen from +0.2% to -0.3%. Heading into the second quarter, 113 S&P 500 companies have issued guidance. Of these, 87 have issued negative guidance, with just 26 issuing positive guidance. If the number issuing negative guidance does not increase, it will be the second highest number since FactSet began tracking this data in 2006. So not a rosy picture.

Naturally, in the post-financial crisis bad-is-good-and-good-is-bad-world, the S&P 500 is up nearly 20% in the face of contracting earnings — potentially three quarters worth — and experienced the best first half of the year since 1997. In the past week, both the S&P 500 and the Dow Jones Industrial Average have closed at record highs as Federal Reserve Chairman Powell’s testimony before Congress gave the market comfort that cuts are on the way. This week’s stronger than expected CPI and PPI numbers are unlikely to alter their intentions. Welcome to the world of the Central Bankers’ New Clothes

Central Bankers’ New Clothes

Here are a few interesting side-effects of those lovely stimulus-oriented threads worn in the hallowed halls of the world’s major central banks.

https://www.tematicaresearch.com/wp-content/uploads/2019/07/2019-07-12-EU-EM-Neg-Yields.png https://www.tematicaresearch.com/wp-content/uploads/2019/07/2019-07-12-Greek-below-UST.png

Yes, you read that right. Greece, the nation that was the very first to default on its debt back in 377BC and has been in default roughly 50% of the time since its independence in 1829, saw the yield on its 10-year drop below the yield on the 10-year US Treasury bond. But how can that be?

Back to those now rather stretchy stimulus suits worn by the world’s central bankers that allow for greater freedom of movement in all aspects of monetary policy. In recent weeks we’ve seen a waterfall of hints and downright promises to loosen up even more. The European Central Bank, the US Federal Reserve, the Bank of Canada have all gone seriously dovish. Over in Turkey, President Erdogan fired his central banker for not joining the party. Serbia, Australia, Dominican Republic, Iceland, Mozambique, Russia, Chile, Azerbaijan, India, Australia, Sri Lanka, Kyrgyzstan, Angola, Jamaica, Philippines, New Zealand, Malaysia, Rwanda, Malawi, Ukraine, Paraguay, Georgia, Egypt, Armenia, and Ghana have all cut rates so far this year, quite a few have done so multiple times. From September of 2018 through the end of 2018, there were 40 rate hikes by central banks around the world and just 3 cuts. Since the start of 2019, there have been 11 hikes and 38 cuts.

That’s a big shift, but why? Globally the economy is slowing and in the aftermath of the financial crisis, a slowing economy is far more dangerous than in years past. How’s that?

In the wake of the financial crisis, governments around the world set up barriers to protect large domestic companies. The central bankers aimed their bazookas at interest rates, which (mostly as an unintended consequence) ended up giving large but weak companies better access to cheap money than smaller but stronger companies. This resulted in increasing consolidation which in turn has been shrinking workers’ share of national income. For example, the US is currently shutting down established companies and generating new startups at the slowest rates in at least 50 years. Today much of the developed world faces highly consolidated industries with less competition and innovation (one of the reasons we believe our Disruptive Innovators investing theme is so powerful) and record levels of corporate debt. It took US corporations 50 years to accumulate $3 trillion in debt in the third quarter of 2003. In the first quarter of 2019, just over 15 years later, this figure had more than doubled to $6.4 trillion.

Along with the shrinking workers’ share of national income, we see a shrinking middle class in many of the developed nations – which we capitalize on in our Middle Class Squeeze investing theme. As one would expect, this results in the economy becoming more and more politicized – voters aren’t happy. Recessions, once considered a normal part of the economic cycle, have become something to be avoided at all costs. The following chart, (using data from the National Bureau of Economic Research) shows that since the mid-1850s, the average length of an economic cycle from trough to peak has been increasing from 26.6 months between 1854 and 1919 to 35 months between 1919 and 1945 to 58.4 months between 1945 and 2009. At the same time, the duration of the economic collapse from peak to trough has been shrinking. The current trough to (potential peak) is the longest on record at 121 months – great – but it is also the second weakest in terms of growth, beaten only by the 37-month expansion from October 1945 to November of 1948.

https://www.tematicaresearch.com/wp-content/uploads/2019/07/2019-07-12-Economic-Cycles.png

Why has it been so weak? One of the reasons has been the rise of the zombie corporation, those that don’t earn enough profit to cover their interest payments, surviving solely through refinancing – part of the reason we’ve seen ballooning corporate debt. The Bank for International Settlements estimates that zombie companies today account for 12% of all companies listed on stock exchanges around the world. In the United States zombies account for 16% of publicly listed companies, up from just 2% in the 1980s. 

