11 Sep Capital 19 Catch-Up

Weekly Index Movement

S&P500	-1.3%
Nasdaq	-1.4%
Aussie All Ords	-1.8%

More weakness last week in US stocks mainly due to rising interest rates.

To explain why we need to go back to the classroom.

I know this might sound amazing, but charts don’t move stock prices. (please don’t send the technical analyst lynch mob after me). Fundamentals move stock prices.

When you buy a stock you are actually buying the future cash flow of that company. So how much should you pay for that future cash flow? That is where stock valuation comes in.

Analysts add up all the future cash flows for a company and then say, ok I could earn $x this year and $y next year. But what is the alternative? Instead of buying this company I could just invest my money for 2 years in a risk-free asset such as the US government 2-year note.

This is what interest rates have been doing on the 2-year note.

As you can see, interest rates are at a 5yr high. In fact you have to go back to 2006 before you find rates this high.

With the risk-free rate this high, you really need a decent return on your investment in stocks to justify buying them. The way to get a decent return is to buy them at lower prices.

It might be a different story if you thought company earnings were going to grow substantially. If your future cash flow was going to be a lot higher than your present cash flow then you might be tempted to buy a stock even with 5% risk-free rates.

While future earnings are picking up slightly, they are not enough to warrant paying up for stocks.

Hence stock prices meander sideways to down.

In the current environment, it is unlikely earnings will surprise to the upside. Therefore it is the direction of interest rates that will determine the direction of stock prices. To see any meaningful gains from here we need interest rates to fall.

Of course that analysis is at the index level. If you look at earnings forecasts at the sector level……

So now you know where to concentrate your buying.

Recession? What Recession?

As you all know, last year when everyone was worried about a recession I said it would not happen because everyone has a job.

Well now everyone is saying we will avoid a recession.

And I am starting to get worried it is coming.

The New York Post has said Americans are defaulting on credit cards and auto loans at levels not seen since the GFC.

My big fear is the oil price heads back to $100. That would send inflation significantly higher, central banks would raise interest rates……and the already struggling consumer gives up. With 70% of the US economy not spending, somewhere, something, breaks.

Last weekend the Saudi’s announced they would extend their present 1million barrels a day cut to the end of the year. At the same time Putin said he will cut production by 300,000 barrels a day.

This is why I keep saying to buy oil stocks. The suppliers basically set the price and they will never set it low. Putin has a war to finance and the Saudi’s are building 109 mile long walled city in the middle of the desert.

Oil is back into the mid $80’s

Owning oil companies is your hedge against inflation.

Then there is this:

Last year the 10-year yield and 3-month yield inverted. Everyone ran around screaming “there is a recession coming”. It’s now been 300 days since that happened. So everyone has forgotten and moved on.

But 300 days is at the low end of recession start times for this indicator.

In summary, we are not out of the woods yet. Things could get worse from here and oil prices moving higher is a significant possibility.

I just don’t feel that stocks are discounting these risks appropriately so I would not be surprised to see a light blub moment when the market suddenly realises that a 23 multiple on stocks is a little high and we get a 5% retracement

Owning Oil companies is the perfect hedge against this risk.

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.