Labor Day weekend is the official end of summer. When I was a kid, school had either just started or was about to start this week. Our summers were full of unscheduled, unstructured, and most importantly, unsupervised adventures. Today most kids (at least here in Georgia) have been back in school for a month. Everything they did this summer was scheduled, structured, and most importantly, supervised. The only thing that remains similar is the mandatory summer road trip. It might be to the beach or to Disney World or to see Grandma, but we have all piled into the family car and gone down the road on a hot summer day. Thirty minutes into our four- or five-hour drive the kids start asking, “Are we there yet?”
That is what investors want to know. The long market rally was interrupted by the month of August, which saw the S&P finish basically unchanged while small companies were actually down. The rally had already changed complexion from a broad-based celebration of hope lifting all types of companies to an only-the-strong-can-survive, FANG-driven market. That was a troubling sign. Now we have basically hit pause and many are wondering, are we there yet?
And where is “there,” one might ask? There is where we turn around and head in the other direction. In this case: down. So, are we there yet? Every time my six-year-old daughter asks that question, I tell her that it adds another hour to the trip. While that is not actually true of a car trip (which my daughter knows, and reminds me every time I say it), it can be true of the market.
There is an old saying in our business that markets climb a wall of worry. When people are saying, “It is time for a correction,” that is usually a sign that we, in fact, are not there yet. When they start saying things like, “This time it is different,” that is when it is time to worry. Yes this rally has come a long way, but it has been backed up by strong corporate results and better economic growth -v GDP growth was just revised up to 3 percent for the second quarter. It has also been prolonged because it has changed complexion. Old leaders peter out and new ones have come to the fore.
However, we have come a long way in a short time and it would not be a surprise if we slowed down. Our best guess (others might say forecast, but best guess is more accurate) is that we pause a little longer, then a stimulus comes to push us one way or the other. The most likely thing would be tax reform. If the administration and Congress could actually pull off a package, then the rally is back on. Negative stimuli are always harder to see. (In fact, most of the time no one sees it until after the fact, and then everyone claims that they really did see it. We’ll save that insight for when it happens.)
Let’s hope for the positive. We need it. This past week there was a story in The Wall Street Journal about an economic study which showed that corporate America has gotten more concentrated. There are fewer but larger companies than in the past. As this has happened, marginal profits have spiked to what the researchers say are historical heights. In a free market that would not happen because the extraordinary profits attract competition. They theorized that the cost of technology is a driver in what has led to this situation. Their data shows that this spike to profits started in 2009, which coincides with a trend for fewer start-up companies.
This research is interesting and worth pursuing. However, there seems to be another, perhaps more obvious, source of this problem: high taxes and over-regulation are two of the most effective barriers to entry ever created. The more expensive – and just plain frustrating – it is to build a company, the fewer companies will be built, as we have seen since 2009. Fewer companies means less competition, which means higher profit margins, as we have seen since 2009. Less competition for consumers also means less competition for workers, which means flat wages, as we have seen since 2009.
Tax reform would signal a true change in direction and could be very helpful to more than just the stock market. Fingers crossed they get their act together is Washington and give us something. If not, then it is more of the same and we will have to ask, “Are we there yet?”
Our thoughts and prayers remain with our friends and clients in Houston and the surrounding areas.
Chuck Osborne, CFA