11 Apr Capital 19 Catch-Up
Weekly Index Movement
| S&P500 | +0.0% |
| Nasdaq | -1.0% |
| Aussie All Ords | +0.5% |
At the index level, it does not look like much happened last week. But under the hood, there was a fair amount of style rotation going on.
Expensive, high-priced, growth stocks gained while Value and Dividend stocks lost.
This is the opposite of what happened all of last year and shows the market in 2023 has changed focus.
All the gains seen in 2023 have come from valuation expansion rather than earnings increases. In fact, earnings are forecast to hit a trough in Q1 2023. We are about to find out just how much of a trough as the reports will start this week when the major banks start to report on Friday with Blackrock (BLK), Citi (C), JPMorgan Chase (JPM), PNC (PNC), and Wells Fargo (WFC) all on the calendar. Outside of these banks, the only other notable reports this week will be Delta (DAL) on Thursday and UnitedHealth (UNH) on Friday.
Thursday will be a very interesting day also when First Republic Bank (FRC) reports Q1 earnings and the CEO gets grilled in the following press conference. This stock is down 89% since the start of the year and is possibly the next bank to go.
Jamie Dimon, CEO of JP Morgan said this week:
“As I write this letter, the current crisis is not yet over, and even when it is behind us, there will be repercussions from it for years to come.”
I’m not sure I believe him. He is more likely just talking his own book and trying to scare deposits out of his competitors.
The S&P500 is currently sitting at 4100. The market is supposed to be smarter than us, and always right, so how can we justify this price?
This is from FactSet’s weekly earnings outlook report
The Street expects Q1 2023 to be the trough for corporate earnings this year. Based on analysts’ current estimates, Q1 EPS of $50.67/share would be down 10.5 percent from Q2 2022’s peak of $56.64/share.
While there is usually some seasonality between Q1 and Q2, analysts expect a stronger bounce this year versus 2022. Last year, S&P 500 EPS grew by 4.8 percent from Q1 to Q2. This year, expectations are for 7.4 percent sequential growth
Even with macro concerns about recession and bank lending, analysts still see the S&P 500 posting record profits by Q3 ($56.79/share versus that $56.64/share in Q2 2022) as well as Q4 ($58.37/share) and Q1 2024 ($57.45/share).
These expectations total earnings of $220.23 / share for 2023. Which puts the index on a PE of 18.7.
But everyone knows analysts are always too bullish and that the earnings in the second half of the year will be lowered.
It seems excessively optimistic to think that earnings can make record highs in the back half of this year. But holding at current levels feels achievable. I think a more realistic number would be around $51 for Q1 and rising to $54 by Q4 for a total of $210 / share and a PE ratio of 19.6.
The next question is, is a PE of 19.6 a fair price to pay?
The only way this price can be justified is if you wholeheartedly believe the Fed is going to cut rates in the second half of 2023.
Turning to the FedWatch CME tool it tell us the market expects
- 72 percent odds of a 25bps rise on May 3rd
- 70 percent odds of a pause on June 14th
- 45 percent odds of a 25bps cut on July 26th
- 36 percent odds of a second cut by December 13th
This high degree of confidence the Fed will start easing later this year is the fundamental buttress supporting stocks against the pressure of likely cuts to earnings estimates.
Stocks are starting to feel expensive here. They are priced for a certain set of near perfect conditions that see the entire environment become very positive later in 2023.
Stocks are pricing for earnings to rebound to a new record and the Fed to cut rates at the same time.
I fear neither of those things will happen. I see the most likely course being earnings flat for the year and the Fed sticking with high rates until inflation is below 2% for several months.
All of which means, I am a seller here, not a buyer.
But I could be tempted to buy gold. A few weeks back I highlighted something strange is happening to the yellow metal and now it is decoupling from some long-term relationships.
The chart below illustrates the historic relationship between gold and real yields. In general, gold has behaved much like a TIPS bond with inflation-protected yields: when real yields drop, gold rallies, and vice versa. As shown in the chart, historically gold prices around $2,000/oz would require real yields of around -1.00%. Conversely, real rates around positive 1.00% would mean gold prices in the low 1,000s per ounce. In other words, since the start of 2022 (as shown below) the relationship has completely collapsed
Gold is being bought by central banks as an alternative to US dollars. If you watch carefully for stories you can see world trade is fracturing.
Saudi Arabia has traded Oil exclusively in US dollars since 1974 due to a deal with the Nixon administration that included security guarantees for the kingdom.
But in January of this year, the Saudi’s announced they would be open to selling gold in other currencies. The Saudi’s sell 25% of their oil to China. Changing settlement currency from US Dollars to Yuan would have profound implications.
From the start of 2019, Gold is up 55% and the S&P500 is up 66%
You could argue that the appreciation in Gold is due to the debasement of the currency. That would also mean nearly all of stock price gains in this period are due to the same reason.
I think there is a very good argument for adding Gold to your portfolio here. A nice way to do it is to use the GOLD ETF that trades on the ASX so you have gold in Aussie dollars.
Why in Aussie dollars? Well, strange as it sounds, if global trade does move away from the US Dollar, the inital impact will be the USD strengthens. As weird as it might sound the fear of the unknown will send money into the very asset that is set to struggle long-term. But short-term it will rally and then you will get a double impact of gold going up and the the Aussie dollar doing down.
Some other short pieces of news that I found interesting this week:
According to CNBC: Apple’s worldwide computer shipments fell 40.5% year over year in the first quarter of 2023, amid a broader contraction in consumer demand, according to research firm IDC. All five of the largest computer makers — Apple , ASUS , Dell , HP and Lenovo — saw double-digit drops in first-quarter shipments, reflecting weaker demand and persistent inventory woes. But Apple’s decline was the biggest of the bunch.
This comes after Micron Techology (MU) reported excess inventory and gave weak guidance and does not bode well for earnings. Apple will report at the end of the month.
Tesla (TSLA) has also been weak. Tesla started the year by slashing prices by up to 20%. That gave a boost to sales as it sent out nearly 423,000 vehicles last quarter. But here is the snag. That is only a 4% uptick from the previous underwhelming quarter, amounting to 36% growth from the same period last year. Elon reiterated 50% growth in January, so he was left with egg on his face. More worrying, sales of the bread-and-butter Model 3 and Y grew but the more profitable models took a nosedive.
A company on a PE of 50 does not want low-margin sales increasing but high-margin sales decreasing. That will hurt profitability. Add in the price war it just started but can’t win and the future is looking grim.
Then there was the story of Tesla cars recording videos and employees sharing them. It’s not enough that Big Brother is watching. Now you have to worry about what your car catches you up to.
Get rid of it now before this story gets worse.
After a quiet couple of weeks, things will heat up this week. On Wednesday we get an inflation reading. Expect to see small changes in the right direction but not enough to change the course of Fed action. Then the real excitement starts with bank earnings. Hold on tight. Things could be about to get interesting.
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 and might not be suitable for you.