Capital 19 Catch-Up

Weekly Index Movement

Aussie All Ords-1.1%

Stocks closed out the week on a strong note after initial weakness but still gave a little ground back overall.

The main theme now driving markets is recession. We have moved on from interest rates to recession risk talk.

That is why BHP (BHP.AX) fell 8% last week and Apple (AAPL) gained 2.1%.

The market has already factored in interest rates increasing to 3.5%-4.0% by the end of the year, which is what has caused the bear market in tech stocks.

But recent weak economic data now points to a possible recession. If that were to happen then interest rates would not be high for long as the Fed would roll them back to stimulate the economy once more.

If rates don’t stay high for long then long-term valuations of Tech stocks have been lowered too much and they now represent good value.

Conversely, for the likes of BHP, contracting economies buy less commodities which reduces the future earnings of miners.

But we don’t see a serious risk of economic contraction.

On Friday we learned that retail sales were up +8.4% on last year. Mind you, CPI on Wednesday was +9.1% so all-up retail sales do look to have contracted -0.7% on a real basis.

But this data shows the consumer can still spend. This is no surprise as we have record low unemployment and wage growth at +5%. If consumers can spend then there is little chance they stop and the economy contracts.

In other good news, Oil fell down to $93 a barrel last week. If it stays down here it will reduce next month’s inflation number and the Fed will be able to say “see, we told you we would get it under control” even when the truth is they had nothing to do with the outcome.

It all points to a much more bullish picture.

But we do have one area of concern and that is forecasted earnings

Q1 Earnings for the S&P500 came in at $54.02

The forecast for Q2 is $55.44

But more concerning than that is Q3 and Q4 around $60.

This is hard to believe this is possible when we have high inflation, China supply chains in lockdown and the Fed aggressively raising rates. Just where do they think this extra profit is going to come from?

Margin expansion is the idea but again we just can’t see how this will happen in this environment.

We will know a lot more about this over the next three weeks as companies report Q2 actuals.

We had a few Q2 reports last week.

JP Morgan (JPM) reported earnings of $2.76 vs $2.63 for Q1

Wells Fargo(WFC) reported earnings of $0.74 vs $0.88 in Q1

Morgan Stanley (MS) reported earnings of $28.90 vs $40.44 in Q1

So, JPM managed to deliver growth on Q1 but WFC and MS both went backwards by quite some way.

It’s way to early to think this trend will continue with other companies. But it does illustrate our point of the market expecting too much from companies in this environment.

We will have Bank of America (BAC) and Goldman Sachs (GS) tonight. Other notables this week will be Netflix (NFLX) and Tesla (TSLA).

If we are correct, and earnings in Q2 are not as high as Q1 then analysts will bring down forecasts for the rest of the year and stock prices will follow.

But we feel we have a different situation in Australia, at least in terms of commodity plays.

All our commodity stocks have been beaten down because of the feared recession (which we don’t think will happen. Or rather, we might have a technical recession but it won’t hurt company earnings anywhere near what the market fears)

China GDP grew just 0.4% in the second quarter, reflecting the country’s ongoing struggles with lockdowns to limit the spread of Covid-19. Whenever China slows, Australian commodity stocks sell-off.

But we have no doubt that China will introduce stimulus measures in the second half of the year to get economic growth back on target. And that will send our commodity stocks straight back up.

Buy them now while they are cheap.

We saw the same thing happen this week in coal stocks in Australia. At the start of this month, New Hope Coal (NHC) was trading at $3.34. It is $4.30 today. That’s a two-week gain of 29%, all on the back of unsubstantiated rumors that China might start buying our coal again.

Mind you, Whithaven Coal (WHC) just announced sales prices of $514/t which is up 63% on Q1 and 321% on last year. They could see earnings of $3billion this year, verses $200million in 2021. That’s up 15 times but the stock has only doubled in the same time. It still has room to move higher.

We are going to enjoy this bullish sentiment for now but will be keeping an eye out for changes to full-year earnings.


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