This is why central bankers around the world are so desperate for inflation and fear deflation. In a deflationary environment, the record level of debt would become more and more expensive, which would trigger delinquencies, defaults and downgrades, creating a deflationary cycle that feeds upon itself. Debtors love inflation, for as purchasing power falls, so does the current cost of that debt. But in a world of large zombie corporations, a slowing economy means the gap between profit and interest payments would continue to widen, making their survival ever more precarious. This economic reality is one of the reasons that nearly 20% of the global bond market has negative yield and 90% trade with a negative real yield (which takes inflation into account).

Debt Ceiling Debate – I’m baack!

While we are on the topic of bonds, the Bipartisan Policy Center recently reported that they believe there is a “significant risk” that the US will breach its debt limit in early September if Congress does not act quickly. Previously it was believed that the spending wall would not be hit until October or November. As the beltway gets more and more, shall we say raucous, this round could unnerve the markets.

Trade Wars – the gift that keeps on giving

Aside from the upcoming fun (sarcasm) of watching Congress and the President whack each other around over rising government debt, the trade war with China, which gave the equity markets a serious pop post G20 summit on the news that progress was being made, is once again looking less optimistic. China’s Commerce Minister Zhong Shan, who is considered a hardliner, has assumed new prominence in the talks, participating alongside Vice Premier Liu He (who has headed the Chinese team for over a year) in talks this week. The Chinese are obviously aware that with every passing month President Trump will feel more pressure to get something done before the 2020 elections and may be looking to see just how hard they can push.

Trade tensions between the US and Europe are back on the front page. This week, senators in France voted to pass a new tax that will impose a 3% charge on revenue for digital companies with revenues of more than €750m globally and €25m in France. This will hit roughly 30 companies, including Apple (AAPL), Facebook (FB), Amazon (AMZN) and Alphabet (GOOGL) as well as some companies from Germany, Spain, the UK and France. The Trump administration was not pleased and has launched a probe into the French tax to determine if it unfairly discriminates against US companies. This could lead to the US imposing punitive tariffs on French goods.

Not to be outdone, the UK is planning to pass a similar tax that would impose a 2% tax on revenues from search engine, social media and e-commerce platforms whose global revenues exceed £500m and whose UK revenue is over £25m. This tax, which so far appears to affect US companies disproportionately, is likely to raise additional ire at a time when the US-UK relationship is already on shaky ground over leaked cables from the UK’s ambassador that were less than complimentary about President Trump and his administration.  

That’s just this week. Is it any wonder the DHL Global Trade Barometer is seeing a contraction in global trade? According to Morgan Stanley research, just under two thirds of countries have purchasing manager indices below 50, which is contraction territory and further warning signs of slowing global growth. This week also saw BASF SE (BASFY), the world’s largest chemical company, warn that the weakening global economy could cut its profits by 30% this year.

Domestic Economy – more signs of sputtering

The ISM Manufacturing index weakened again in June and has been declining now for 10 months. The New Orders component, which as its name would imply, is more forward-looking, is on the cusp of contracting. It has been declining since December 2017 and is at the lowest level since August 2016. Back in 2016 the US experienced a bit of an industrial sector mini-recession that was tempered in its severity by housing. Recall that back then we saw two consecutive quarters of decline in S&P 500 earnings. Today, overall Construction is in contraction with total construction spending down -2.3% year-over-year. Residential construction has been shrinking year-over-year for 8-months and in May was down -11.2% year-over-year. Commercial construction is even worse, down -13.7% year-over-year in May and has been steadily declining since December 2016. What helped back in 2016 is of no help today.

