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Mastering the Market Cycle

By Chris Hill – Oct 11, 2018 at 12:51PM

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The Fools discuss inflation, wages, the low unemployment rate, and more.

Unemployment hits a 49-year low. Tech giants may have been hacked by China. Elon Musk's tweeting sends Tesla (TSLA 0.56%) shares lower. Costco (COST 0.05%) struggles with "material weakness." And Tronc (TPCO) decides to change its name back to Tribune Publishing.

In this episode of the Motley Fool Money podcast, host Chris Hill and analysts Ron Gross, Matt Argersinger, and Aaron Bush analyze those stories, discuss the latest news from Barnes & Noble (BKS) and Tencent Holdings, and share some stocks on their radar.

A full transcript follows the video.

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This video was recorded on Oct. 5, 2018.

Chris Hill: It's the Motley Fool Money radio show! I'm Chris Hill. Joining me in studio this week: senior analysts Aaron Bush, Matt Argersinger, and Ron Gross. Good to see you as always, gentlemen! We've got the latest headlines from Wall Street, legendary investor Howard Marks is our guest, and as always, we'll give you an inside look at the stocks on our radar.

But we begin with the big macro. The jobs report for September put America's unemployment rate at 3.7%, the lowest it has been since 1969. Wages continue to tick up. Something we don't talk about that often, Ron, 10-year treasury bonds hitting a seven-year high.

Ron Gross: Should we say it? Should we give them a firing on all cylinders for the economy?

Hill: I think we need to.

Gross: It's pretty impressive. 4.2% GDP. As you said, lowest unemployment since 1969. We have the S&P 500 up 8.5% as a result, that's not including dividends. If you add on those, you've got a 10% year, all things being equal. 

Now, not everything is always rosy. There's two sides to every story. You worry about inflation when things are so good. Inflation's at about 2.7% now, a little bit higher than the Fed's target of 2%. But that's actually being rethought. It's kind of an arbitrary number, and maybe it is a bit too low. The interest rates you mentioned are actually a negative. Markets trade down on the highest interest rates. We did see the markets trend a little lower as a result of higher interest rates.

But overall, we robbed Peter to pay Paul a little, I think, with these tax cuts. We'll see what happens down the road. But for today, for now, [laughs] things look pretty strong. 

Matt Argersinger: I agree with Ron. I'm really paying attention, though, to those hourly wages. A 2.8% increase, it's certainly not barnstorming. Watching that going forward is going to be important because that's really a major determinant of inflation. If we do finally see a lot of wage pressure, that's what's going to bring the inflation. You saw the 10-year yield hitting a seven-year high. There are important implications to that, Ron mentioned it. As an anecdotal example, the interest rate on one of my rental properties just got adjusted. It's a three-three arm, so the interest rate adjusts every three years. Last month, it climbed a full percentage point.

So, believe me, I'm feeling that. I think a lot of people around the economy who have loans like that are dealing with it, and they're going to be feeling that, as well. 

Hill: Speaking of wage pressure, Aaron, Amazon (AMZN 0.01%) applying some pressure on the competition this week when Amazon announced it was raising its hourly wage to $15 and encouraged others to do the same.

Aaron Bush: Man, they're just playing chess. It's pretty amazing to watch. Yeah, they're just giving politicians what they want. Then they can go do their own thing that others cannot copy them at.

Hill: Ron, when you look at the 10-year treasury bond, the seven-year high, we're a show that's focused on stock investing, but how much higher does this need to climb before you start thinking about bonds in a really serious way?

Gross: A little bit more. We're not there yet. I don't want to nerd out on anybody, but it affects the discount rates you use when you value equities. The higher the interest rates, the lower the present value of future cash flows are, and that actually lowers value when you run the numbers, in conjunction with creating competition for stocks when other investable assets become more attractive.

Argersinger: Right. The relative attractiveness of stocks goes down as yields go higher. For us Foolish investors, long-term, it probably doesn't matter that much. But it does matter for institutions, who are moving around a lot of capital. I think that's why you're probably seeing a little bit of volatility come back to the stock market this week. 

