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Capital 19 Catch-Up

Weekly Index Movement

S&P500-1.2%
Nasdaq-1.0%
Aussie All Ords+0.8%

It’s a chaotic time to be a growth stock investor. The past week was a slight reversal of what we saw in the week before. US stocks gave back 18% of their prior week’s gains and Australian stocks recovered 22% of the prior week’s losses.

Looking at Australia first, we had a run of positive economic announcements. GDP was up 0.8% for Q1 vs Q4 2021 and up +3.3% year-on-year. Retail sales grew 0.9% month-on-month and Australian company gross operating profits grew 10.2% quarter-on-quarter.

That’s a nice list of positive news that shows the Australian economy, at this stage at least, is very healthy.

Couple that with record low unemployment and it gives the RBA carte-blanche to raise rates when they meet tomorrow. Everyone is expecting the RBA to raise by 0.4% to take the overnight rate to 0.75%. Obviously, the banks will fully pass this on to mortgage holders immediately so the Australian consumer will have less discretionary spending power than last year, which is the point.

But Australian consumerism only affects a handful of Australian stocks. Most of what we do here is dug out of the ground and sent off to China. What’s happening in China is far more important to our corporate profitability.

And the good news is China is finally starting to re-open after strict lockdowns to stop the spread of Covid. The government there is well aware of the damage those lockdowns did to their economy so is on a stimulus path.

Now, where have I heard that story before? Oh yes, just about every developed western nation did this last year. That means we have a fairly good idea of how this will play out.

The Chinese economy will quickly bounce back, things will look good for 6 months or so and then rumors of inflation will start and stock prices will fall again.

For those brave enough to trade a short-term bounce, Chinese equities look attractive here. FXI is a popular large-cap China ETF but if you really want excitement have a look at YINN – 3X China Bull.

But we prefer a longer-term play and one that we have been promoting every week, so we might as well do it again this week to keep with tradition.

This time we have some data from FactSet to back up our thoughts.

What you are looking at is changes to earnings forecasts made by analysts in April and May for the different US Sectors. (we use this kind of information in our Top 30 strategy) Analysts changing their forecasts for company earnings is a big deal for stock prices.

Recent changes in the US have seen earnings for the Consumer Discretionary sector get cut by over 10%. Which makes sense when you think of what is going on.

Petrol prices, heating costs and food costs have all increased in the last 12 months and now mortgage rates are climbing too. All of these dip into consumer pockets which leaves those consumers with less money for discretionary spending.

At the other end of the scale, look at what is happening to the Energy and Materials sectors. Earnings forecasts are climbing rapidly.

It is these two sectors we have focussed on for the last few months so it is nice to now see the analysts agreeing with us.

But is it too late Matthew to get into these sectors now?

No, I don’t think so.

Here is another piece from FactSet.

PE ratios are a way of valuing stocks.

Energy is on the far right of the chart. This research is saying the average 12-month forward PE for the Energy sector over the last 10 years has been 15.8 and right now it is 10.8. That means stock prices for Energy companies could add 50% and they would still only be at the average PE of the last 10 years.

Materials aren’t quite as undervalued with a 10-year average forward PE of 16.2 and a present reading of 14.6.

Now take a look at Consumer Discretionary. Here the present reading of 24.8 is 14% higher than the 10-year average of 21.7 and would indicate prices have further to fall.

Tech is interesting, with a present forward PE of 21.5 against the 10-year average of 18.2. This is a sign that tech probably hasn’t hit a bottom yet.

This data set very neatly explains why the Australian index has been outperforming the US index this year. The Australian index is very heavily weighted to materials and energy with little weighting to tech.

For now, we continue to favour Energy and Materials over Tech, but if Tech stock prices were to fall 15% from here, that story would change and we would become keen buyers.

Consumer Inflation is the big report for the week ahead, as investors watch to see if the late May rally can resume. Also, keep an eye out for companies lowering profit forecasts. We saw Microsoft (MSFT) do it last week and we are entering the crucial window to influence analyst numbers lower to make a beat easier before we start Q2 earnings in July.

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.

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