Volatility's Rising, Sears Is Sinking, Snap's Stumbling, and Bill Ackman Is Caffeinating

Investors have been enjoying a powerful period of growth in the stock market for years, but at a certain point, all such runs have to end. Are we at such a moment now? For a host of reasons, it's looking more likely. But for those less focused on the macro and more interested in well-known individual companies, there's interesting news from three of them. First, there's Sears (SHLDQ), which this week looks extremely close to the end of its long, weird, and -- according to the MarketFoolery guys -- not-always-inevitable trip toward bankruptcy. Also, billionaire activist investor Bill Ackman has revealed a $900 million stake in Starbucks (SBUX 0.67%), and his optimistic forecast for the coffee giant may or may not be good news for other shareholders. Finally, a leaked memo from Snap (SNAP 23.90%) CEO Evan Speigel has delivered another blow to the company's share price. 

In this MarketFoolery podcast, host Chris Hill and senior analysts Jason Moser and Matt Argersinger discuss market conditions, the outlook, and investment strategies for such times; reflect on the road not taken by Sears CEO Eddie Lampert; ponder just what Ackman thinks he's going to do to "improve" Starbucks; and ask themselves how the Snap founder can move forward when he's displaying so little understanding about what his company really is.

A full transcript follows the video.

This video was recorded on Oct. 10, 2018.

Chris Hill: It's Wednesday, October 10th. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio today, Jason Moser and Matt Argersinger. It's the 1,500th episode!

Matt Argersinger: That's incredible!

Jason Moser: Who'd have figured?

Hill: It's kind of crazy! You know what's also crazy? Sears is still technically a stand-alone public company. We're going to get to Sears.

Moser: I think its time is limited. I feel like we're still on an upward trajectory with this show, though. Two very different pictures.

Hill: I like to think we're going to last a little bit longer, but we'll see. We're going to get to Sears, we're going to get to Starbucks, Snap. It's an all S show, apparently. 

Let's start with the market in general. We talked about this, Matty, on Motley Fool Money, the rise of interest rates, the 10-year Treasuries hitting a seven-year high. Not surprisingly, those things that have been shoved in the corner for so long, bonds, are now suddenly more attractive, and we're seeing a healthy amount of volatility today.

Argersinger: Yes, the most volatility I think we've seen since February. It feels like it's been a while as we tape. The Dow's down about 400 points. It's just certain parts of the market. If you look at Netflix, for example, it's down more than 20% from its high. Amazon's down almost 15% from its high. I don't know what Facebook is, but Facebook's down even lower from its high and so. The leaders of the market, even before this recent volatility that we've had in the past week, have all come down pretty sharply.

Jason and I kind of looked each other this morning and were like, "It's about time!" It feels like the stock market's been grinding higher steadily for so long this year, and going back several years now. We haven't had as much as even a 5% pullback. That feels rare. So, it's nice to see it. 

Bonds do matter, interest rates do matter. There's now more competition for stocks.

Moser: Man, I don't know what the problem is. Everything selling off, that's fine. You know what is in the green right now, Chris? McCormick. The market knows that at the end of this day, especially at the end of this day, you're going to want to go home and have something flavorful for dinner, and chances are, McCormick is going to be playing a part in that. Now, watch, it'll finish down in the red after I jinx it.

Hill: Nice work!

Moser: Yeah, thanks a lot! Matt Frankel and I were talking about this on Monday's Industry Focus. We're seeing long-term rates start to push up a little bit. The volatility comes into play because it seems like now, the bigger institutional investors have these risk-adjusted options to invest in something other than stocks. And it makes sense. I mean, if you can get x return for basically zero risk, there a lot of lot of parties that are going to consider that. 

For us, it doesn't really change our style of investing. But I think it is worth noting, at least, that if you invest like we do, chances are, you probably have some nice growth names in your portfolio. And chances are pretty good that those growth names are getting hit pretty hard. It's worth noting that there has been a lot of great expectations pulled forward in a lot of those names. Those high-growth names taking a little bit of a haircut today, it's OK. That's supposed to happen.

What I think this really makes the argument for is diversification. Diversification is really what helps counter that. I made a little bit of a joke with McCormick, but frankly, owning McCormick in my portfolio, I feel better knowing that I've got a staid dividend aristocrat to go along with those other high-growth names that I hold, as well. 

Hill: I think it's a for diversification, and Matty, it's also a case for having a watch list. We talk about that a decent amount and it's for days like this. 