Hill: This week, Bloomberg reported that a secret division of the Chinese military has used tiny computer chips to compromise the motherboards of major U.S. tech companies, including Apple and Amazon. Aaron, I should point out that both Apple and Amazon have denied this report. This is one of those interesting things that could possibly get interesting in an ugly way.

Bush: Yeah, I mean, it's a pretty crazy story once you dig into it. What these microchips allegedly do -- and they're so small, they're like the size of a grain of rice. Allegedly.

Gross: [laughs] They're allegedly the size of a grain of rice?

Bush: Well, we'll see. What they allegedly do is spy, but also allow for changing the operating system on the computers that they're attached to, which opens the door for potential software attacks. So, if you think about this going on, and these tiny microchips being placed in some of the largest motherboard suppliers that go all over the world, yeah, some of that stuff could be widespread already in a lot of our computers and servers.

It's interesting to see Amazon, AWS, for example, deny this. I think there's definitely a lot of investigating going on behind the scenes right now. It's going to be really interesting to see what comes up with that. Earlier in the year, when ZTE got smacked for violating U.S. trade laws, if anything even remotely related to that comes up here, it could cause pretty big shifts in the technology supply chain, moving things out of China, much further oversight. Yeah, it'll be really interesting to watch it unfold.

Hill: One of the potential ripple effects here is probably if manufacturers start to move out of China, presumably, Matty, they're moving to places that are more expensive. Those costs probably get passed on to the consumer.

Argersinger: That's right. The one scary part of this to me is that it seems so logical. We haven't really thought of a possibility like this in the past just because we have been so dependent on China for manufacturing. So, yeah, taking it out of China, of course, is a possibility from this. But, man, the margins that companies like Apple have been enjoying for decades could be a lot tighter.

Hill: Another rollercoaster week for Tesla shareholders. Shares of Tesla were up big on Monday after Elon Musk agreed to a settlement with the SEC. The deal included tens of millions of dollars in fines for both Musk and Tesla, a requirement that Tesla add two new independent directors, and a three-year ban on Musk serving as chairman of the board. But the stock fell later in the week, when Musk took to Twitter once again to mock the SEC, calling it the Short Seller Enrichment Commission. Matty, someone has got to take this guy's phone away.

Argersinger: Take it away! Take the Twitter account away! I don't get it. I really thought... I need to stop believing that this is going to work out logically. I mean, I just feel like after the settlement, this is a great time for Musk to just step back, accept it, he's going to pay this fine. In my mind, he got off. The SEC's original lawsuit was for him to be banned from serving as an executive on a publicly traded company! And by the way, I don't know if Elon knows this -- I'm sure his lawyers do -- a federal judge still has to accept the settlement! So, in fact, he could have put that in jeopardy. If a federal judge decides that, first of all, there were questions about settlement anyway. But now, you have Elon Musk essentially ridiculing the SEC, and possibly the settlement. If this doesn't go through, I think it's very possible that Elon Musk could eventually not be serving as a CEO of Tesla.

Gross: Yeah, the exact thing that Tesla needs, besides a better balance sheet, is a strong Chairman or a strong No. 2, à la Sandberg at Facebook. Whether he can relinquish control and not install a puppet chairman remains to be seen. I think we're setting ourselves up for a big fight sometime within the next three years between Musk and whoever that new chairman is, with the end result possibly being Musk leaving.

Bush: Honestly, I'm just tired of the shenanigans, period. A lot of it is Musk's fault. A lot of it isn't, too. But there are interesting developments going on behind the scenes. For example, last month the Model 3 was the highest-grossing car in the U.S. We don't see those headlines because all we see is Musk and the SEC headlines. But there are interesting things going on here. It's really important for Tesla to contain the narrative so that they can improve their balance sheet and do things like that. It's just crazy how hard it is to just keep his mouth shut. 

Hill: That's the thing. He's a smart guy, and you would think, Matty, that the best way to shut up the short sellers is to put up more numbers to celebrate those types of actual business wins. 

Argersinger: That's exactly right. I guess I just don't know when Musk woke up one day, and decided, this is a day, from now on, I'm going to go to war with my critics. Anyone who criticizes me or my company. He just doesn't have to do it. I know a lot of the media has been a little bit unfair against Musk. But, again, he's creating his own problems.

