As the third quarter slowly winds down, economic data announcements remain front page stories as the economy recalibrates amid the Delta variant. Even though labor markets and supply chains remain challenged with a less linear recovery and supply bottlenecks, the consumer price index (CPI), an inflation gauge, slowed its’ growth with the smallest gain in seven months as consumer prices increased only 0.3% (0.1% less than consensus). Improving inflation helped boost sentiments and treasury rates on the notion of contained fears, Fed flexibility, and confidence in the current administration’s economic stimulus. Furthermore, the labor market’s mixed recovery approaches an inflection point on September 21st when government stimulus intends to scale back, potentially standardizing the boost in the labor market recovery in the near-term.
Even though some believe these economic takeaways make a case for the Fed to change their course of action, the Fed will likely still taper (as expected), remaining consistent with the notion that inflation is transitory (which has been the Fed’s belief for months). However, what is likely to change is the consumer. Historically, consumer cyclicals, value, and small cap companies perform best during the beginning stages of the business cycle or where we currently reside. As society slowly returns to a degree of “normal” and the economy reopens, the consumer appears to be the navigator of future societal norms, consumer patterns, and industry actions (which remain highly correlated to the consumer’s reaction). In many instances the consumer is the baseline of individual, societal and macroeconomic sentiment. Additionally, as we have discussed in “Behavioral Economics: The Psychological Shifts Driving the Current Financial Ecosystem” and “Carvana’s Subtle Outperformance: Seamless Integration of E-commerce with the Auto Industry,” individuals (or in this case consumers) can employ irrational decision making spurred by emotional integration, asymmetric information, and cognitive biases. Therefore, the infinite probabilistic combinations of the consumer’s decision nexus coupled with the Delta uncertainty, economic data dependence, and overvaluation in segments of the market can combine to make determining a path forward slightly erratic. However, that does not mean that all assumptions will be erroneous. Nonetheless, we can take a top-down overlay to formulate our base case. For instance, as investors we should first look at the global economic recovery, then the domestic economic rebound, industry trends and performance seasonality, subsector competitive advantages, idiosyncratic outliers, and lastly the investable securities.
With that said, the global economy’s recovery appears staggard. Developed markets are recovering exponentially faster (except for China with 69% fully vaccinated) than emerging markets as vaccinations and economic accommodation outpace. However, even though the US does not rank in the top ten (#43) in the percent of their population fully vaccinated (54%), the domestic economy has rebounded much faster than its’ European counterparts. With COVID uncertainty lingering from the Delta variant and cemented COVID induced status quos, industry trends appear to be in the most speculative state of change seen in decades. E-commerce, convenience, sustainable product alternatives (EVs), taboos on travel/leisure, permanence of work from home, blockchain integration/cryptocurrencies and staggard back-to-school initiatives culminate into a unique once in a lifetime industry wide shift towards technological innovation and advancements. This shift will eventually highlight which subsectors could benefit and loose as a result of their competitive advantages and core competencies. The shift of industry norms increases in complexity as irrational and unpredictability of the everyday consumer create pockets of novel opportunities. Therefore, once the global and domestic economic backdrop is defined, the industry trends can be understood in the context of the consumer and the subsector competitive advantages will be highlighted, enabling the investor to identify the most optimistic subsectors for any idiosyncratic outliers that have tangible potential from a fundamental or behavioral investing outperformance. Therefore, during times of colossal societal and economic shifts a top-down overlay with a bottom-up analysis can yield the best returns.
What’s an example of a novel application of this strategy?
The answer to this question can be seen in the modern reseller model, specifically the strategic “use” of resellers by traditional large brand name retailers. Resellers can be retailers themselves, wholesalers, or e-commerce affiliate marketers. Traditionally, a reseller would buy goods for resale and make a profit. This economic arbitrage is created when a retailer does not optimize their sale price, generating a larger consumer surplus. In essence, the larger consumer surplus is created from a false equilibrium price or as we discussed in “The Disequilibrium of Innovation,” a disequilibrium. Resellers can take advantage of this disequilibrium through repackaging, faster deliveries, realistic pricing patterns, etc.
Lately, larger retailers have recognized that this disequilibrium has muted scalable economies of scale and have started to foresee the increasing scope and growth trajectory of e-commerce-like models. Therefore, companies like Macy’s, Walmart, JCPenney’s, and other larger household brand names have scaled their vendor partners, increased their merchandise availability and streamlined their e-commerce platforms in an attempt to contain reseller reserves. However, as e-commerce becomes more mainstream and continues to grow exponentially over the next five years it may become increasingly difficult to contain resellers the traditional way. Therefore, acquisitions and industry consolidations may follow. Already visible in some segments, smaller reseller focused companies remain a high acquisition priority for large conglomerates to strategically contain their disequilibrium, optimize their economies of scale, and continually grow their business prospects. In short, the new normal of consumer patterns and the integration of technological innovation for the customer experience will not only have an impact on how retailers think about corporate growth organically, but it will likely spur inorganic growth, industry consolidation, and R&D/intangible asset purchases in an attempt for companies to optimize their strategic assets, contain economic arbitrage, and sustain growth. Even though e-ecommerce and online shopping solutions appear to overshadow their brick-and-mortar counterparts, the traditional retailer is not going away anytime soon, at least not the large brand names. The challenges smaller retail stores may face in the near-term could be offset by M&A arbitrage opportunities and the corporate synergies, partnerships, and collaborations small retailers can have with these larger brand names. As we have seen in the past within other industries such as financials, industrials, and utilities, technological innovation can consolidate the industry as a result to product/service homogeneity. This remains a key takeaway of the economic recovery. The understanding that technology not only spawns’ niches and new opportunities, but it also squeezes out the middleman. Understanding this simple yet complexly applied takeaway can put investors and fund managers at an advantage when navigating the impending economic recovery, social uncertainty, and seasonal tailwinds.
All in all, neo-classical economic theories have their limitation, but understanding the nuances of economics from a macro level can have tangible influence on any bottom-up fundamental analysis. As displayed with the future containment of the reseller to the non-linear economic recovery to the predictably irrational consumer, technological innovation is a two-edged sword. On one end it causes industry consolidation, while on the other end it generates new niche opportunities. Therefore, investors must remain cognizant and limit their influence from street opinion biases about innovation and focus on the commonsense macro developments and their fundamental analysis investing approach. In short, a disciplined manager remains poised to outperform during the ensuing economic recovery.