22 Oct Capital 19 Catch-Up

Weekly Index Movement

S&P500	-2.4%
Nasdaq	-3.2%
Aussie All Ords	-2.1%

Last week was a case of more of the same. Bond yields rose after Fed Chair Powell’s speech on Wednesday. The 10yr touched 5% mid-week but settled back at 4.92% on Friday. Stocks fell as yields went higher.

Federal Reserve Chairman Jerome Powell acknowledged recent signs of cooling inflation, but said Thursday that the central bank would be “resolute” in its commitment to its 2% mandate.

“Inflation is still too high, and a few months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal,” Powell said in prepared remarks. “We cannot yet know how long these lower readings will persist, or where inflation will settle over coming quarters.”

“While the path is likely to be bumpy and take some time, my colleagues and I are united in our commitment to bringing inflation down sustainably to 2 percent,” Powell added.

RBA take note.

The Fed sees inflation at 3.7% as still too high and they are worried inflation will become entrenched.

Australian inflation is at 6%. You would think the RBA would be even more worried than the Fed. But they are still scared to raise rates. The next attempt will come on Melbourne Cup day. I doubt they will increase then but unless they get very lucky they are going to have to at some point.

But what is driving yields higher?

Really it all comes down to supply and demand.

Given the growing U.S. fiscal deficit, the Treasury Department has been increasing its auction sizes for U.S. Treasury bills and notes, adding more government bonds to the market.

At the same time, The Federal Reserve is undertaking quantitative tightening, allowing Treasury bonds to roll off its balance sheet and reducing its holding of Treasuries by about $650 billion over the last year. Some foreign buyers, such as China, have also slowly been reducing their holdings of US Treasuries.

More supply and less demand results in lower prices for Bonds and as yield is calculated at 100 – Bond Price the yields have been increasing.

This has led to falls in Bond ETFs of over 50%. This is the ETF – TLT

A lot of people are saying this is a good time to buy bonds and wait for the inevitable recovery.

I don’t agree. One of my trading rules is – don’t buy a 52-week low. Inevitably it always goes lower. You are much better off waiting for it to trade sideways along the bottom in a range for a while before buying.

I suspect this is what will happen with bonds. I doubt we have seen the high in yields. Markets always overshoot. We will see 5.2% before this is over. Then the conditions of increased supply and less demand will mean no recovery in prices.

Unless economies take a drastic downturn and recessions look likely. Then we will see a flood of money chasing the safety of bonds and bond prices will recover.

That is pretty unlikely though. The GDPNow predictor thinks the US is going to post a 5.4% GDP figure in Q3 of 2023

Whilst stocks fell last week as rates pushed higher, I still say this is a buying point as rates will top out soon and then stocks can rally as earnings have generally been positive again this week

Earnings Announcements

Bank of America (BAC) reported EPS 10.6% higher than expected on a revenue beat of less than 1%. Loans were in-line, and deposits came in 6% higher than expected as big money center banks are showing no sign of stress competing for that form of funding. The bank’s CFO noted they are “not seeing deposit pricing pressures.”

Johnson & Johnson (JNJ) also reported Tuesday morning, beating revenue estimates by 1.4% and adjusted EPS by 5.6%. Guidance for both sales and adjusted operational EPS were raised.

Lockheed Martin (LMT) (aerospace and defense contractor) reported a modest 1.5% adjusted EPS beat on sales 0.7% higher than consensus. Guidance was reiterated on backlogs that were up 12% YoY. A 5% drop in aeronautics sales was sparked by a drop in F-35 sales driven by slower production volume.

Over in Europe on Wednesday, Dutch semiconductor company ASML (ASML) reported bookings 42% below estimates despite topping estimates for Q3 sales and margins. 2023 sales growth guidance of 30% was also confirmed, but 2024 revenue was guided “similar to the 2023 level” and a “transition year”. China was 46% of sales in Q3, illustrating how sensitive the business is to ongoing sanctions on that country by the US and the EU.

This could be a problem for the likes of NVidia going forward and since this stock in particular is priced for perfection it is one I would avoid. In fact, I would even go so far as to say NVDA is a short right now. I just can’t see how it lives up to the hype as more and more competitors look to profit from the burgeoning AI market.

Wednesday saw earnings from Tesla (TSLA) and Netflix (NFLX).

Tesla has been cutting prices aggressively in both China and the US to protect market share. That clearly had an impact: gross margins were 17.9%, the lowest since Q2 2019, while adjusted EPS missed by 11% and free cash flow was one-third of what analysts had penciled in. Total revenues also missed by 3%. Vehicle production guidance was unchanged and guidance for the Cybertruck was for “some limited deliveries” taking place “later this year” starting November 30th.

Output of Model Y SUVs at the Texas and Berlin factories will take place “very gradually”. TSLA shares lost more than 9% in reaction to its earnings on Thursday, a continuing trend over the last three quarters now. With that said, the stock is still up 20% over that period. Musk was clearly dissatisfied on TSLA’s conference call with the impacts of higher interest rates on affordability as well as challenges involved in the production and delivery of the very highly anticipated Cybertruck.

The reality of no longer being the only EV play is starting to hurt Tesla, which is still overpriced and needs to come back some way if you ask me.

NFLX shares, on the other hand, gained 16% in trading on Thursday in reaction to its earnings. Net change in paid streaming accounts was 41% larger than estimated by analysts. Q3 EPS was 7% higher than estimated on in-line revenue, while Q4 guidance for revenue was slightly light versus estimates for earnings and EPS. Management reports they will boost some prices in the US, UK, and France. The subscriber increase was the largest since customer counts surged during the pandemic and represents a major victory for the company’s effort to crack down on password sharing.

But what next? Crackdown on sharing, tick. Increase prices, tick. Netflix needs something innovative now because the easy moves are down. Unless it can come up with genuine revenue increases for long-term strategy, this stock will also fall.

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.