Argersinger: Absolutely! About a month ago, I had a long list of stocks that I've been waiting to buy. And I've stupidly been waiting, because they've gone up so much. What I said was, "I'm going to go in, I know a lot of these companies are near their highs. They're up 100% over the last year. I'm going to go buy a little bit of each of them." Knowing that for days like this -- hopefully this downturn is a little sharper and I get even better prices -- but, knowing that there'll be a time for me to eventually double down on those, that's why I have a watch list.

Moser: I'm going to make a promise to you right now, both of you guys. By the end of the day, I will have added to a position in something that I own. I don't know what it's going to be yet. But I'm going to click the buy button today. It's going to happen!

Hill: Share it later, though?

Moser: Two days after said transaction occurs. 

Hill: Exactly. In news that really can't be a surprise to anyone who has a basic understanding of how math works, Sears has hired advisors to help the company prepare for bankruptcy. Shares of Sears down 35% today. 

Argersinger: Yeah, once you DIP, there's no going back. When I say "DIP," I mean debtor in possession, which is the loan they're seeking, which is a loan that provides short-term financing. It's the most senior of debts that you get when you're in bankruptcy, just to keep the business and the lights on until everything can be sorted out. That's what's happened to Sears. 

Chris, as you said, it's really no surprise that we're here. What's most surprising to me is actually how we got here. Step back 20 years ago, you could have said, "The world is changing a little bit. I can see this e-commerce thing going. I can see Walmart and Target having all this success. Sears feels a little behind. The stores are older, the catalog business isn't as strong as it used to be. Eventually, maybe, this is a retailer that's not going to be around." But what happened was, it had this weird end to it, which is, Eddie Lampert comes in, and it becomes a story of not just a retailer that's going bad, but a financial engineering story. A value investor with a great track record at the time comes in, he buys Kmart, then mergers Kmart with Sears. It becomes a real estate play, it becomes an asset play. It becomes, "I can raise money, I can pay down debt, I can buy back stock. I can create this investment vehicle that'll be really successful." 

But it was always built on a crumbling foundation, which is the Sears business. All of that other stuff didn't put customers back in the stores. Stores declined over time. There was no reinvestment in the core business. I think that was ultimately what happened, and it's why we're here today, with Sears essentially on the verge of bankruptcy. 

Hill: The Wall Street Journal had a line today. For people who are not looking at the business news every day, for people who are not focused on investing every day, it's probably easy to just say, "Well, this is the narrative that has played out over the last 20 years, which is the rise of e-commerce and bricks and mortar going down." The line in the Journal is, "The company was not helped by Mr. Lampert's unconventional approach to retailing," pointing out that, among other things, he really resisted investing in upgrading the stores and that sort of experience. 

One other thing I'll throw in there with the financial engineering is the brands that Sears owned, that was part of Lampert's strategy, as well. "Well, if we need a little bit of money, we can sell those." They sold off the tool brand that they had.

Argersinger: Craftsman, Lands' End was spun off.

Hill: Yeah. It's kind of sad to see, but, again -- I was saying this right before we started taping -- I'm not sure what I'm more surprised by, the fact that we've been doing this show for nearly eight years, or that we've been talking about Sears going bankrupt for nearly eight years, and they're still in business!

Moser: That headline is killing me. It talks about possible bankruptcy. I mean, come on, man! This thing is imminent! Just say that they're getting everything in order to go ahead and file for bankruptcy. It's imminent! It's not possible anymore!

Hill: Starbucks is in the news, but not because of anything that the company did. Starbucks is in the news because Bill Ackman has announced that Pershing Square, the fund he runs, has invested $900 million in Starbucks. Ackman, no shrinking violet, said that he expects shares of Starbucks to double in the next three years. I will just say, from my standpoint, this is the single biggest holding I have in my portfolio, is Starbucks. And I do not view this as welcome news.

Moser: [laughs] It's the curse!

Hill: It's not even so much the curse. I just thought, you know what? I don't need that right now. And I don't even work at Starbucks. I just thought, if you're Starbucks' management, if you're Starbucks' board, you're looking at Bill Ackman saying, "I'm here. I've got some ideas. Let me share with you the wisdom that I shared with the people at Chipotle when I took a stake there, and Burger King." I don't want to dump all over Ackman, even though I just did, because the guy has had some success. But this just seems like, ultimately, more of a distraction for Starbucks' management than anything positive.

