Getting Better? Or Worse?

Retail sales crushed it on Friday. Early estimates are that Black Friday retail sales jumped 8% over last year to $23 billion. 

It’s the best gain I’ve seen in years. And it was somewhat predictable. The U.S. economy has continued to add jobs. Consumer sentiment is high. Happy people with jobs tend to buy stuff…

Question is, is that enough to finally put a floor under this stock market meltdown and get prices moving in the right direction? 

The U.S. economy is a complicated machine. I’m not even going to try get a handle on each of its moving parts and how they work together. I like simple. And that’s why I like the concept of inertia. It’s been my experience that the U.S. economy will continue to move in one direction until it is acted on by external forces. 

The inertia for an economy is pretty simple: people going about their daily lives. 

Demographics. Populations grow, more people buy more stuff, more people get jobs to make stuff, corporate revenue and profits grow…

It’s not a perfectly straight line. There will be zigs and zags. But over time, inertia will keep the U.S. economy moving until something happens to change it, to change the way people go about living their lives. This “something” is a shock to the economic system. 

Economies don’t tend to shrink on their own. If nothing changes, you’ll likely go about your business tomorrow the same way you do today. But of course, change is the one thing we can count on. Nature never stays in balance for long…

The GrubHub Lesson

The correction that started on October 3rd has been all about the fact that earnings growth is slowing.

Take GrubHub (NYSE: GRUB) for instance. You may not know the company, and that’s fine. GrubHub is a food delivery app — put it on your phone, and you can order delivery food from a whole bunch of restaurants. GRUB takes a percentage, and that’s how it makes money. 

Back in the summer, GRUB shares rallied up to the $160s. It was posting fantastic earnings numbers. And the story was pretty good. Sure, no one should expect there to be a high barrier to entry for food delivery. But the theory goes that once a company hits a certain point of critical mass, its inertia will carry it forward (unless management does something really stupid). In other words, once you put the GRUB app on your phone and start using it, why would you delete it and get something else? 

So GRUB had this business inertia. And it was also riding the smartphone inertia. The U.S. smartphone market is saturated. And smartphones are really useful — just look at Uber. Plus, GRUB has bought out its significant competitors.

There have been food delivery apps for a decade at least. But it seemed like GRUB had really figured out the market and had a little luck of being in the right place at the right time.

Then the company reported second quarter earnings…

Revenue was roughly in line — I think it missed a little. Earnings per share was really bad. I mean, GRUB still made money, but expenses were up, and the company said it will stay that way because it is having to spend more to maintain its market share against competitors. So much for that whole “figured it out” thing. 

GRUB has been cut in half since that earnings report. $160 down to $80. This is what happens when the growth story changes. And there’s been a lot of it in tech-land lately.

Every Stock Is a Story Stock

Investors tend to imagine the best-case scenario for companies like GRUB when the market is running. And the news and earnings flow tend to beat expectations and justify the best-case scenario and higher prices. 

Investors switch to the worst-case scenario when stocks start falling. And ironically, the news and earnings flow tend to surprise on the downside. I’ve learned this stuff over the years.

Six months ago, I had a colleague ask about GE (NYSE: GE). I don’t really follow GE, but I did do a pretty exhaustive dig after the dividend got cut. And I told my colleague that I thought GE would get a lot worse before it got better. 

Eventually it will switch, but sheesh, I’ve got no idea when. 

Now, if you read my predictions 2019 article from last week, you know that after 10 years of being an unrelenting bull, I’m feeling a little bearish. But there’s a very important point to make about this. Actually, two points.

One, the stock market is saying “danger,” but the economic switch hasn’t been flipped yet (hence the nice Black Friday numbers).  

Two, recessions haven’t been eradicated. Again, we had the mother of all economic shocks 10 years ago. Nine to 10 years before that it was the tech bubble and 9/11. In 1997, the Asian currency crisis nearly sparked a global depression. My guess is the next shock to hit the U.S. economy starts in China. 

Right now we are more likely to get more good economic data that follows on the Black Friday report. The China/recession potential is very much background noise at this point.

Until next time,

Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.