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Capital 19 Catch-Up

Weekly Index Movement

S&P500-3.3%
Nasdaq-4.0%
Aussie All Ords-3.9%

Both the Australian and US indexes fell 3% to 4% last week, marking the third weekly setback in a row for the S&P 500. The decline was steepest for the NASDAQ, which has fallen nearly 11% over the past three weeks.

And it’s all because the focus is back on interest rates again.

The 2yr treasury yield hit 3.5% last week, a new high for the year. Why is this significant? It is telling us the bond market thinks the average interest rate over the next 2 years will be 3.5%.

At present, it is 2.5% which means the bond market thinks it is going over 3.5% and staying over 3.5% for 2 years.

The bond market is about 3 times the size of the stock market so when it talks you listen.

But we don’t need the Bond market to tell us the Fed is a long way from being done.

As you know, the Fed is trying to fight inflation with the only tool it has. Interest Rates. Raising rates takes money out of consumers pockets so they can’t spend it on other things. This in turn reduces demand and eventually lowers inflation.

The problem for the Fed is employment. The JOLTS report this week was terrible (for the Fed anyway). It showed there are 5.6million more job openings than unemployed workers. The ratio of quits to total separations came in at 70.5%, well above pre-pandemic levels.

This shows 70% of all job endings are because the employee quits. An employee only quits when they think they will find a better job elsewhere. Better in this case meaning higher wages.

Which is what is happening. On one hand we have the Fed trying to take disposable income away from consumers but the consumers are using their other hand to get paid more to compensate.

The Fed really is in a tough spot and I believe rates will have to go a lot higher. 4% will not be enough.

Seeing as Powell told us all he does not want to make the same mistake as Volcker did when he lowered rates too fast in 1980, we can be fairly sure high-interest rates (maybe high isn’t the best description for 4% rates) will be with us for a timeframe measured in years, not months.

Powell has been telling us he wants corporate America to stop hiring. But, as yet, no one is listening to him.

Which does bode well for company earnings. We are 6 or so weeks away from Q3 earnings. The market is expecting earnings to come in the same as Q2. This seems an easy bar for the market to beat.

And if earnings are high and growing then stock prices should do likewise.

But the market still fears Fed actions will induce a recession and that recession will reduce earnings.

It really is very uncertain times. I can’t really remember a time when the argument for both bulls and bears was so even.

Maybe that is why stock prices have been declining in such an orderly fashion in the last few weeks. We have not seen any panic selling. Just a steady and controlled decline.

Looking at the recessions in 1990, 2001 and 2008 we can see that initial claims for unemployment insurance increased first and corporate earnings fell second.

This will be our canary in the coal mine. Once we start to see unemployment pick up, then we need to be worried about recession. But not until then.

So where do we put our money to work?

The first thing to avoid is interest rate sensitive sectors, such as Buy-Now-Pay-Later and unprofitable Tech.

Large-cap tech isn’t as sensitive to interest rates. We think of them as more like a modern-day industrial.

Emerging markets are also a no go, as investors have no appetite for risk.

Until we get some clearer direction on these matters, you really are better off hiding out in cash generating companies. Like those found in our Dividend Growth Strategy

US markets are closed today for the Labor Day holiday but expect more volatility in the week ahead. There isn’t much economic data in the calendar but we do have several members of the Fed speaking, including Powell. You can expect them to continue with the higher for longer rhetoric.

CatchUp Stock Tips

Higher interest rates are hurting our tech stocks so this week we have found something a little different that value investors are going to love.

Buy DateBuy PriceCurrent PriceGain / LossStop Loss
MSFT1 Aug 22277.82256.06-7.8%240.00
TXN1 Aug 22177.94163.00-8.4%145.00
ASC8 Aug 228.529.93+16.5%6.40
CDNS15 Aug 22188.83168.17-10.9%130.00
UNH22 Aug 22541.39516.35-4.6%450.00
WMB29 Aug 2235.0033.72-3.7%29.50

Buy Gulf Marine Services (GMS.London) with a stop at 4.00

We can’t quite believe the value offered by Gulf Marine Services. But first an explanation of what they do.