Argersinger: I agree. I mean, he's investing a little over 1% of the shares. This has to be a passive investment. I don't know what value he thinks he can add. In my mind, Starbucks is a business that has a pretty clear trajectory. There's not really a lot wrong with the business. I know growth has been slower, but this isn't a business where I think Ackman's coming in, saying, "Here's a problem. Here's something that's undervalued that I think I can create value or add value to." 

Again, I don't know why we have to keep talking about Bill Ackman. He's definitely a newsmaker. But you start tallying up misses here over the last, say, decade, starting with Target, Herbalife, then Valeant Pharmaceutical, which was multi-billion dollars.

Moser: JC Penney.

Argersinger: JC Penney, right! The list is building here! I share your discomfort as a Starbucks shareholder, as well. I'm not sure what Bill Ackman actually brings to the table anymore. 

Moser: Yeah, I think he's just looking for an easy win, frankly. Given the stretch that he's had... you just listed off some of his failures. That wasn't all of them. He's had a really tough go of it lately. I think, frankly, he's just looking for an easy win. We were talking about this yesterday, I think it's easy enough to get out there and make fun of Ackman for picking Starbucks. Oh, it's no big secret, everybody knows what Starbucks is. But that's kind of the point, too, really. I think we talk about this a lot that -- really, at the end of the day, those great businesses, they're not secrets. They're out there right in front of us. So, I mean, the reasoning behind this, he listed off a lot of qualities that we like about the business. 

I don't think he's going to go in there and try to turn things around or shape their strategy whatsoever, because he certainly has a history of seeming to think he knows more than he really does. Starbucks is obviously a very big company, with management there already set on a strategy. I guarantee you they know more about the business and its future markets than he ever will. 

So, yeah, to me, I really just think he's looking for an easy win here. And I can't blame him. Starbucks is a good business. It's one we like a lot here. I think if you can hang on to it for even longer than three years, you'll be better off.

Hill: Do you think it doubles?

Moser: No, I don't think it doubles.

Hill: I would love to be sitting here in three years doing this show talking about how wrong I was to doubt Bill Ackman that Starbucks shares had doubled in a three-year period. It's such a mature business at this point. As you said, Matty, the trajectory for Starbucks is pretty clear. If I had to bet, I'm betting it's higher in three years. But it's a $77 billion company!

Argersinger: Yeah. To me, Starbucks is more of a total return story. You're looking at dividends, you're looking at buybacks, you're looking at a little bit of growth on the top line, you're looking at what they can do in China. But a double in three years? For that to happen, there has to be the dreaded financial engineering or something like that that does that. Ackman kind of does bring that to the table. I hope that's not the case. To me, Starbucks is a steady 10% returner business. Certainly not a double in three years. I'd love to see it!

Moser: I think it's also worth remembering, Starbucks is probably going to witness a little bit more on the expense line there as it pertains to employees, because they continue to revamp the benefits that they offer. Just a recent example here was the child care subsidy. I think they're expanding that offering to every employee in the company. As an investor, I think you have to applaud that. As an employee, I'm sure you love that. Does it perhaps tamp down potential returns in the short run? Yeah. Is it the right thing to do? Yeah. And I think longer-term, it gives the company more opportunity to succeed, to grow. Those are good things. It'll definitely play into that returns projection over the course of the next three years. I mean, 15% annualized over the next three years -- oh, no, you're saying double over the next three years, it'd be more than that. 15% would be five years. That seems like a really high hurdle. A very high hurdle.

Hill: You mentioned financial engineering. I'll just say this. I've never sold a single share of Starbucks in all the years I've owned it. If Eddie Lampert joins the board of directors, I'm selling some of that stock.

Shares of Snap are down today. They're down about 13% this week, and the stock is hitting an all-time low. There are a few reasons for this. Jason, I have to believe that one of them is the memo from CEO Evan Spiegel to employees that was subsequently leaked to the media, in which, in the memo, Spiegel argues, among other things, that Snap's competitive advantage is that it is not a social media company. It's not?

Moser: Yeah.

Hill: What is it?!

Moser: I think that's the big question after you read that memo.

Argersinger: We've been asking that question for years.

Hill: I don't think that's helping, to have the CEO say, "We're not a social media company." If you polled 100 people who use Snap, 99 of them would say, "Yeah, it's a social media company."

Moser: I think it is. I think he's just in a weird place right now. There's a lot to go through with that memo. Having read it a couple of times, I mean, it seems to me, at least, that at this point, not only is Evan Spiegel in over his head, but he really doesn't even quite know how to define his company at this point. On the road show before they went public, it was a social network. He corrected everybody. They filed the IPO, and they're a camera company. Alright, you're a camera company, what does that mean? Now, they're going through and they're talking about, this memo, the phrase "fastest way to communicate" was brought up 26 times in that memo. That basically was the North Star. That's the North Star for his vision of what Snapchat is. It's the fastest way to communicate.

