North America

The bear market in analysis…and jobs

When it comes to economic and investment analysis there are a lot of conflicting ideas about, some good, some bad. Occasionally you see something that’s just laughable. I recently read something that claimed – with apparent authority – to be evidence of a strong US economy. It was on the basis of a stuffed toy company’s rising stock price. Even modest digging shows this to be way off the mark. In fact there’s one other simple thing that indicates that structural US weakness is ongoing.

The company in question is Build-A-Bear Workshop Inc. (NYSE:BBW). I happen to have been to one of the company’s stores with my kids a year or so ago, so I know the product they sell.

BBW’s stores are fun places. The idea is to create your own stuffed bear, or other cuddly animal. The kids choose the bear they want. Then it’s taken to a machine where someone shows you how to fill it with stuffing. A heart is inserted to bring it to “life”. It gets a name. There’s a “birth certificate” that records its “birthday” and identifies which kid has adopted it.

As you pass through the store the upselling begins. Clothes are needed. But then there are other accessories – sunglasses, an electric guitar, a bag to carry it in, a bag for it to carry, and so on and so on.

You go in thinking it’s going to cost $15 and come out down $40 per animal. If you really went to town it could cost more. But it’s fun, and it keeps the kids and their parents busy for about an hour. My kids came away very happy. I came away modestly poorer.

So much for the product. What about the company and its stock? The article I read claimed that because the stock price was up nearly 400% in the past three years this was a sign that the US economy is strong. It’s supposed to signal that the US consumer must be alive and well. (The analyst in question shall remain anonymous.)

A look at a longer term stock chart tells a different story. BBW’s stock price is well down from the highs seen in 2005-2007, and in fact moved sideways from 2009 to 2012.

But undoubtedly the price rose strongly in 2013 and 2014 – along with the market as a whole – before heading sideways again in 2015 – also with the market as a whole.

BBW

Do rising stock prices tell us anything about the economy, or about the strength of consumption? Not really. Company sales and profits could be flat or down, but stock prices could be up anyway. There are a lot of factors at work.

Most obviously there could have been multiple expansion – higher P/E and other valuation ratios. In fact that’s largely what’s driven the US stock market in recent years, much more than profit growth. (See here for our latest take on US stocks.)

In the case of BBW closer inspection reveals that it was a loss making company for the four years 2010 to 2013 inclusive (I didn’t look back further than that).

Sales in 2014 were actually 2% lower than in 2010, although 3% higher than 2013. This is hardly evidence of miracle growth in this company, let alone in the US economy.

Ok, so management appears to have finally cut out a bit of cost and turned a profit in 2014. And it’s just about scraping along at a profit in 2015. The company doesn’t pay dividends to shareholders, but the pace of share buybacks has been accelerating.

When a company buys its own stock it means the value of the business is spread across fewer shares, and so the price is driven higher – all else being equal. Company managers like doing buybacks for a couple of main reasons.

…if they can pump up the share price with a bit of financial engineering then they get rich. Option prices usually go up much faster than stock prices.

First, a rising stock price gives the illusion of achievement, even if there is actually little to brag about in terms of profits. Second, managers usually have a lot of stock options. So if they can pump up the share price with a bit of financial engineering then they get rich. Option prices usually go up much faster than stock prices.

If BBW’s rising stock price shows us anything it’s that corporate financial engineering and stock price manipulation are alive and well in the US today. Still, at least this particular company doesn’t appear to be doing it by borrowing money, unlike a great many others.

My point is that the movements of stock market prices, let alone individual stocks, tell us little about the economy. All they tell us is that when stocks have gone up, they’ve gone up. When they’re down, they’re down. That could be for loads of reasons that don’t have much to do with economic conditions.

There could be anticipation of things getting better or worse, even if nothing has happened yet. Sometimes markets get it right. Just as often they get it wrong.

Rising prices can indicate that investors are feeling more optimistic, even over exuberant, but they rarely show that investors have become more intelligent. In fact, at extremes of valuation they often appear to indicate the opposite.

Also, price moves could just be a function of the heavy market manipulation that central banks insist on doing these days. Most recently the US Federal Reserve’s decision to delay an expected (modest) rise in the base interest rate was seen as positive for stocks.

But if the Fed hasn’t yet got the guts to increase record low interest rates then it hardly screams to us that the economy is on a sound footing. On the contrary it means that the US economy must still be incredibly weak.

And so to another piece of evidence which convincingly backs up that idea. This is the so-called “participation rate”. It’s a measure of how many adults are actually going to work, as a percentage of the potential working population. See more on the exact definition and trends here.

At 62.4% the US participation rate has been falling steadily since year 2000 and is now at its lowest level since October 1977. Just think about that for a moment.

At 62.4% the US participation rate has been falling steadily since year 2000 and is now at its lowest level since October 1977. Just think about that for a moment. A lower percentage of Americans are working now than 38 years ago. That’s more than a generation of elapsed time.

US civilian labour force participation rate since 1948

LabourFederalReserve

Presumably a huge amount of women entered the workplace for the first time in the intervening decades – especially during the 1970s and 1980s. This must mean there are huge numbers of men these days who can’t find a job. Or even worse, many of them have simply given up looking.

This weak employment picture definitely doesn’t point to a structurally strong US economy. Quite the opposite.

What’s likely to give us a better understanding of the supposed strength of the US economy? The stock price of a medium sized toy vendor that barely grows or makes a profit? Or the percentage of people who can get a job? It’s clearly the latter. A long term bear market in jobs is a clear sign of a structurally weak US economy.

Remember: be careful whenever you see anyone claiming that price movements in stocks tell you anything about the economy. They usually tell you much more about the person making the claims.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.