19 Dec Capital 19 Catch-Up
Weekly Index Movement
|Aussie All Ords
Another confusing week of stock movement where the market didn’t do what everyone expected it to do.
First up was inflation numbers which came in at +7.1% year-on-year and just 0.1% month-on-month. It really does look like we might have seen peak inflation which was +9.1% in June and has fallen every month since.
Helping this is the fact Oil is down to $75 a barrel now.
It is important to remember that inflation is measured as a year-on-year change. This means inflation can come down to the Fed’s 2% target because prices remain high but don’t go higher. Crucially, prices could just remain high and flat and inflation could come down to 2% simply because prices are not going up anymore.
At this +0.1% month-on-month gain, if that continues, inflation will be down to 2% by June 2023.
Most subsets of inflation are showing marked improvement. It is just housing that remains stubbornly high and is likely to remain so for some time.
Markets welcomed this news and the S&P500 was up 2.2% after it.
Then came the Fed interest rate announcement. Powell gave us a 50bps raise instead of the previous 75bps. Rates are now at 4.25%. Interestingly both the UK and EU also issued lower rate rises than previously in a central bank case of copycat.
This should have been positive for stocks. But instead, the S&P500 fell 4.2% to end the week down -2.1%.
Why fall by so much after positive news?
It must have been the Fed’s predictions that upset the apple cart.
The Fed is predicting rates will top out at +5.1% (that is higher than the market expected), that inflation will end next year at +3.5% (also higher than the market thinks) and that GDP growth will only be +0.5% (last time it was +1.2%) and unemployment will increase to +4.6%.
So that is higher rates, higher inflation, lower growth and higher unemployment.
If the Fed is right it means conditions for company profits are getting worse on every front. Which is why the market took it so badly.
But this is the same Fed that continually gets forecasts wrong. Remember words like “transitory” and “rates on hold until 2024”?
If we take away their forecasts, then this week we saw better inflation numbers and lower interest rates. It should have been a good week for stocks.
All this got me thinking about my outlook for the future. For something has been bugging me lately.
For some time now I have been mildly bearish on stocks. My main concern was analyst earnings for next year are too high and also that prices are not discounting any risk of recession.
What worries me is everyone else is expecting a recession and is bearish on stocks. Although their reason is slightly different, the outcome is similar.
If everyone thinks it, it doesn’t happen. And I’m in the majority camp. So I am most likely wrong.
If I am wrong, then stocks rally. Can I make a case for that?
Quite easily it turns out.
Let’s think about recession first and I’m going to say something you should never say if you work in the markets.
This time might be different.
Yes, I know the 2-10 yield curve is inverted and that happens before recessions (historically speaking) and yes inflation over 5% has only been fixed by recessions (historically).
But employment is still very high. Until this changes there will not be a recession. As much as Powell keeps saying the problem is the labour market, employers are not willing to help him out and reduce staff.
We have seen some token reductions by big tech but they only employ 2% of the workforce so these numbers are insignificant.
The way I see it, employers are reluctant to let people go because they have learned how hard it is to find workers. The last thing they want is to fire the workers they did manage to find and train in case they need them again shortly.
So I don’t see big changes coming to employment numbers soon. When everyone has a job they have earning power to pay the bills. There are signs they are cutting back. For example, according to the US Energy Information Agency, gasoline demand is lower than the same time last year. As gasoline has come down from $5 a gallon to $3.50 a gallon, the only reason US drivers are not buying more is because they need the funds for elsewhere.
That is exactly what Powell wants. Just a tightening of the belts, not a massive reduction in spending, and he might get it because everyone has a job.
The longer this situation can go on for the more opportunity there is for inflation to come down to 2% for the reasons cited earlier. Prices can remain high, but consumers can pay them because they have jobs, they just reign it in a bit.
That scenario is what Powell calls a soft-landing and it is very possible.
If you remove the recession risk then stocks are fairly priced. A rally can occur simply if the market starts believing a recession will not happen and the only thing needed for that is continual weak inflation numbers like we have seen for the last 6 months.
Add to that a China that is quickly abandoning the most restrictive Covid measures and a Chinese government keen to bring back growth and things start to change.
The more time I spend thinking about recession the less I find myself believing there will be one and maybe this time the 2-10 inversion will not correctly forecast a recession. ( I truly hope this is the case because in years to come we won’t know whether to trust this as a predictor or not and that will make things exciting)
The market thinks the Fed will lower rates in the second half of 2023. I doubt that as it is too soon. The market also thinks earnings will be $231.59 in 2023 as compared to $220.87 in 2022 for a 4.8% profit increase next year, nearly all of which is predicted in the second half. I also think this is too bullish.
All of which leaves me where?
Kind of in the middle I suppose. I’m not recession level bearish, but I can’t get bullish either because I think analysts are expecting too much.
I suspect the most likely course for next year will be much like the second half of 2022.
The S&P500 fell 22% in the first half of the year but is up 3% in the second half. That 3% gain is made up of a 14% rally, a 17% fall, a 14% rally and a 5% fall.
This kind of action is the most likely course for at least the next 6 months as markets continue to grapple with the question of bullish or bearish.
How do you invest in such an environment? You can either trade the swings or ride them out with value stocks that pay hefty dividends. Luckily there are plenty of those around.
Or, focus on the areas of the market that are showing growth.
Like oil services. I’ve been trying to buy NINE for weeks now and it stubbornly refuses to drop to my $8 target. So I am raising it to $9 so I can finally get it.
Another Oil services company is MMA Offshore, listed on the ASX as MRM. They had this to say today:
“We are very pleased to report a stronger than expected start to the financial year with increased activity across all of our key markets driving higher earnings and returns on our assets. The current recovery in oil and gas activity combined with growth in offshore wind developments presents a unique opportunity for MMA to maximise the returns from our existing business whilst positioning the company for the future”
Seems our theory of Wind competing with Oil for these services is correct. You could buy MRM instead of NINE and basically get the same thing.
As we wind down to Christmas this week we will get another read on US inflation and GDP.
This will be our last publication for the year as we will take a little break from writing until January but we would like to take this opportunity to wish everyone a very Merry Christmas a prosperous 2023.
CatchUp Stock Tips
|Gain / Loss
|1 Aug 22
|8 Aug 22
|15 Aug 22
|22 Aug 22
|5 Sep 22
|12 Sep 22
|19 Sep 22
Right. I’m giving up and admitting NINE is never going to fall to my $9 target price. Raise buy order to $9
Buy Nine Energy Service (NINE) at no more than $9
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.
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.