While the headlines over the employment data (excepting ADP’s report last week) have sounded rather solid, we have seen three consecutive downward revisions to employment figures in recent months. That’s the type of thing you see as the data is rolling over. The Challenger, Gray & Christmas job cuts report found that employer announced cuts YTD through May were 39% higher than the same period last year and we are heading into the 12thconsecutive month of year-over-year increases in job cuts – again that is indicative of a negative shift in employment.

Stocks – what does it all mean?

Currently, US stock prices, as measured by the price-to-sales ratio (because earnings are becoming less and less meaningful on a comparative basis thanks to all the share buybacks), exceed what we saw in the late 1999s and early 2000s. With all that central bank supplied liquidity, is it any wonder things are pricey?

On top of that, the S&P 500 share count has declined to a 20-year low as US companies spent over $800 million on buybacks in 2018 and are poised for a new record in 2019 based on Q1 activity. Overall the number of publicly-listed companies has fallen by 50% over the past 20 years and the accelerating pace of stock buybacks has made corporations the largest and only significant net buyer of stocks for the past 5 years! Central bank stimulus on top of fewer shares to purchase has overpowered fundamentals.

This week, some of the major indices once again reached record highs and given the accelerating trend in central bank easing, this is likely to continue for some time — but investors beware. Understand that these moves are not based on improving earnings, so it isn’t about the business fundamentals, (at least when we talk about equity markets in aggregate as there is always a growth story to be found somewhere regardless of the economy) but rather about the belief the central bank stimulus will continue to push share prices higher. Keep in mind that the typical Federal Reserve rate cut cycle amounts to cuts of on average 525 basis points. Today the Fed has only about half of that with which to work with before heading into negative rate territory.

The stimulus coming from most of the world’s major and many of the minor central banks likely will push the major averages higher until something shocks the market and it realizes, there really are no new clothes. What exactly that shock will be — possibly the upcoming debt ceiling debates, trade wars or intensifying geological tensions — is impossible to know with certainty today, but something that cannot go on forever, won’t.

What’s Behind the Commodities Rally?

What’s Behind the Commodities Rally?


On this episode of The Thematic Signals Podcast Chris Versace checks in with Sal Gilbertie, Teucrium Trading Chief Investment Officer


Welcome to the Thematic Signals podcast, where we look to distill everyday noise into clear investing signals using our thematic lens and our 10 investing themes. On this episode Chris Versace welcomes Sal Gilbertie, the Chief Investment Officer at  Teucrium Trading, back to the podcast. In the past on Tematica’s Cocktail Investing podcast, Chris and Sal have talked about the thematic influences on agricultural commodities, including Tematica’s New Global Middle-class one. They touch on that today but also discuss the current supply constraints as well as looming ones that have led to a supply imbalance, particularly for corn and soybeans, that has sent prices soaring. Sal explains how investors should think about these commodities across the 5 to 7 year cycle and shares why the upcoming G20 summit could serve as another catalyst for commodity prices to move higher. The two also discuss the ripple effect to be had on both consumers and companies in the agricultural complex but also those that count corn as a key input. 

Have a topic or a conversation you think we should tackle on the podcast, email me at cversace@tematicaresearch.com

And don’t forget to subscribe to the Thematic Signals Podcast on your favorite Apple device

Resources for this podcast:


G20 summit will determine what the Fed does next

G20 summit will determine what the Fed does next

Welcome to the Thematic Signals podcast, where we look to distill everyday noise into clear investing signals using our thematic lens and our 10 investing themes. 



On this episode, host Chris Versace discusses the sharp June rebound in the stock market that is being fueled by “bad news is good news” with return of Fed related hopium for a rate cut. Recently Federal Reserve Chairman Powell confirmed the Fed is closely watching trade and tariff developments and “will act as appropriate to sustain the expansion.” As Chris explains, given the timing of the G20 meeting vs. the next Fed monetary policy meeting, those hoping for a June rate cut are likely to be very disappointed. Also on the podcast, several ripped from the headlines signals for a number of our investing themes, including Cleaner Living, Middle-Class Squeeze, Guilty Pleasures and Safety & Security

Have a topic or a conversation you think we should tackle on the podcast, email me at cversace@tematicaresearch.com

And don’t forget to subscribe to the Thematic Signals Podcast on iTunes!

Resources for this podcast: