22 Aug Capital 19 Catch-Up
Weekly Index Movement
| S&P500 | -1.2% |
| Nasdaq | -2.4% |
| Aussie All Ords | +1.0% |
The major U.S. stock indexes were little changed through most of the week but ended with a decline on Friday, snapping a string of four consecutive weekly gains for the S&P 500 and NASDAQ.
Concerns are growing once more of just how many interest rate rises the Fed is going to bring us. The strange thing is we all know they will keep raising until inflation falls.
Yes, inflation was lower in July (+8.5%) than June (+9.1%) but a single month isn’t enough to change the course of interest rates.
The good news is Oil continues to fall and ended the week at $88/barrel. This is well down on the highs we saw of $120/barrel in June.
Sales of existing homes fell for the sixth consecutive month in July as a recent rise in mortgage rates continued to weigh on the U.S. housing market. Sales fell 5.9% versus the previous month and 20.2% relative to July 2021, according to the National Association of Realtors.
Again, no surprise to anyone here. After 2 years of outsized gains, shock and horror, the real estate market is slowing down because mortgage rates are now up close to 6%. Who would have thought that would happen?
The US Retail Sales report was broadly better than expected. Excluding annual inflation (headline CPI +8.5 percent in July), Retail Sales and Food Services revenues were up 1.8 percent year over year (+10.3 pct headline growth).
That is the highest inflation-adjusted Retail Sales growth since February 2022 (+9.5 percent) and only the second positive month since then. The monthly sequence of inflation-adjusted Retail Sales is as follows: March (-1.5 percent), April (-0.4 pct), May (+0.2 pct), and June (-0.5 pct).
This pushed 2-year and 10-year Treasury yields higher, which is what is now leaning on further stock price gains.
This chart shows the progression of 2-year yields since the start of 2022 and compares them to the S&P 500. The lows for US large caps on June 14th, down 23 percent from the start of the year, coincides to the day with the peak in 2-year yields. Since then, 2-years have been quietly trading in a band. Since they are primarily priced off expectations for future Fed monetary policy, that has been enough to convince equity markets that future monetary policy was becoming more predictable.
However, the strong retail jobs report, showing a reacceleration of consumer spending, has caused the 2-year yield to nudge higher towards its previous highs in June.
For stocks to see further gains from here, we need to see the 2-year rate fall back again.
The offsetting positive for stocks, is that July’s retail sales do bode well for current quarter earnings.
Where to from here?
We think the most likely outcome is some further volatility this week. Stocks got a little too excited and became overbought. They can work their way out of that situation either by stock prices falling, or prices flatlining for a period so the averages can catch up.
Either way, we see no reason to rush out and buy stocks right now. But we would get excited if prices were to fall this week.
Turning to Australia, we have the strange mix of companies reporting massive earnings but Chinese data showing lessening demand.
BHP announced net profits of $30.9billion and a half-year dividend of US1.75 which is about $2.50 in Aussie terms. Add in franking and you get a tax-equivalent $3.57
With BHP trading around $41 – that equates to a yield of 8.7% for this one single dividend payment.
We wish this was as good as it looks.
For, whilst this payment might be massive, the market is not expecting them to repeat this in future.
The BHP result saw less profit from iron ore but that was more than made up for with coal profits.
The reason for the falling iron ore profits is China.
Chinese urbanization and industrial capacity scaling has been the incremental driver of demand for commodities over the past two decades.
That party is largely over: net Chinese demand for everything from crude oil to iron ore is starting to slide. While manufactured goods inputs like copper are still holding up for now, incremental demand for raw materials from China is likely to shift from the largest in the world to a negligible contribution, even for domestic Chinese value chains.
This is why the BHP yield looks so attractive. The market is not expecting a repeat next time.
Talking of yields, Telstra (TLS) announced full-year profits of $1.8b, down 4.6% on last year. They maintained the same dividend as last year, which means a full-year payment of 16.5cents.
After franking that is 23.5c for a tax-equivalent yield of 5.7%
Telstra booked a net profit for the year of $1.8b but somehow returned $1.9b to shareholders. How long can they maintain that for?
