So you think you’re having good times
With the boy that you just met
Kicking sand from beach to beach
Your clothes are soaking wet
But if you look around and see
A shadow on the run (on the run)
Don’t be too upset because it’s just a paper sun
Traffic, Paper Sun
Paper Sun was the debut song of the band Traffic in 1967. I happened to hear it when I was getting coffee a few days ago, and it made me think of the market. I’d say the song is about believing something is true when it’s not, and reality comes crashing down eventually. The sun is something that effectively lasts forever. How long will a paper sun last? It may look pretty for a while, but if there’s nothing really there, it will lack permanence.
I believe investors are playing the same basic game they’ve been playing forever, which is essentially the idea that whatever has happened lately will happen forever. Thus, FAANG stocks will be able to have strong, expanding margins forever. The market should continue to do great, because there haven’t been any real problems.
Eventually, margins go as high as they’re going to go, products mature, sales slow, and economies decelerate (it’s particularly easy to see in debt-driven economies). The start is a lot of fun, the end not so much.
Right now we’re getting told a story that a friendlier Fed will cure the already peaked-looking tech stocks, and any kind of trade deal will have us back to the races. Those are nice stories, but how real is that promised daylight for tomorrow?
Daylight breaks while you sleep on the sand
A seagull is stealing the ring from your hand
The boy who had given you so much fun
Has left you so cold in the paper sun
Traffic, Paper Sun
I think the Fed story is particularly strange. People spent 2017 pointing to a strong economy and how the rate hikes were proof of that paper sun. Tech stocks zoomed. Now we’re supposed to buy tech stocks because that 2017 rate hike story seems to be over? Buy tech on rate hikes has become buy tech on rate hikes slowing? I don’t get it.
I could definitely see how a trade deal could affect some companies, but is it enough to overcome what looks like peak business and economic growth? It could impact the rate of change, but it would be really hard to change the direction of the overall economy. You can hope for profit margins to go even higher than the peaks they’ve hit lately, but doesn’t that seem awfully unlikely? Looking at the latest data shows this process of lower margins has already started. Will it reverse? Anything is possible, but some things are more likely than others.
The base purpose of my research process is to come up with a range of likely outcomes for how a company is likely to do, and use economic analysis to help weight likely outcomes. As of a few months ago, there were plenty of growth companies that were assuming not just growth, but growth acceleration going on forever, even while the broad economy is having a hard time creating any growth from more and more debt burdens. That’s a rough combo.
The Fed potentially stopping rate hikes sooner than thought may be good for the market, but how good? What if it means we only go down 10% rather than 15%? For that matter, how meaningful is it, really? Based on Powell’s speech Fed funds futures (expectations for short rates) hardly budged (admittedly after having already declined for most of November), while credit markets barely moved and LIBOR (the London Interbank Offering Rate) actually rose. Markets outside of the stock market didn’t seem to care a great deal about the purported major change in Fed policy. To them, it looks like a paper sun.
Again, a trade agreement probably is a good thing, at least for financial markets, as the alternative of a trade war implies more turbulence. That said, what are people assuming would make for higher stock prices? Is keeping the status quo on trade (which seems unlikely given the rhetoric) enough to cause more than a short term rally? Whether rates or trade, are we talking about lasting, significant economic improvement or a paper sun?
Wall Street constantly tells us that all is well, that we are seeing a real sun. But time after time it turns out that Wall Street has sold us a paper sun. Then they excuse their mistake by telling us they are shocked – no one could have seen it coming. What do you think – do you see a real sun or a paper sun?