The operate lift boats. That’s these things….

I had no idea they existed either until I did some research on offshore wind farms.

These boats power (I was going to say sail but they don’t) out to whatever location they are needed and then drop their legs down and then jack themselves up and out of the water. They can then act as a platform for whatever is needed out there in the ocean and when done, lower themselves back down and move on to the next location.

As you can imagine, there are not too many companies in the world offering these liftboats.

Gulf Marine Services is listed in London. But that’s fine. It is as easy to buy for us as an Australian stock and we are not biased by country.

A recent article in Offshore Magazine had this to say

Liftboat service companies report a major increase in business driven by international customers from as far away as China and Nigeria.

“(We have seen) a ten-fold increase interest in liftboats by the international marketplace during the last three years,” said Mike Audirsch, Manager of International Business Development for Cudd Pressure Control.

Other fleet operators; including Danos & Curole, Superior, and Global, report similar levels of interest. 

It takes a long time to build these boats so owners of existing boats are charging more for them.

Demand for these liftboats is coming from two areas

  1. Offshore Wind Farms
  2. Offshore Oil drilling

Australia is planning on building 200 offshore wind turbines off the coast of Victoria with more coming in New South Wales, Western Australia and Tasmania with construction starting in 2025.

China is planning up to 30 GW of new offshore wind capacity before 2025, according to an estimate by CNOOC Energy Economics Institute.

The UK is the world leader in wind farms. They currently have 11,000 wind turbines in operation but to meet government targets that would need to quadruple by 2030, according to the BBC.

And then there is oil. Due to the European Energy Crises, countries are looking at ways of replacing Russian Oil.

Norway is expanding its offshore drilling. The UK has ordered more offshore drilling in the North Sea.

Even the US is at it. The Biden administration unveiled a five-year proposal for offshore oil and gas development in areas of existing production.

I think you can see where the demand is coming from.

Now the fundamentals.

Gulf Marine Services is trading at a market cap of about $63million. But its tangible book value is $260million. So it is trading about 70% less than just the value of its boats.

The present PE is just 2. That’s right. Just two years of profits could buy the entire company.

They only announce profits once per year so 2021 is the last report available.

2021 revenue was 12% higher than 2020 due to higher day rates and the company made $30m in profit. They also completed a capital raise in 2021 so are very well financed for the future.

What often happens with these deep value stocks is it can take the market a while to also find them and react accordingly. So don’t expect the thing to go shooting up tomorrow.

But a PE of 2 in a sector with increasing demand is too good to ignore. Buy it now, put it in the bottom drawer and come back in 2 years to see what has happened.

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.

Disclaimer: Capital 19 Pty Ltd ABN 17 124 264 366 AFSL 441891 (‘Capital 19’) believes the information contained is reliable, however, no warranty is given as to its accuracy and persons relying on this information do so at their own risk. This communication is for general information only and was prepared for multiple distributions and does not take account of the specific investment objectives of individual recipients and it may not be appropriate in all circumstances. Persons relying on this information should do so considering their specific investment objectives and financial situations. Any person considering action based on this communication must seek individual advice relevant to their circumstances and investment objectives. Subject to any liability which cannot be excluded under the relevant laws. Any opinions or forecasts reflect the judgment and assumptions of Capital 19 and its representatives based on information at the date of publication and may later change without notice. Any projections contained in this presentation are estimates only and may not be realised in the future. The investment manager certifies that all the views expressed in this document accurately reflect their views about the companies and securities referred to in this document and that their remuneration is not directly or indirectly related to the views. Capital 19, its directors, representatives, employees or related parties may have an interest in any of the companies and securities in this document and may earn revenue from the sale or purchase of any financial product referred to in this document or any advice. Past performance is not a reliable indicator of future performance. Unauthorised use, copying, distribution, replication, posting, transmitting, publication, display, or reproduction in whole or in part of the information contained in this document is prohibited without obtaining prior written permission from Capital 19.