Hill: Costco's fourth quarter results were pretty good but shares down on Friday. Wall Street, Ron, seemed more interested in Costco's warning about a material weakness. What is all this about?

Gross: As you and I were talking before the show, anytime we see "material weakness" in a headline, we get a little nervous. But I think this is much ado about nothing. They've identified a problem with their financial reporting, where some of the company's information technology department and maybe some outside contractors had access to the financial control system at Costco. But it doesn't appear to have affected anything. The company doesn't think any kind of misstatements will be necessary, although they need to complete their review.

I think, in the end, this shouldn't happen, and they should be more careful, but it probably has no real effect. Therefore, we can go and focus on the actual results of Costco, which are pretty strong, with comp sales up 9.5%. They're saying in-store traffic is as strong as it's ever been, up 4.9% for the quarter. The one area of concern is online growth. The ever-important online growth in the age of Amazon is actually decelerating, 26% vs. 36% in the previous quarter. Something to keep an eye on. But profits were still up 14%. The company's doing really well. Stock's not cheap right here at around 30X vs. something like 15X for Target. But the company's putting up solid numbers. 

Hill: I mean, there's not really a good time to have problems with your financial controls, but particularly as we're heading into the all-important holiday season, it would seem like they want to get this behind them as quickly as possible.

Gross: For sure. From a technology perspective, that's not hard to do. The review may take a little longer to see if they need to restate anything or if any breach really impacted anything. I think in the end, though, everything will be fine.

Hill: We're coming to Denver! We are having a listener meetup in Denver, Colorado on October 23rd. If you're in the area, we want to see you. E-mail us, [email protected], and we will give you all the details. 

Spotify (SPOT 2.22%) has 180 million monthly active users. If you think that's impressive, you're going to be interested in the upcoming IPO for Tencent Music Entertainment. The company filed to go public in the United States, with one of the key data points, Aaron, being that Tencent Music has 800 million monthly active users in China.

Bush: Not bad at all. Tencent Music is essentially a holding company for four of China's largest music services of various types. Yeah, 800 million monthly active users is crazy, and it's still growing pretty quickly. This is in China and also in the greater Asian area anyways. So, yeah, it should be a pretty massive IPO. 

What's interesting about the company to me, besides its obvious dominance and the fact that it's growing quickly, is how it makes money. Instead of relying solely on subscriptions and advertisements like a Spotify, Tencent Music actually makes most of its money from virtual gifts sent through live streaming. Live streaming has been a big trend in China lately. It seems like Tencent Music is in on it, too. Also, online karaoke is a big revenue driver, and song sales. So, this is a very different type of music company than we see here domestically. 

They're also more profitable, too. The gross margin is higher than what we would see in a Spotify here, too. It'll be really interesting to see how this company does once it's public.

Hill: Tough week for Stitch Fix (SFIX 1.39%). Fourth quarter revenue for the online apparel company came in 23% higher than a year ago, but Wall Street was looking for more. Shares if Stitch Fix down 40% this week. Matty, is that an overreaction? Because on the surface, it kind of looks like one.

Argersinger: It does look like an overreaction to me. But you have to go back to the previous quarter, where revenue was up 29%, active clients grew 30%. That got investors excited. The stock was up 40% from that quarterly announcement. So, going into this one, and then certainly, as you mentioned, revenue was just up 23%, active clients were up 25%. That's quite a sharp deceleration. I think a company like Stitch Fix, which obviously, like a lot of growth companies, was given a pretty high valuation going in.

At the same time, I look at the stock now, after the drubbing it's gotten this week, and you have a business that's still growing about 20%, maybe 20-25%, trading for a little over 2X sales. And it's profitable. This is a business that, I know for one, David Gardner's really excited about, and Tom is excited about, as well. It's an interesting disrupter in the apparel business. It's one I'm interested now that, of course, it's down 30% from its high.

