Ok, so the corporate earnings season is just about done, and it was pretty solid; even when allowing for how ugly Q1 2016 looked with energy write-downs clouding the picture.

In the future, when you see a particular sector being trashed just remember the cries of Armageddon during the crude oil crunch. 

Then take advantage of the situation.  

Can anyone say retail?

As experts would have it retail is dead, useless and ready for the trash heap.

Except that while I was at Mall of America this weekend it looked pretty darn busy to me. 

I digress.

Lost in the Amazon...

In his most recent Woodstock in Omaha, Warren Buffett said that he missed Jeff Bezos and Amazon completely. And he offered a one-word answer as to why: "Stupidity."

So let's look into AMZN and how we might see its latest impact in the most recent GDP data.

Amazon has been described as a "piranha-like corporation that eats up retailers, particularly the anchor stores, and doesn’t even leave the bones."

But you know, I remember about 20 years ago when Wal-Mart was being described in just about the same way.

Here’s the view from economist and President of Yardeni Research, Dr Ed Yardeni from an IBD article last week: “Amazon is killing lots of businesses. In the process, it may also be killing inflation.”

I would add that inflation is being killed by the entire process of Generation Y growth.  They’re all about multi-tasking, cutting layers of fluff and going straight to the end point. 

And I’m confident we’ll be shocked at margin growth over the coming years as these Millennials move deeper into the corporate management structure. 

Granted, they’re just getting started - so let's be patient. 

Yardeni’s Take

Dr Ed went on to say, "Using Chief Executive Jeff Bezos’ playbook, Amazon has pummelled rivals with price cuts enabled by its smart logistics and relentless drive toward efficiency.  Labor-displacing warehouse robotics give Amazon a cost advantage, and it aims to one day deploy delivery drones to extend its edge all the way to the customer’s doorstep." 

In a nutshell, of late it has Gen Y DNA all over it.  

Amazon’s casualty list already is formidable. Over the years the company has left consumer-facing retailers such as Borders, Circuit City and Sports Authority in the dust. Department chains have been closing stores, unable to answer the e-commerce challenge as the article went on to say.

Consider the following: Amazon is going after big-box retailers like Wal-Mart and Costco by leaning on their consumer staples vendors to sell their products (which are packaged in big boxes) to consumers direct through Amazon’s distribution system.

The $1.3 trillion US grocery market could be Amazon’s biggest potential source of revenue upside.

The IBD article noted, “Amazon hopes to eliminate store cashiers at Amazon Go convenience stores now being tested. Amazon Go stores use sensors to track items as shoppers put them into baskets. The shopper’s Amazon account gets automatically charged.”

Amazon is also going head-to-head with Netflix and all of Hollywood by producing and distributing movies. 

On-demand & logistics channels galore  

IBD reported: “Amazon recently was granted a patent for automated, ‘on-demand apparel manufacturing.’ The patent highlights plans to go beyond clothing into other fabric-based products, such as footwear, bedding and home goods."

Amazon is also bringing more of its logistics and delivery operations in-house.  This suggests it is aiming to compete with, and eventually chew up, the airfreight, trucking, and home delivery industries.

The cloud may be the largest event. But after this weekend and a slew of ransom attacks keep in mind that security will be massive in the future.  

As corporate America outsources more computing work to Amazon's AWS unit and other highly automated cloud services, companies buy less hardware and software for internal data centres.

The "cloud" is deflationary and the fear is it collapses markets. It’s a sea-change to be sure, but we have weathered lots of sea changes and each one brings about new opportunities to build upon.

Buffett and IBM

In a CNBC interview, Warren Buffett said he sold off about a third of his company’s 81 million shares of IBM since the start of the year.  

His reason?  “I would say what they’ve run into is some pretty tough competitors,” Buffett said. “IBM is a big strong company, but they’ve got big strong competitors too.”

Finally, in the latest nominal GDP data release, capital spending on software and on information processing equipment both rose to record highs during Q1-2017 of $346.2 billion and $334.3 billion. 

However, keep in mind that spending on computers and peripheral equipment, included in the latter category, has been effectively flat in both current and inflation-adjusted dollars since Q4-2010 at around $82 billion according to Dr Ed.

This flattening out effect, after rapidly increasing since the early 1980's, coincides nicely with the steady shift to the cloud since 2006.

It's easy how companies can be more efficient and effective

Companies simply don’t need to buy computers when they can sign up for the computing power and storage they need on the cloud, which uses all layers of hardware much more efficiently.

But don't fear this. It’s the law of business, and little different from the great plains of Africa where we once lived in caves: Adapt or die.

The bottom line  

Retail has seen this before.  It was called Wal-Mart back then. And retail will adjust again. You see, as compelling as the AMZN story is and as powerful as they are, we have seen it all before.

The shift will continue. The battle is on.  

There is always value amongst the ashes, it just takes work and patience to find it.

(Anyone remember Best Buy's death march a few years ago?)

Speaking of consolidation…

As Boomers age, a large part of the markets going forward will be driven by the search for expanding dividends. 

Utilities are the normal thought when it comes to this topic. And while the fear of interest rate increases has harmed the sector over the last year or so at times, as each stumble unfolded we suggested in these notes that the long-term trend is likely stable - and one that won't be massively hurt by an adjustment in rates.  

Besides, the interest rate fears are largely misunderstood in our view. 

The deflationary pressures (some noted above) in our system will provide for solid growth in the future without the normal tinge of feared inflationary pressures from the past.

The economy is changing. And the generational baton being passed is all about new efficiencies. 

As such, we suspect utilities are just getting a second wind for the patient investor.

Dna Chart

The larger picture?

Remain patient and focused on the long-term. 

Poor investor sentiment remains an underlying positive and the Barbell Economy continues to move along nicely - even though earnings seasons tend to create a lot of internal interruption, chop and short-term reactions.

And one more thing: Pray for a market correction, then take advantage of it.  

Mike Williams
Founder and Managing Partner

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