It is because, of that 16.5cents dividend, 3cents of it comes from a promised capital return to shareholders from the nbn rollout. That is now complete so expect next year’s dividend to be less.
Let’s say they keep it at 13.5c. That would make the tax-equivalent yield 4.6%
If you want yield, you could stick your money in a term-deposit for 12 months and get 3.3%.
What would you rather? Have your money invested in a company with profits going backwards and your capital at risk for a 4.6% yield, or get a 3.3% yield with a capital guarantee?
Us too. We would be selling our Telstra shares if we had any.
It’s a different story with New Hope Coal (NHC) though. It’s latest quarterly report shows a profit of $645m which makes the full year somewhere around $1.56b. They have sold around 12% less coal than they did in 2021 but coal prices are significantly higher.
Expect a very hefty dividend announcement when NHC announces profits on September 20.
CatchUp Stock Tips
Our shipping stock, Ardmore (ASC) has been a great performer but TXN gave back its gains last week – that just means anyone who missed out gets a second chance to pick this stock up.
| Buy Date | Buy Price | Current Price | Gain / Loss | Stop Loss | |
| MSFT | 1 Aug 22 | 277.82 | 286.15 | +3.0% | 240.00 |
| TXN | 1 Aug 22 | 177.94 | 176.45 | -0.9% | 145.00 |
| ASC | 8 Aug 22 | 8.52 | 9.94 | +16.7% | 6.40 |
| CDNS | 15 Aug 22 | 188.83 | 188.04 | -0.4% | 130.00 |
Our new stock for this week is United Health (UNH)
Buy United Health (UNH) with a stop loss at $450
There is a whole lot to like about UnitedHealth Group (NYSE: UNH) as the largest insurance provider in the US with two primary business platforms: ‘UnitedHealthcare’ (provides health benefits) and ‘Optum’ (for health services). The company’s Optum businesses have been a source of strength in recent years, and we expect the strong expansion to continue.
On July 15, UnitedHealth Group reported second quarter 2022 earnings that beat both consensus top- and bottom-line estimates. The health care giant also boosted its non-GAAP adjusted EPS guidance to $21.40-$21.90 for 2022, up from $21.20-$21.70 previously, in conjunction with its second quarter earnings update. Please note that this is the second time UnitedHealth Group has increased its earnings guidance for 2022.
UnitedHealth Group’s GAAP revenues grew 13% year-over-year to reach $80.3 billion in the second quarter of 2022 due to solid growth at both its UnitedHealth and Optum divisions. Its GAAP operating income climbed higher 19% year-over-year to reach $7.1 billion as UnitedHealth Group benefited from revenue growth, economics of scale, and meaningful improvements in profitability at its UnitedHealthcare division.
Its non-GAAP adjusted diluted EPS came in at $5.57 in the second quarter, up from $4.70 in the same period in 2021, as UnitedHealth Group benefited from strong net income growth and a reduction in its diluted outstanding weighted-average share count on a year-over-year basis.
The company generated $11.0 billion in free cash flow during the first half of 2022 while spending $2.9 billion covering its dividend obligations and another $5.0 billion buying back its stock. We are enormous fans of UnitedHealth Group’s stable cash flow profile. Additionally, UnitedHealth Group is very shareholder friendly.
UnitedHealth is in the process of acquiring Change Healthcare Inc. (CHNG) through a ~$13 billion deal that has faced sizable regulatory headwinds (the merger agreement was extended to the end of this year). This deal aims to bolster UnitedHealth Group’s billing and payment solutions operations, though the acquisition may ultimately not end up going through.
Additionally, UnitedHealth Group is working on acquiring LHC Group, Inc. (LHCG) through a ~$5.4 billion deal that would improve its ability to provide in-home health care services. Through its Optum UK unit, UnitedHealth Group is also working on acquiring UK-listed EMIS Group Plc for approximately GBP£1.2 billion (~USD$1.5 billion), which provides software, services, and technology used in the health care sector.
These deals, if completed, will not significantly weaken UnitedHealth Group’s financial health given its large net cash position on hand at the end of June 2022. UnitedHealth Group is a highly acquisitive entity, though it possesses the ability to quickly rebuild its balance sheet if needed given its strong free cash flows.
Warning
Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account.