The broader U.S. economy appears to be growing solidly, yet many pundits wonder for just how long stocks can continue to rise. Valuations in most sectors are markedly above 5- and 10-year averages. Still, the big picture reveals that employers are creating more jobs (even with labor in short supply), the services sector remains firmly in expansion territory, inflation is tame, and interest rates are low. A look beyond those aggregate figures—a look we got at CES last week—provides some clues as to the reasons to believe U.S. (and global) growth is likely to continue.
The Consumer Electronics Show changed its name to CES a couple years ago, hoping that the world would realize the show is no longer about only consumer electronics. The event now covers new technologies for industries ranging from beauty and health care to industrial automation and transportation. And while many of the products on display across the 2.9 million square feet of show space will not hit the market for many years, the show also provides a look at current applications of the latest technologies from chip makers, lighting designers, sensor developers, system integrators, artificial intelligence programmers, and many others. The real action is behind the scenes in meeting rooms and hotel suites where suppliers and their customers get together to make plans for new products or to negotiate new manufacturing arrangements. Investors also attend in droves to dig into the directions technology is taking and to meet with company management teams to get the latest updates on the current business environment and company prospects. Total attendance this year looks on track to top 180,000, as it has in each of the last couple of years.
Randall Coleman and I logged over 20,000 steps each day, according to our Apple Watches, mixing in discussions with companies on the show floor and one-on-one meetings with company management teams.
Insights on the Economic Cycle:
The trade war hurt. Many companies we spoke with cited the trade war as one cause of the 2019 slowdown in spending by their customers. They noted that uncertainty surrounding changes in U.S. and China tariffs caused customers to cancel some orders and to postpone expansion plans. More directly, the tariffs on China-produced goods, including appliances and electronics, were reported to have caused notable declines in demand for components from U.S. suppliers of parts going into those goods. While there was a slight pickup in production by manufacturers outside of China to fill the gap, that increase was much less than the drop in China’s production. But the clouds are beginning to part. Demand has picked up, orders and backlogs have strengthened, and the outlook for shipments in 2020 has improved. Several companies believe the December quarter marks the bottom for this cycle. They note, however, that this depends on the phase-1 China trade deal coming to fruition.
Inventories are low. Many companies last year responded to the uncertainty in demand conditions from the volatility in trade policy by reducing production, cutting back on inventories, and pushing out investments. Multiple companies we spoke with reported that inventories among customers (or distributors) have become uncomfortably low and will likely be replenished in coming quarters. That’s good news because production will have to outstrip end demand to rebuild those inventories. It also means that production in factories will be running hot for a while, and that raises utilization rates and so profit margins.
Cool Stuff: CES isn’t all future hype.
We won’t try to summarize all the innovations at CES; those eager to learn more should check out CNET’s most excellent coverage here. But we will highlight some areas which play into several of our major investing themes.
While autonomous driving may still look a lot like hype to many of us, the innovations in current driving technology are creating concrete, investable opportunities right now. Advanced driver assist systems (ADAS) are making cars safer and more efficient, as anyone who’s purchased a car over the last couple of years knows. Companies providing microcontrollers, sensors, radar (and lidar), drivetrain enhancements, infotainment, emissions controls, and more can be found in info tech, consumer discretionary, materials, and industrial sectors. All of the improvements in cars require much higher dollar content of advanced components, and this points to a growing market, even if total autos sold remains flat this year (as is widely expected). While many companies in this space have sky high valuations, we are still finding select value opportunities.
CES also showcased the advances currently arriving in communications technology which will benefit consumers directly (more capable smart phones and homes) and indirectly (greater efficiencies in the delivery of services or the manufacture of consumer goods). We see further upside for our investments in companies enabling the next generation of cellular technology (5G) not only for the role they play in smartphones, but also in global communications infrastructure, industrial applications, and medical devices. Regardless of the aging of the U.S. economic recovery, our research and discussions at CES, indicate that companies playing into the 5G rollout appear well positioned for several more years of above-average growth.
Personalized medical and fitness devices are getting smarter and many of the enabling technologies showing up in smartphones are also powering these devices. Measuring your heart rate on your FitBit or Apple Watch is old news, but now we are seeing devices capable of picking up sleep apnea, heart arrhythmia, blood sugar levels, and blood pressure. The spread of technology originating in computers and smartphones to other sectors, such as fitness and health care, automotive, industrial, and consumer, reinforces our view that productivity growth is likely occurring at a faster rate than official measurements suggest. That could be one reason behind the longevity of the current expansion and the modest pace of inflation. It also points to more expansion to come. So while the S&P 500 remains near a record high and its P/E multiple is above the long-term average, we see areas where structural, multi-year growth are creating attractive investing opportunities