12 Dec Capital 19 Catch-Up
Weekly Index Movement
| S&P500 | -3.4% |
| Nasdaq | -3.6% |
| Aussie All Ords | -1.3% |
What a difference a week makes.
The prior week’s Powell-fueled risk rally that landed the S&P 500 on top of its 200-day moving average for the first time since April has now been fully reversed and then some.
What was an upside breakout is now a failed upside breakout. A declining moving average ready to be rejected has again become a declining moving average that must be respected.
This meant US markets had their worst week since September but the index still sits relatively high.
I say relatively because it is all about valuation.
At the 4000 level the index is trading on 18 times trailing earnings. The long run average is 17. Trading on an 18 multiple says the market is not worried about a slowdown in earnings next year.
This is where things start to confuse me.
The Fed is not done with raising rates. This we know for a fact. What we don’t know is where the Fed will top out at. The market thinks it will happen in Q2 next year but worryingly that rates will then fall by the end of 2023.
What could cause rates to fall next year? Presumably, the only thing could be either the economy slows so dramatically that the Fed pivots to an easing basis or inflation slows so fast as to go under the Fed’s 2% target.
Inflation is now +7.7%. Yes, oil has fallen this week to $72 which will help to reduce inflation but we are seeing offsetting gains in the services.
We’ll find out a bit more when inflation is announced on Tuesday.
It’s a case of – be careful what you wish for.
Surely an economy that slows so fast as to cause the Fed to reassess is not healthy for company profits?
Prior recessions have seen earnings fall by around 20%. But there is no sign we will have a recession yet.
Except if you believe in the yield curve inversion.
2 year yields represent short term interest rate expectations whereas 10 year yields are more about long term inflation expectations.
History shows that when this difference between the two is negative, a recession follows. 2-10s have been inverted for some time and the depth of this inversion is growing. It is now at a level beyond what occured prior to the last 4 recessions.
Of course, just because it is inverted does not mean we will definitely have a recession, but it has been a fairly good canary previously.
Recessions have also been a good fix for inflation. So it isn’t all bad.
But a recession will be all bad for stock prices. If it happens. And the market is saying it will not happen right now.
While on the topic of 2 year interest rates. They can be used to explain stock price movements quite well
When the 2 year rate increases, stock prices fall. When it stablises, stock prices rally. At least, that is what has happened this year. Keep an eye on the 2 year yield, if it starts to move higher stock prices will be in trouble.
The other big event this week will be the Fed interest rate decision on Wednesday.
Based on what he said 2 weeks ago, you can be sure he will deliver a 50bps raise. But listen to his comments after. I bet he says something along the lines of, yes this raise is less than we did last month but it does not mean we are going to stop anytime soon and you need to factor in higher interest rates for a long time.
Stocks are only factoring in higher rates for another 6 months and then for them to decrease. I just cannot see this happening. There is no way inflation will be below 2% in 6 months. In fact, I am growing increasingly worried inflation will head higher again due to government policy. More so in Australia than the US, but Biden is also spending more.
I can’t quite believe what Albanese is doing to Australia. He obviously does not care about inflation. “Not my problem, go talk to Philip Lowe” (he isn’t on record for saying that but I bet he did)
Everyman and his dog has successfully negotiated a pay rise and his new labor laws make it even easier. Even the aviation industry firefighters successfully got a pay rise. I didn’t even know we had aviation industry firefighters. But apparently, they are so rushed off their feet with work they need a pay rise.
You better not ask me what I think about the government interfering in capital markets for energy either. This coal price cap gets my heckles up. When has government intervention ever worked out well? I’ll leave it at that.
In summary, I am worried markets are not factoring in interest rates remaining high for a long time, not factoring in any kind of slowdown in profits and governments are only fueling the inflation fire which will add heat to interest rates.
I’m sticking with deep value stocks that pay good dividends because I can’t see this ending sweetly yet.
CatchUp Stock Tips
| Buy Date | Buy Price | Current Price | Gain / Loss | Stop Loss | |
| TXN | 1 Aug 22 | 177.94 | 174.26 | -2.1% | 145.00 |
| ASC | 8 Aug 22 | 8.52 | 14.49 | +70.1% | 6.40 |
| CDNS | 15 Aug 22 | 188.83 | 163.67 | -13.3% | 130.00 |
| UNH | 22 Aug 22 | 541.39 | 539.20 | -0.4% | 450.00 |
| GMS | 5 Sep 22 | 6.50 | 5.46 | -16.0% | 4.00 |
| AAPL | 12 Sep 22 | 159.59 | 142.16 | -10.9% | 130.00 |
| CRK | 19 Sep 22 | 18.22 | 13.97 | -23.3% | 12.00 |
| OXY | 24 Oct | 70.81 | 62.60 | -11.6% | 58.00 |
I’m determined to wait for NINE to fall to $8. It is at $9 right now. Hold in there and wait.
Buy Nine Energy Service (NINE) at no more than $8
Nine Energy Service, Inc. is a service provider for the unconventional oil and gas industry in North America and abroad. It does cementing and coiled tubing services for oil drillers
Our thinking on this one goes like this. Capex spending by the oil industry has fallen dramatically. That hurt Nine back in 2018 and 2019 and was compounded by the Pandemic in 2020. But Nine survived and was made lean during the process.
With the new upcycle in the oil price and increasing demand from Europe the US oil drillers are likely to expand capex going forward. They can do this because they are making more profits so have money to spend and have a longer-term demand structure from Europe. Biden would even be happy as it might keep a cap on oil prices.
For a company the size of Nine, increased Capex spend by the big guys is massive. We saw the first signs of this in their Q3 results
“Q3 was a very strong quarter for Nine,” said Ann Fox, President and Chief Executive Officer, Nine Energy Service, “driven mostly by price increases across our service lines, as well as increased volumes within completion tools, which enabled us to drive strong incremental margins again this quarter.”
One aspect we don’t particularly like is the amount debt they run. But they are addressing this
“De-levering the balance sheet continues to be a top priority for Nine. During Q3, we repurchased $13.0 million par value of bonds for $10.1 million of cash or 77.7% of par, leaving $307.3 million outstanding. I am extremely happy with our team’s ability to take over $90 million of debt off the balance sheet, while also maintaining strong liquidity throughout one of the most volatile environments we have faced. The Company is poised to generate free cash flow going forward and we plan to continue to reduce our financial leverage. Going forward, we believe that Nine can de-lever through a combination of growth in profitability, as well as reduction in net debt.”
When it comes to valuation, the recent margin expansion and increased demand changed the dynamics of the business. From making a loss in 2021, the company is forecast to make a profit of $2.29 in 2023, putting it on a PE of 4.5.
The stock has had a stellar run recently, we watched it go from $7 to $10 so now we don’t want to chase it but will wait for a pullback to buy into. Hopefully around the $8 mark which allows us to buy it on a PE of under 4 and we will aim to sell when that PE approaches 8 for at least a 100% gain.
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.