Capital 19 Catch-Up

Weekly Index Movement

Aussie All Ords-0.4%

After three straight weeks of losses and a weak finish to February, stocks have gotten back on track in March. All three major indices are up over 1.5% in the first three trading days of March with both growth and value pretty much performing in line with each other.

Every sector has also rallied to kick off March. Energy and Materials have led the way to the upside with gains of over 3% while industrials and technology have added 2.5%.

In the commodity space, Natural Gas and Oil are up sharply to start the month while Gold and Silver are also up 1.5%.

The thing is, this should not be happening.

10yr bond yields topped 4% last week and the terminal Fed Funds rate prediction is now 5.47% in September.

Last year, when bond yields rose, stocks fell. It was an almost perfect tandom move. But this year, the market is ignoring higher yields. That shows something has changed.

It’s all well and good to define a bull market as up 20% and a bear market as down 20% but that doesn’t really help anyone.

A much better way is to consider how the market is reacting to news. The interest rate news of the last couple of weeks is bad news for stocks. Yet stocks are holding their ground.

My definition of a bull market is “when stocks ignore bad news” and that is where we are right now.

That being said, stocks are hardly a bargain. But they are fairly priced. This is from FactSet’s Earnings Insight Report.

Q4, 2022 earnings are now done and came in at $53.42, 3.6% lower than the same period a year ago.

Next quarter earnings are forecast at 51.15, but then a significant recovery is forecast for the following 4 quarters.

This explains why stocks are ignoring bad news. Earnings are forecast to be at all-time highs in Q4 of 2023 and as the market is always looking forward, this is the number they are pricing. The average across this 4 quarter period is $57.02 which, on an 18 multiple puts the S&P500 at 4105 or 1.5% higher than where it is now.

If you are looking at why the S&P500 is trading over 4000, FactSet has given you the reason.

But everyone knows analysts are always too bullish. Let’s be more pessimistic. A bit like Nouriel Roubini. Ok, no, not at all like that pessimistic idiot. Let’s call it a pragmatic approach to valuation.

What if S&P500 companies cannot increase earnings but what we just saw is maintained for 12 months? That makes the next 12 months’ earnings $213.68 and applying an 18 multiple gets us to 3846. That is pretty much the lows we saw in December.

Those two levels are your buy and sell points. Down around 3850 you can buy and up around 4150 it’s time to sell or hedge.

Being even more pragmatic, what if the forecast trough earnings of $51.15 turns out to be the average for the next year? Then earnings are $204.60 and the S&P500 is 3682. The price of the October 2022 lows.

The average earnings in 2018-2019 for the S&P500 was $162. Our calculated $204.60 is 26% above that. Right now the S&P500 is 25% above the level it ended 2019 at.

Who would have thought that stock prices actually make sense when you look at earnings? This is why I read the FactSet earnings report every week and get my calculator out to see if stocks are cheap or expensive.

Talking of expensive stocks, Tesla (TSLA) (trades on a PE of 57) held an information day last week. Rather than tell the market about new models or cool features coming, Elon spent the time talking about is Master Plan to take over the world, so investors sold his stock down 6.5%.

At the end of the day, Tesla is a car company. Car companies do not make good investments. Why has all car manufacturing left Australia? Because making cars is not big margin business. Ford has been bankrupt twice. General Motors went bankrupt in 2009.

Ford (F) typically trades on a PE between 5 and 10. General Motors (GM) trades between 3 and 8. Toyota (TM) trades on a PE between 8 and 10.

Why would you pay 6 times as much for Tesla as you would for another car maker?

One day Tesla will be just another car maker and trade on a PE of less than 10. Maybe then I will think about buying it, but no way am I paying 6 times for it. Then again, seeing as making profits from cars is not easy, I will more likely avoid the entire sector and buy a profitable business with a big margin instead. Like an oil refiner.

Moving on from earnings something else came up this week that needs discussing.

The Biden administration disclosed conditions for awarding $39billion in subsidies to revamp US semiconductor manufacturing. Clearly, he hasn’t been told there is an inflation problem. He has some conditions. He wants companies to use this money on R&D and not to fund share buybacks but also he wants the companies to share excess profits with the government.

Although no chip industry companies said they would scrap expansion plans to build in the US, they grumbled a lot. So did Warren Buffett.

US companies use share buybacks a lot to reward shareholders. I’m a big fan rather than a dividend.

I will explain why. Let’s say a company has $ 1 billion to return to shareholders. If they send it to me as a dividend, I receive cash that I then have to pay tax on that year (yes I might get a franking credit) but I have to pay tax at that point and it might not be a good time for me.

If they instead complete a share buyback I effectively get the same benefit but in a tax-advantaged way.

It works like this:

Suppose I own 1 of the 100 shares on issue. They buy back 10 shares instead of paying a dividend. I now own 1 of the 90 shares on issue.

If the company was worth $10,000 before, then my share was worth $100. The company is still worth $10,000 after, but because there are now only 90 shares, each share is worth $111.

My share value has gone up 11%. The best bit is I haven’t sold it so I don’t have tax to pay. If I hold it for more than 12 months and then sell it, I get a 50% tax reduction.

I won’t go into holding it in an SMSF and waiting to switch my fund into pension mode so I don’t pay any capital gains tax at all. But you get the idea.

Share buybacks are good for existing holders. Warren is upset his semiconductor compies will cease buybacks if they accept Biden’s money. I doubt they will. Companies will put shareholders ahead of receiving funds from a government body that imposes rules and then having to share profits with that body on top. Biden might well find no-one takes him up on the offer.

Governments imposing sneaky rules is nothing new. Take Albanese. Last week I moaned about his silly tax on $3 million balances.

Well, it turns out he is trying to sneak an extra detail through. At the bottom of page 2 of this 5-page document titled Better Targeted Superannuation Concessions sits this little nugget.

“The calculation of earnings includes all notional (unrealised) gains and losses, similar to the way superannuation funds currently calculate members’ interests.”

They want to tax you on unrealised gains now. Take the situation of a large property in super. That property value goes up but you don’t sell it. Under the new rules, you still have to pay tax on the gains. And that tax could be quite a bit, so much so that you might then have to sell assets to pay it.

Of course, if the value goes down, they are not going to compensate you for it. Tax is a one way deal, my friend.

Of course, this is just for balances over $3 million but there was no mention of this in the press release. They tried to sneak it through. Watch them or they’ll sneak through something that does affect you.

This is a busy week on the macro front, with Chair Powell testifying in front of Congress, January JOLTS, and February’s Jobs Report.

We could have a bit of movement, but keep that level of 3850 in mind before considering new buys. If Powell says anything along the lines of taking a 50Bps off the table then expect stocks to get back to that 4150 area when it will be time to sell or hedge.

Lastly, good news. I’ve been waiting for a while but they have gone and done it. There are now ETFs that track Jim Cramers recommendations.

LJIM gets long the stocks he recommends

SJIM gets short the same stocks.

Jim gets a lot of press for making bad calls. That might be a touch unfair as we all make good and bad calls.

Then again – take a look at this guy.


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 and might not be suitable for you.