October 25, 2017
Dow Jones Average: 23,321
S&P 500 Index: 2,553
The Amazon Effect
If you type in www.relentless.com on your computer it will forward you to Amazon’s home page. The internet address hints at an early name considered in 1994 by Jeff Bezos, the founder of Amazon. It certainly reflects his approach to business. The company went public in 1997 and in the twenty years since it has become nearly a $500 billion company. It has reshaped many elements of the retail industry, built out an industry-leading internet infrastructure business, and dived into the entertainment business. In 2017 Amazon has been more aggressive, more disruptive, and more impactful to investors, than in any prior period. There is a natural tendency for large companies to try and build protective moats around their profits. They try to fend off new competition and in the process they can ossify, especially in the fast-developing technology industry. Amazon appears to be doing the opposite. Their relentless competitive push and sweeping ambitions are only accelerating with increased size.
These new ambitions were made apparent this spring when the company acquired Whole Foods. Amazon had intimated that it would enter the traditional grocery industry in the past and it has long sold groceries online, but this was a bold entry that had immediate effects on the competition. Kroger, which is the largest independent, publicly traded, supermarket company in the United States, has lost 1/3rd of its value since Amazon announced it was purchasing Whole Foods. A month after that announcement, Amazon filed a trademark around a new meal-kit business, entering a business made popular by the company Blue Apron. Blue Apron has lost half its value since its IPO this summer. Most recently, Amazon has declared that they are considering entering the pharmacy business. There is no firm commitment from the company and no details on what their business model might look like. Since that speculative announcement just a few weeks ago, shares of Walgreens and CVS have fallen by 10%.
These recent losses borne by investors pale in comparison to the the toll taken by Amazon’s earliest competitive casualties. Companies like Sears and J.C. Penney have no adequate response to Amazon at this point and their shares are moving closer to zero. The entire department store industry has shrunk to the point where it’s irrelevant to the overall stock market and its valuation is 1/20th the size of Amazon’s. However, if their fate is immaterial to the stock market, it matters tremendously to the half million people employed by these companies. While the national debate currently hovers around the job losses in smokestack industries, it is important to remember that department stores employ nearly four times as many people as do steel plants and coal mines in this country.
Amazon wields enormous power and uses it to a variety of ends, both positive and negative. Many of us use their services, and dozens of cities are currently vying to be the location of Amazon’s second headquarters. Boston has offered $500 million in tax abatements to lure Amazon to the city. Amazon, at its size, has retained the disruptiveness, aggressiveness, and relentlessness of a much smaller upstart company. Because of this, more and more investment discussions and decisions need to incorporate the far-flung effects this company has, and could have, on the larger business world.
The stock market climbed higher in the third quarter in a slow, steady fashion. Price volatility in the broad indices has been at record lows for months. It has been sixteen months since the Standard & Poor’s Index corrected by more than three percent, and daily moves in the market have rarely exceeded one percent. This serene environment has emboldened bullish investors, who have begun to think of stocks as a riskless way to earn outsized returns. No market is without risk, least of all stocks.
We captured profits in recent months on certain positions that we feel had run their course. The proceeds went mostly into cash reserves as new buys are hard to find in this high market. Portfolios are in a slightly more defensive position due to the sales, which we think is appropriate given current stock valuations. While the shares of most large companies are fully or richly valued in our opinion, we continue to look for opportunities in companies that are less popular or simply ignored. Certainly many of our current investments are not household names. Yet those same investments, by and large, have driven our performance in 2017.
There have been signs of inflation increasing for the first time in years, perhaps as a result of a rise in commodity costs and a tightening labor market. Inflation is still historically low, at about two percent, but any rise encourages the Federal Reserve to raise interest rates in their effort to restore normalcy to the bond market. As investors anticipated further action from the Federal Reserve, short-term and long-term rates began to rise late in the quarter, and have continued to edge higher in October. It still does not reward an investor to buy most longer-term bonds in our view, so we maintained a basket of short-term corporate and treasury bonds for many clients.