Bush: I think the concept of what they're doing is fascinating. They're essentially a data company that happens to sell and deliver clothes. But I think they're finding that it's not that easy to keep the momentum going. For years, Stitch Fix pretty much relied on word of mouth marketing in order to grow its brand, grow its revenue. Now, even though it is the top dog, there's more competition than there's ever been. They're having to pay up more for customer acquisition than they've ever had to do before. I think we're starting to see some of those issues appear in the financials. Retention isn't awesome, either. They do have issues to work with, even though it's still a really interesting idea.

Hill: Shares of Barnes and Noble up 20% this week on the news that the iconic bookseller is putting itself up for sale. Ron, they've tried this two other times this decade. Do you think the third time's the charm?

Gross: [laughs] Third time's the charm? Is that what you're saying to me? Oh, we'll see. Supposedly they've received interest from multiple parties, including chairman Leonard Riggio, who owns 19% of the stock. They think this is real. They put a shareholder rights plan in place, which is commonly known as a poisoned pill. If an unsolicited investor tries to take the company over, they can thwart that if they need to. It'll be interesting to see, at a market cap of $500 million now after the pop, what is this thing worth and who would want it, especially in a situation where their online sales -- again, the all-important online sales when you're going up against somebody like Amazon -- has been declining.

But they did do $100 million dollars of EBITDA and cash flow in the last year. You throw a 5-7X multiple on top of that, if you so choose to, and you can make money off of a purchase of a $500 million market cap. So, maybe folks see the ability to firm this up a bit. They've had five CEOs since 2013. They need to get things in order. But maybe there is some money to make here.

Argersinger: Do we feel like books are back? I'm saying non-Kindle, non-e-books. Maybe it's anecdotal, but I feel like I've seen more people who are in bookstores, buying physical books and enjoying that experience more than Kindle.

Hill: Yes, and part of that is a rise in independent bookstores, as well. Two years ago, Tribune Publishing announced it was changing its name to Tronc, which stood for a combination of Tribune and online content. This week, the company announced it is changing its name back to Tribune Publishing, although the company did not say why it was changing back.

Argersinger: They also didn't say who was fired for originally coming up with Tronc.

Hill: I mean, do we think the change back to Tribune Publishing had anything to do with the massive amount of ridicule that this show and others gave them?

Argersinger: I don't know. I mean, the name... Where were they years ago, when they were in a room, and someone raised their fist and said, "Tronc!" Did they all get excited about that? Because I tell you, I think collectively in the world, we were like, "What? What is that?"

Hill: Not that Reed Hastings at Netflix needs more things to feel good about, but one more thing that he can feel good about is, when they had the Qwikster debacle, they changed course on that very quickly.

Gross: It's no Mondelez. Compared to Mondelez, everyone's like, "Yeah, we'll go with Tronc! We'll give that a shot!"

Hill: Hey, Mondelez is still Mondelez! They haven't changed it back! Let's go back to our man behind the glass, Steve Broido. Steve, you're a proud son of Chicago. Are you happy that Tribune Publishing is back? 

Steve Broido: I think so. I think it's a good thing. I mean, in Chicago, it's either the Sun Times or the Tribune. You pick your poison. I always liked the Tribune more.

Hill: Let's go back for a second to Tencent. When Aaron Bush was talking about the online karaoke, I thought of you, Steve. You're a singer.

Broido: I'm doubling down on that.

Hill: [laughs] Is there a go-to karaoke song that you have if you really need to kill it? Whether it's online or in-person karaoke? 

Broido: Cheap Trick usually does the trick.

Gross: Oh, that's a good one! Can you give me an example of a virtual gift? What does that even mean?

Bush: It's essentially a way of tipping. I don't know, it could just be like, you like how this person sings, so you'll give them a nice little digital sports car.

Gross: And Tencent gets a cut of that?

Bush: Yeah, they take a healthy cut. It's just pure profit.

Hill: Guys, it's our 500th episode! Can you believe we've been doing it this long?

Gross: That's awesome!

Argersinger: It's amazing!

Hill: It's incredible! Aaron Bush, I think, was in middle school when we started doing this.

Bush: Yeah, I was like 12 years old. I was a listener, though.

Gross: That's awesome!

Argersinger: Chris, is it any coincidence that Tom Brady happened to throw his 500th TD pass last night? I don't know. It's so perfect!