Now, that's absurd, I think, on a number of levels. No. 1, how do you even really quantify that? No. 2, if you're going in there to try to actually be that, there are a lot of concepts already out there that have you beat on a lot of fronts there, not only in the size of the user base, but I'd venture to say they probably are even faster than Snapchat is. 

So, now, is it a camera company? Is it a social network? Is it the fastest way to communicate? Nobody really knows. Then, today, we see the original content that they are going to start wheeling out. Frankly, as a total Snap bear, I applaud them for that. I think that's probably a low-cost way for them to boost engagement. Now, the flip side to that is, if you look at the original content that's coming out, it's clearly marked for kids between the ages of 13 and 20. 

Hill: It's not Ozark?

Moser: It just doesn't look like very relevant content for a big audience. I think therein lies the big problem for Snapchat. Their audience size is very limited, and I don't know if there's anything they can do to really change that, other than possibly acquiring or developing a new app that does something else.

Argersinger: I'll tell you what Snap is. It's still almost a $9 billion company. When you think about the fact that it's lost roughly three-quarters of its value since it IPO-ed last year, that's still a sizable company. Even at $6.75, I'm looking at it right here, there's still potentially a lot of downside to this business, especially if we see the user base continue to plateau and fall off, as we've seen. Yeah, don't go bottom fishing on this one, at least that's my personal advice here.

Hill: I was just going to say, if Sears has taught us anything, it's that a stock can always go lower.

Moser: Absolutely! There are a lot of lessons learned through a lot of the social-oriented companies that IPO-ed before Snap did. One of the points to really note here is that setting this goal of becoming profitable in 2019 is a very, very lofty goal when you consider the whole picture. No. 1, growth decelerating; No. 2, an extremely bloated cost structure; and No. 3 a potential liquidity crisis. Let's not forget that. They very well could run into a position where their balance sheet becomes a problem. And if they have to go through another capital raise, the market is going to punish this thing in the worst way. I just don't see any reason why you would go in and buy this stock. 

I wouldn't short it at this point, either. It feels like the low-hanging fruit has been picked there, too. It's like it's in the twilight zone. We can sit here and make fun of it on Market Foolery, but don't buy it, don't short it. Just leave it alone.

Hill: Just walk on by?

Argersinger: Avoid it.

Moser: Just watch, pay attention, learn a lesson here or there.

Hill: Just to wrap up, when we started doing this show, the S&P 500 was around $1,280. Today, even with the volatility and the drop that we're seeing, the S&P 500 is over $2,800.

Argersinger: Nice run!

Hill: It's a nice run!

Moser: You're welcome, America!

Hill: [laughs] I wasn't looking for Market Foolery to take credit for that. The larger point just being the benefits of long-term investing, holding on. Since we started, in January of 2011, to now, there have certainly been plenty of days like this. There have been plenty of days where we look at the market and we see a lot of red. And we look at our own portfolios, and we see a lot of red. And it's like, "Oh, boy!" But over the long-term, it tends to work out in the market. 

I just want to say a couple of quick thank yous. First, thank you to you guys and all of the analysts who come here. As I like to point out from time to time, you're not paid to be here, and you come here anyway. I appreciate that. Thank you to our man behind the glass, the workhorse Dan Boyd, who's produced the overwhelming majority of these 1,500 episodes. And thank you, listening! Yes, you! Thank you to the dozens of listeners, whether you just started this year, or you've been with us since 2011! Thank you for listening in your car, at home, taking a walk, doing your work, walking your dog, if you're at the gym going for a run. Thank you for taking us with you! Thank you for choosing us to keep you company! You can listen to anything, and we're aware of that. We don't take that for granted. I mentioned to someone -- I'm not going to say who -- that we were doing our 1,500th episode. And this person, in the course of conversation, intimated an end. Essentially, "When do you think you'll wrap up?" And I was like, "No, we're not wrapping up here."

Moser: Yeah, let's not do that!

Hill: Yeah, we're just getting started!

Moser: We look forward to the next 1,500!

Hill: With this, and with all of The Motley Fool podcasts, we're just getting started. Jason Moser, Matt Argersinger, guys, thanks for being here!

Argersinger: Thank you, Chris!

Moser: Thank you!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!