Most thought there would be a 2023 recession. Then stocks rebounded 30% from lows.
In January I remarked on a unique event in the financial markets. Economists, as a group, for the first time ever, were predicting a recession. Well, here we are more than halfway through 2023 and the big bad recession has yet to arrive. Why were the bearish forecasts wrong (so far)? I can point to three factors.
First, companies have not reacted to rising interest rates and higher costs of doing business (inflation) by cutting capital spending plans and reducing hiring, as they did in the past. Second, weakness in housing related industries has not filtered through to problems at financial institutions or caused banks to reduce lending, as occurred during the 2008-2009 financial crisis. Third, innovation in the tech sector created a reason for optimism around future earnings growth that was not previously factored into estimates. Overall, consumer spending (2/3 of US economic activity) has weakened, but only slightly, as wage gains have mostly offset higher costs. Jobs remain plentiful.
Should we blame the economists for being too cautious (& the financial media for amplifying this message)? I don’t think so. As I see it, economic forecasting is essentially the act of taking data collected about the past and using it to predict the future. It would be pretty surprising if this worked. Here’s a dumb sports analogy to illustrate my point: Can you predict next season’s Superbowl winner using last year’s statistics? A resounding maybe.
Some economic data series are known as “leading indicators”. These indicators, for example consumer confidence or the durable goods orders, are also comprised using data from the past but have historically correlated with certain future outcomes. I am sure these are helpful. Unfortunately, there aren’t any “indicators” for future geopolitical conflict, regulatory change, changes in tax rates, commodity price movements, the weather, natural disasters, scientific discoveries, fashion trends, or technological or business innovation, which can all impact the economy. In short, economic forecasters are stuck with an incomplete playbook.
What about now, are we in a new bubble?
A few frustrated bears who’ve missed the big move up in large tech stocks are complaining again about valuations and “lack of breadth” in 2023’s rebound. Sometimes (with the benefit of hindsight) it’s obvious that prices were too high relative to the outlook. Most of the time, however, stocks are neither in a bubble nor being sold off in a panic. Currently, the S&P 500 (which is largely composed of gargantuan tech names) is trading at a modest premium to its 10-year average forward price to earnings ratio (P/E) of 17.6x. Perhaps future estimates are too high (or they could be too low). Nevertheless, current valuations feel pretty far from bubble territory, in my opinion.
Am I a buyer or seller of stocks here?
Here’s my view: It’s nearly impossible to predict where the economy is going over the near-term, and most of the time stocks in general are neither ridiculously overvalued nor stupidly cheap. Consequently, I am not a buyer of stocks in general. My approach is to find fantastic companies with solid brands, high margins, robust cash flows and the ability to grow and to try to buy these names when stock prices are interesting relative to each company’s outlook. I won’t claim this is easy or a foolproof approach. However, regardless of both the economy and the market, there are always some good names being sold at an unwarranted discount and bad companies trading for too high a price.
Selection from our investment portfolio” The Meta-Thread (META)*
On July 5, 2023, META announced the launch of Threads, a new app to compete directly with Twitter. On July 3, 2023, the last trading day before the announcement, META closed at $286 per share. In the excitement following the Threads launch, META shares ran up to the $315 range before falling back at the end of last week. This two-week surge added about $74B to META’s market cap. This is notable as it is nearly 2x the $44B value that Musk paid to acquire Twitter.
The $74B gain in META shares post Threads makes little sense, except for one thing. We don’t own META for the potential of Threads. My view, unchanged from over four years ago, is that META is still in the very early stages of monetizing its user base, which is an astonishing 3.7 BILLION global active monthly users. Whether Threads is a great success or an utter failure it is probably immaterial to this long-term potential for value creation. So why would I say the $74B move makes some sense? Because Threads reminded the market that META is a company founded on innovation. Its business value does not rest only in the cash flow we can see today, but also in its ability to reinvest this cash flow into launching other yet-to-be-announced high-potential ideas. Critics may point to the apparently still-born Metaverse experiment, but we would rather that Zuckerberg try some things that don’t work than play it safe and avoid risk. Meanwhile it was just announced that Musk is depluming Twitter’s blue bird icon and replacing it with a not particularly compelling ‘X’. I couldn’t have come up with a better symbolic death for Twitter if I had tried. Message to Musk: your vanity project is not working. Please stop making it worse.
*This is not a recommendation to buy or sell any security. Please consult with your investment advisor for advice tailored to your investment objectives and risk tolerance.
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John Zolidis
President & Founder
Quo Vadis Capital, Inc.
John.zolidis@quovadiscapital.com
Mr. Zolidis founded Quo Vadis Capital, Inc., a Registered Investment Advisor (RIA) and research consultancy, in 2017. He started his career in finance in 1996 following degree studies in Philosophy at Kenyon College and the University of Oxford. He has followed U.S. consumer companies as a senior analyst since 1999, mostly on the sell-side, writing research for institutional investor clients. He also managed money in a buy-side role at a long-short equity fund over 2013-2014. He was named in the Wall Street Journal’s Best on the Street list in 2005. Mr. Zolidis and works from New York, NY and Paris, France or wherever he has his laptop.
Whereabouts and going-ons: In June I enjoyed several trips around the U.S. Each one seemed to provide an excuse to go mountain biking. First, after a meeting with Walmart, I hit the trails Bentonville, AR. (Thank you to the Walton grandsons for developing the trails.) Second, while attending ValueX Vail, I took on the downhill courses on the Vail mountain. This year at Vail I gave a talk on destructive mental models for investors. You can check out a condensed version of the sides via this link or watch a clumsy video of the presentation on my youtube channel here. I also recently recorded three podcasts. I was a guest on the Stansberry Investor Hour and I was the featured speaker on the podcast Business Breakdowns, for a discussion on Lululemon, a company I have followed closely since its debut as a public company in 2007. Both podcasts are also available on Spotify. The third podcast will be available in September. I don’t have any business travel in July but I am not letting that stop me from more mountain biking. Here’s a shot from a ride this week in French garrigue. Have a great summer!
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The author of this letter and accounts managed by Quo Vadis Capital have a long position in shares of Facebook, Inc. (META).
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