Hill: I think it is. Let's go to our man behind the glass, Steve Broido. He's going to hit you with a question as we get to the stocks on our radar. Ron Gross, you're up first. What are you looking at this week?

Gross: It's just a radar stock for me, it's a recent recommendation by Fool analyst Mike Olson. It's KKR (KKR 0.42%), Kohlberg Kravis and Robert, some of you may remember it as. The ticker symbol is... KKR. One of the world's top private equity investment managers. Really remarkable long-term track record. Employees own more than 40% of the stock. I like to think shareholders and employees are nicely aligned there. Stock is $27 a share. My friend Mike thinks that could be worth $36 a share. It has a 2.4% dividend yield at the moment. So, it's something I'm taking a look at.

Hill: Steve, question about KKR?

Broido: How do I evaluate a company that's business is owning and managing other companies?

Gross: Based on that track record, what kind of after tax and fee returns are they putting up for their investors? 

Hill: Aaron Bush, what are you looking at this week?

Bush: My stock is WWE (WWE 0.20%), ticker WWE. I think there's a trend. I hope Matt doesn't ruin it.

Argersinger: I'm going to ruin it!

Bush: Aw! I took a look at this stock recently and I was really impressed. First of all, I didn't realize just how huge and growing this brand was. The numbers it generates on TV are impressive. It upsells to its network really well. It's one of the most popular YouTube channels in the world. Its toys sell better than Marvel and Star Wars

Hill: What?!

Bush: Yeah! But what blew my mind the most was, in June, they renegotiated or renewed their domestic TV rights for 3.6X the rate they were doing before. That's a snap-your-fingers, instant multi-bagger moment. They're continuing growing overseas. They have new contracts up for renewal. I have a feeling we're going to see more moves like that. The explosiveness isn't over. 

Hill: I had no idea wrestling toys were selling like that. Steve Broido, question about WWE?

Broido: Do pay per view experiences still happen? I haven't heard about pay per view in years.

Bush: It still exists, but they largely have shifted away to the network, where they have about two million subscribers for about $10 bucks a month. 

Hill: Matt Argersinger, what are you looking at this week?

Argersinger: I'm looking at Vail Resorts (MTN -0.15%). The ticker symbol, appropriately, is MTN. I love this business. I've owned it for a long time. Of course owns some of the most irreplaceable assets in the country. Vail, Breckenridge, Park City, Stowe, to name just a few. This stock rarely goes on sale, but it's currently off about 15% from its recent high and now yields 2%. That rarely ever happens with this company. So I'm very interested in it right now.

Hill: Steve?

Broido: Where's the money in skiing? Is it the rental? Is it the renting of the boots and the skis? Where's the money come from?

Argersinger: They make money from skiing, but obviously, that can be very seasonal and cyclical. The resort, the amenities, the restaurants, the hotels, the activities, all that stuff around skiing makes them a lot of money.

Hill: And the goggles. Don't forget the goggles. Vail Resorts, WWE, KKR. Steve, you got one you want to add to your watch list?

Broido: I may take a look at KKR.

Hill: Ron Gross, Aaron Bush, Matt Argersinger, guys, thanks for being here! That's going to do it for this week's edition of Motley Fool Money. Our engineer is Steve Broido. Our producer is Mac Greer. I'm Chris Hill. Whether you just started listening, or you've been with us from the start, thank you for listening! We'll see you next week!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Aaron Bush owns shares of Amazon, AAPL, FB, NFLX, Tesla, and TWTR. Chris Hill owns shares of Amazon. Matthew Argersinger owns shares of Amazon, NFLX, Stitch Fix, Tesla, TWTR, and Vail Resorts and has the following options: long January 2019 $15 calls on TWTR. Ron Gross owns shares of Amazon, AAPL, Costco Wholesale, and FB. The Motley Fool owns shares of and recommends Amazon, AAPL, FB, NFLX, Stitch Fix, Tesla, and TWTR. The Motley Fool has the following options: long January 2020 $150 calls on AAPL and short January 2020 $155 calls on AAPL. The Motley Fool recommends Costco Wholesale, KKR, and Vail Resorts. The Motley Fool has a disclosure policy.

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