Capital 19 Catch-Up

Weekly Index Movement

S&P500+0.8%
Nasdaq+0.1%
Aussie All Ords+2.1%

Stocks added to year-to-date gains last week after encouraging data on inflation and stella bank earnings propelled stocks to the fourth weekly gain in five weeks.

Two years ago, inflation was 2.6%, up from the lows of the shutdown and slightly above pre-pandemic rates. But then spending fuelled by surging demand from the reopening, global supply-chain bottlenecks, and spiking oil prices stemming from the Russia-Ukraine war saw CPI hit 9.1% last year.

Last week’s release of the March CPI report revealed that inflation remains on its downward path. Headline inflation has dropped materially, falling from 9% last summer to 5% in March, driven in large part by a drop in oil and food prices. Gasoline prices were down 4.7% in March versus February while food-at-home costs declined thanks in part to an 11% month-on-month drop in egg prices.

Core inflation, which excludes volatile energy and food costs and serves as the more structural measure of inflation upon which the Fed bases monetary policy, rose by an expected 0.4% versus the prior month, putting inflation at a 5.6% annual rate. This is down from last September’s peak of 6.6%, but still a long way from the Fed’s 2% long-term target.

Also out last week was the March read on the producer price index (PPI), which measures wholesale prices paid, effectively capturing inflation on input costs through the supply chain. The trend here is particularly encouraging, as producer prices are in outright decline, with PPI falling 2.5% in March versus the month prior. This brings the annualised PPI inflation rate down to 3.4%, the lowest in two years. Trends in PPI tend to lead consumer prices by several months (it takes time for prices to work their way to the final purchaser), which tells us consumer inflation is poised to remain on its path lower.

Great news for bulls as it gives the Fed a reason to end the relentless hikes.

Earnings season has just started and finally, the analysts are making adjustments. They now have earnings for 2023 just 0.5% higher than 2022. But the indexes are up 8% in 2023 which means stock price gains have all come from valuation expansion.

The only reason to value stocks higher is that you believe the future is bright and the brightness they are looking at is lower interest rates in the second half of the year.

I just don’t buy into this narrative

The only way the Fed is going to lower rates is if the economy slips into recession. But if that happens earnings will most likely decline and for stock prices to increase at that point you would need even more of a valuation expansion. Highly unlikely at the outset of recession.

I’m still not a buyer here. If the market changes its mind and decides rates will not drop in 2023, I might be tempted to take a nibble. But not until then.

But I have been nibbling on New Hope Coal (NHC) today. It went ex-dividend. For all those who own it, you just received a fully-franked 40c.

For those that don’t, or those that are looking for something to buy, here is your chance to get it cheap.

In 2022, the April dividend was 30c. They increased it to 40c in 2023 on the back of high coal prices. Coal was trading around $400/tonne last year and has dropped to $250/tonne now. This has caused the price of coal miners to drop back a bit.

Whitehaven (a competitor) announced quarterly activities last week and stated they had a problem at a mine and will produce less coal this quarter, but that they are still managing to get $400/tonne.

This is because nearly all coal sold by New Hope and Whitehaven gets shipped to Asia. Seabourne coal contracts are long term so prices today are still based on last year’s prices.

Given you can expect New Hope to sell coal at similar prices to last year, it might be reasonable to expect the next dividend, in October, will be around the same as last year or 56c. Add in Franking and that becomes 80c.

Buying NHC today at 5.25 means that the next dividend in October will be a 15% yield. You will just need to wait 6 months to get it. I don’t mind waiting 6 months to get 15%. I don’t even mind waiting 12 months to get 15%.

There are risks to this. Maybe they have a problem at a mine as Whitehaven did, or maybe they sell coal for a lower price. Or maybe they produce more or sell at higher prices. But these are impossible to predict.

All I see is a monster cash generator that has paid down debt this year with a product in growing demand.

India has 281 coal power plants, is building 28 more and has a further 23 in pre-construction phase.

China has more than 1,000 with another 240 either being built or planned.

My valued readers are probably fed up with me harping on about coal so I’ll leave it there and move on to US Banks.

Ever since that dodgy bank, SVB collapsed, I have had to answer questions like this

“my hairdresser told me all the banks in the US are going to collapse so can you sell all my shares”

Hairdressers, taxi drivers and brothers seem to have a very deep understanding of the extremely complex US financial system. Such a good understanding that they can see the future clearer than the rest of us.

I enjoyed watching an interview with Warren Buffett this week. He was asked about bank failures. His response was that just because a poorly run company failed, it does not mean all companies in the field will fail.

We got a look at how the major banks are faring on Friday.

A month ago, financial markets were focused on how badly the Federal Reserve had broken the banking system. This week, the initial earnings from a few very large banks suggest that the quick work of the FDIC and Federal Reserve in the wake of Silicon Valley Bank’s failure have prevented broader damage. Lenders including PNC Financial (PNC), JPMorgan (JPM), Wells Fargo (WFC), and Citi (C) reported Friday, and the sigh of relief from markets was palpable.

JPM delivered beats on strong investment and commercial banking performance and raised guidance for net interest income this year by some 11%. That drove the stock to its biggest gains since 2020 and its second best earnings reaction day in at least 20 years. JPM stock is now up for the year.

It’s hard to view the US banking system as faulty when its largest lender is finding such firm ground beneath its feet. Other lenders delivered less spectacular results, but reassured investors that among big banks there isn’t much reason to be concerned.

Credit quality didn’t deteriorate much on the quarter, and there are plenty of reserves relative to recent history. At the same time, the core bank business of borrowing short and lending long appears to be doing just fine with net interest margins nearing 3%.

The reports really were encouraging and dispell any fears of a looming credit crunch. Terra firma beneath the feet for financials may be just the platform this market needs to push higher.

Mind you, I’m sure those hairdressers will have a story about why we shouldn’t believe these reports and how the world is going to end soon. Maybe Nouriel Roubini was a hairdresser in a previous life. That would explain a lot.

There isn’t a lot of macro-economic news this week, but earnings season heats up with multiple companies reporting every day.

I’m going to leave you this week with this graphic from our friends at Bespoke. It says Growth led last week and has been leading all year. I still maintain this will be the story all year and I am waiting for a dip to buy into

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.