Hardly a day goes by that there isn’t news about a settlement between some prominent corporation and the U.S. Government. Recently, Target agreed to pay $18.5 million related to its 2013 data security breach. A few weeks back it was Wal-Mart, which settled its foreign bribery investigation with a whopping $300 million settlement. Unbelievably, Wal-Mart has approximately 2,300 employees dedicated to ethics and compliance responsibilities. That is more employees than the total number of workers at 32 companies in the S&P 500. Unfortunately for Wal-Mart and corporate America more broadly, which has been burdened by excessive regulation over the past decade, these internal watchdogs create no revenue, nor do they stimulate creativity or innovation. Yes they serve a purpose, a valuable one at that, but there is a cost that is paid by the entire economy.
The ongoing battle between government and business is far from over, and whether we like it or not, it matters which side wins. Ultimately, the outcome of this struggle will be an important factor in determining the standard of living for the next generation. Again, there are certainly pros and cons related to each side, as there seems to be on just about every issue today. The goal is to find the right balance between government regulation and free-market capitalism. I have to admit, we don’t seem to be able to do that very well.
As he promised, President Trump continues to rescind regulations at a rapid pace, more than any other president in history. Will this have positive consequences for the economy? I hope so. Will this result in problems down the road we aren’t aware of now? Most likely. In a sense, I fear we expect too much from our politicians, yet the catalysts we are all waiting for are in the hands of Congress – tax and health care reform. The prospects for the economy and for the markets hinges on the ability of Congress and the administration to accomplish this daunting task now before them.
On an encouraging note, the stock market continues to perform relatively well as we near the half-way mark for 2017, led predominately by Technology, Consumer Discretionary, and Health Care stocks. These three sectors tend to outperform during growth phases within the economic cycle. To a great degree, growth sectors have led since the election. For this trend to continue, the economy will have to accelerate at some point, and this won’t happen without significant legislative accomplishment in Washington.
Meanwhile, corporate leaders, at the highest level, are under increasing pressure to achieve earnings growth despite an overall economy that is growing ever so slowly. Ford recently announced it was replacing its CEO, Mark Fields, with Jim Hackett, an outsider known for being a change agent; his lack of experience in the auto industry notwithstanding. Apparently, the board at Ford was dissatisfied with Fields’ leadership in the area of driverless cars and other emerging new technologies in the industry. The fact that Tesla recently passed Ford in terms of market capitalization, rankled board members and hurt the former CEO’s reputation. For the record, Tesla’s stock is up 46% in 2017, far outpacing Ford, which has fallen around 10% this year. Interestingly, Tesla is selling about 25,000 cars each quarter, all of them requiring drivers, while Ford sells close to 1,000,000. In terms of relative valuation, the Price/Earnings ratio (PE) for Tesla on 2019 earnings (the first year the company is expected to be profitable) is 55. The PE for Ford on 2019 earnings is 6. With these statistics as a backdrop, I am struggling to understand why Mark Fields should be judged by the relative performance of Ford compared to Tesla. If nothing else, the fact that he was judged accordingly, reflects the growing frustration with economic stagnation as well as the captivating power of new technology. Investors are starved for innovation and will enthusiastically pay a handsome premium for even the potential for significant future growth.
In practical terms, Ford’s primary competition is General Motors, Toyota, Fiat, Chrysler, Honda, and Nissan. Combined with Ford, these companies represent about 75% of auto sales in the U.S. In reality, the board felt strongly that Fields was not up to the task in terms of leading the company to be at the forefront of exciting future trends, like alternative fuel and driverless vehicles, and that sealed his fate.
What does this curious development at Ford mean? Stress in the system is building. Strange things are bound to happen on the global scene as well as in corporate board rooms. Strange isn’t always bad, sometimes it is actually good. From an investment perspective, the senior portfolio managers at Willingdon have lived through strange times before. We intend to take advantage of opportunities and maintain a long-term, analytical mindset. Today, even that sounds, well, a bit strange.