Stocks went nowhere on Friday after an eventful week that saw the economic data flow slow, earnings reports slow, while Fedspeak took center-stage.
First, the scoreboard:
- Dow: 17,494, +59, (+0.3%)
- S&P 500: 2,051, +11, (+0.6%)
- Nasdaq: 4,769, +57, (+1.2%)
- WTI crude oil: $48.45, -0.4%
- 10-year Treasury: 1.85%
Earnings season is over, more or less, and so the popular post-mortem is to think about just how much “adjusting” went on at US corporations.
The answer: quite a bit.
A report from FactSet published Friday showed that 19 of 30 Dow members reported both GAAP and non-GAAP earnings. GAAP earnings, which follow Generally Accepted Accounting Practices, include charges companies might incur from selling or acquiring a unit as well as negative (or positive!) impacts from currency fluctuations.
Managements, then, prefer to present “adjusted” or non-GAAP earnings to give a “cleaner” view of their quarterly performance. Think of this as smoothing the bumps in the road. Which, fine.
But in the first quarter of the year, non-GAAP earnings reported by Dow members were, on average, 29% higher than GAAP earnings. So, maybe this “clean” view is just a way to trick the market into thinking a bad quarter was actually good?
The SEC, at least, is reminding companies this is not really how it’s supposed to work.
Adjusting for certain items is fine and many things that do happen to companies over the course of a quarter really are things that happen once. But is it fair to really leave out every charge or anomaly a company thinks will open happen one time if it turns out some version of that thing happens every quarter?
And so on.
Ben Graham was writing about this decades ago and the answer, as tends to be the case, is that best practice for investors is to do your own homework. Or buy a low-cost index fund. (None of this is investing advice.)
But the basic argument, which comes from K.C. Nelson at Driehaus Capital Management, is that persistent underperformance and an abundance of lower-fee options for investors to get exposure to all kinds of things means the more expensive fare offered by hedge funds will become obsolete.
“I believe there will be a culling of hedge funds like we’ve never seen before,” Nelson writes. “I’d estimate the number of funds gets cut in half over the next couple of years.”
This, if you’re a hedge fund manager, seems bad.
However, the other side of Nelson’s called-for culling of the hedge fund ranks is that as more funds shut down and money gets allocated to other — more likely passive — strategies, the remaining managers should have less competition in finding sources of alpha, or investments likely to outperform a benchmark target.
I’d imagine most hedge fund managers currently operating see themselves as likely to be one of these remaining investors, sort of like how 80% of people think they are above average drivers. Anyway.
Elsewhere in hedge fund news, Goldman Sachs was out with its latest hedge fund monitor report, highlighting, among other things, the big stocks hedge funds are selling short right now (Disney is the most popular short).
Goldman’s report, though, really just unearthed the big problem that was hit on in Nelson’s letter: underperformance. Goldman’s Hedge Fund VIP list — “very important positions” — is down 6% this year and trails the S&P 500’s performance by 7.38%.
And while we could go on about how the S&P 500 is not a fair comparison to hedge funds (it’s not!), it is something that many hedge fund investors and certainly hedge fund observers will harp on as a sign it’s something like a compensation scheme masquerading as an asset class.
Which is, in my view, the meanest thing you can say about hedge funds: you’re just the rake.
Not really related but including the words “Goldman Sachs,” Portia Crowe went to the bank’s annual meeting and CEO Lloyd Blankfein talked about confidence.
Gap is a mess.
On Thursday the company reported in-line earnings, announced it would close some stores, not much happened with the stock, but the real story is that the company knows it’s playing “chicken” with its customers. At least when it comes to sales.
Gap Inc. CEO Art Peck said the company had continued to resort to heavy promotion — to get people into stores and also to rid itself of inventory and fashion misfires.
“If we just think about promotion, I think it depends on the brand, because we’re in very different positions on each brand,” Peck said Thursday in an earnings call.
Now the company is seeing the downside as it tries to wean its customers off of the heavy discounting and promotions.
“Same is really true on Banana, where we have backed off” on promotions, Peck said, adding (emphasis ours): “And I will be the first to say that when you start tightening up in promotion, you are playing a game of chicken with your customers … And so we’ve been playing that now for really the last quarter. And we’ve seen more effects on this quite honestly.”
Chicken is a game in which two drivers speed toward each other to see who can go the longest without veering away to avoid a collision. Ultimately, it spells disaster.
From February: sales are coming to clothing store near you. Discounts, however, cut both ways.
In related mall-style retail news, Footlocker reported earnings that disappointed and citing slowing sales of specialty shoes from NBA stars including Kevin Durant and LeBron James, according to The Wall Street Journal. Now, this might seem like more of the same: a mall retailer doing poorly because no one goes to malls anymore.
But pseudonymous finance blogger The Fly had a really sharp view on the Footlocker story that it’s really about the NBA and Footlocker together looking at peak popularity and what The Fly calls a “generational short” for both the retailer and the league.
Worth noting: the NBA’s salary cap is expected to jump from $70 million to $92 million this summer. This is a monumental shift that will give each team about 25% more money to spend on players and is a result of the league’s latest enormous round of TV contracts. So, if you wanted to call a top, this would seem like the right time.