Summary: The market continues to oscillate between concern of slowing global growth and optimism that U.S. economic expansion can be maintained. The two largest worries are the Fed’s monetary policy, that is, concern that it would hike interest rates too much or too quickly, and that ongoing trade disputes could disrupt growth by creating uncertainty and incremental costs. Looking back, the disastrous December 19 2018 Fed meeting and mishandled messaging convinced investors that the Fed had failed to see the risks and was turning a blind eye to market worries. This in turn led equities to sell off and talk of recession to increase. Subsequent to that meeting, the Fed appears to have woken up. It is now going out of its way to repeatedly indicate a more accommodative and market-friendly stance which has been met with a rally in the markets to start 2019. For our part, we lean bullish as we believe the consumer remains strong, as discussed below, and our best guess is that the Federal Reserve will not tighten too quickly. We also think trade disputes, while unhelpful, will not derail the U.S. economy.
We Expect a Strong Start to Consumer Spending in 2019, Driven by Record Tax Refund Payments
Consumer spending is 2/3 of U.S. economic activity. Employment growth remains very strong. Wages are rising. It’s probably never been easier to find a job or change jobs in the U.S. We believe that employment and wages are the number one determining factor for consumer confidence and spending. The story here continues to be good. That said, the consumer can be derailed and we have seen the consumer impacted in the past by factors such as political uncertainty around elections, changes in commodity prices (a spike in gasoline, for example), international events (such as military conflicts) or extreme volatility in financial markets. We also believe the current government shutdown and furlough could have an impact and we have discussed this with companies that service consumers who work for the government. (Retailers can see in their data that stores with a customer base composed of government employees perform differently than the balance of their chains.) However, taking all this into account, we believe the consumer remains in a good place and is likely to keep spending, providing support for the biggest element of U.S. economic growth.
MOST of last year’s tax reform benefit for individuals is still in front of us. We’re not sure how widespread this is known, but according to research done by a large retail company we trust, less than half of the benefit of individual tax reform for 2018 has been realized. The reason is that few companies and employees adjusted their withholding rates to reflect new credits etc. This same company estimates that 57% of the benefit of last year’s tax reform will be reflected in 2018 tax refunds (paid out in the next few months). In other words, this will be the largest tax refund season in history. This will be positive surprise for most unless you’re a high income $500k+ family living in a high state tax state like CA or NY, in which case you will probably owe more. Sorry. Don’t shoot the messenger.
Tax refunds typically get spent, which will have the effect of boosting economic growth in 1H19. Our experience working with consumer companies over the past 20 years has shown us that tax refund season can have a material impact on the timing of consumer spending and the performance of specific product categories. For example, among the product categories that see a direct, measurable impact from tax refunds are consumer electronics (TVs), mattresses, and high-end athletic sneakers (Jordans). Yes, especially Jordans. Home improvement products are also often funded by tax returns, which brings us to our investment discussion below. Wrapping up, the consumer is already in a good place due to strong employment and wage growth. Tax reform has boosted spending in 2018. These factors will persist for at least the foreseeable future, in our opinion, which suggests to us that the economy will be fine for at least the near term.
An Investment Idea from the Consumer Electronics Show (CES)
Product upgrade cycles often form the basis of successful investment theses: We just returned from the CES show in Las Vegas and it was our first year attending the event. If you don’t know about CES, it is an industry convention where major electronics and technology companies showcase existing and new product to the trade and to other techies. It’s probably the largest conference in the world and is attended by over 180,000 people. Our purpose in attending the show, besides having an excuse to go to Vegas, was just to learn as much as possible and make sure we understand the potential for new products and technologies to change both consumer spending patterns but also how companies operate.
Connected home and smart home is one of the themes we explored: CES can be overwhelming and we saw plenty of cool gadgets, drones, toys, tech-enabled games (including virtual-reality and augmented reality) as well as updates on TVs, phones, and audio devices. Of particular interest to us were updates to traditional devices in the home which are enabling appliances (fridges, ovens, toasters, blenders) as well as utilities (hot water heaters, furnaces) and less-obvious places (doorbells, closets, toilettes) as well traditional electronics (TVs, speakers, and security cameras) to talk to each other and deliver control and analytics to home owners via applications. In turn, there is a competition to stich control of these connected appliances via voice-enabled e-commerce-ready hubs. Amazon’s (AMZN) Alexa and Google’s (GOOGL) Echo are the two leaders here but we expect Apple (AAPL) and other electronics companies to create and introduce solutions. The bottom-line is that the product offering and technology is still fragmented and a fully integrated connected and smart home is still a few years off. It is, however, close enough, in our opinion, to envision and invest in the coming upgrade cycle as consumers replace existing conventional home appliances to take advantage of new products and features.
Yours,
John Zolidis
President & Founder
Quo Vadis Capital, Inc.
[email protected]
www.quovadiscapital.com
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