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Capital 19 Catch-Up

Weekly Index Movement

S&P500+4.7%
Nasdaq+5.8%
Aussie All Ords-1.1%

We were all very happy to see the market bounce last week and it wasn’t wholly unexpected given just how oversold everything had become.

The week started with fairly good earnings announcements from the banks.

Bank of America on Monday posted earnings and revenue that topped Wall Street’s expectations. The bank cited better-than-expected gains from fixed-income trading and interest income, which were fed by rising interest rates and market volatility. Bank of America’s results follow last week’s initial wave of big bank earnings. JPMorgan and Wells Fargo exceeded projections due to strong interest income. Citigroup also topped estimates, but Morgan Stanley fell short due to underwhelming investment management results

On Tuesday the rally continued when Netflix (NFLX) announced they had added 2.4m subscribers in the quarter, twice as many as expected.

Lockheed Martin (LMT) reported that third-quarter sales and earnings rose from a year ago and the defense contractor maintained its full-year outlook. Shares jumped 8.7%. …. Goldman Sachs’ (GS) third-quarter results exceeded Wall Street’s estimates despite a challenging and volatile economic environment, while the banking giant confirmed a restructuring of its businesses. Shares were up 2.2%.

Electric vehicle pioneer Tesla (TSLA) was the big, flashy earnings print of the week: Elon Musk’s company reported EPS 4 cents or 4% higher than estimated. There were some worse results under the hood, though, as revenues were 3% below forecasts and automotive gross margins missed by 0.5%. The revenue miss was placed on transportation capacity which is “increasingly challenging”; an effort to “smooth” both outbound logistics and delivery pace “will improve cost per vehicle”. On new products, the Tesla Class 8 Semi truck offering will see its “initial phase of deliveries” start in December, with industrialisation of the Cybertruck pickup to follow “subsequent to the Model Y ramp-up” at the company’s Texas factory.

IBM (IBM) was another sold earnings announcement which had a very strong top-line Q3 relative to expectations: revenue beat by 4.3% and sparked a raise to the company’s full year constant currency revenue growth guidance of “mid-single digits”; management now expects growth “at the high end” of that range.

The focus on corporate profitability rather than macro-economic reports gave a much more positive backdrop for stock prices even though 10yr yields increased during the week.

The fact stocks gained in the face of rising rates is extremely positive and for this rally to continue we want to see the 10r stabilise as it did for the June-Aug rally.

The question then becomes, is this an investible rally or just another bear market bounce?

That really is impossible to answer. But let’s look at both sides of the coin:

The Bear Case

  • Inflation is still above 8% and has been for 6 months despite rising interest rates
  • The only way to break this inflation is a recession
  • The Fed seems intent on causing a recession
  • In most recessions, earnings drop by 25% which would put earnings at $165
  • Fear of a deep recession could see PE ratios at 15
  • Which puts the S&P at 2,475 or 34% lower than today.

The Bull Case

  • Inflation seems to have peaked. It has not increased for a few months.
  • Leading inflation indicators are dropping suggesting lower inflation soon
  • Markets have factored in interest rates of 4.5%.
  • Company earnings are coming in about the same as last quarter showing no drop in profits.
  • Unemployment is at the same record low levels as 2019, before the pandemic
  • Wages are rising at over 5% per annum allowing consumers to afford higher interest rates.
  • Stock valuations are attractive. Especially small caps.

Which case is correct?

We are a long way off from recession at this point.

To be a big bear, you really have to think something will break. Whilst that could happen, until it does, there is no reason to think it will.

Our psychology might have helped cavemen avoid danger but for the modern investor, our fear of something bad happening often holds us back.

We are yet to see any evidence of a significant risk event causing problems in the market.

But that doesn’t stop investors fearing something will.

All measures of investor sentiment are very negative right now. Until this changes it is unlikely we will see a significant and sustainable rally.

But there is one thing I have observed over the last 14 years of talking to investors. Higher prices always give investors confidence.

The longer stock prices climb the wall of worry, the more confident investors will become and the more money they will plough back into funds.

Fear of missing out is also a powerful motivator.

But, there is an easier way to trade these markets.

Instead of trying to predict if growth stocks will go up or down, I would advocate investing in sectors where the question does not matter.

Stick with Energy – coal/oil/gas and other value stocks and let others worry about growth until the picture becomes clearer.

On the topic of energy. Biden made us laugh this week.

Firstly he announced there would be one more release of 15mm barrels from the SPR, but that would be the last release. This is the event we have been waiting for. Once those 1mm barrels a day of supply stop, and OPEC reduces by 2mm barrels a day as they have announced, oil will march higher once more. It jumped 7% on this news. $80 is the new floor for oil.

Secondly, he announced $2.8billion in spending to support the battery industry. In particular to fund the acquisition of more materials (lithium, cobalt, nickel) to produce more batteries so they can get petrol cars off the road faster. At the same time, he implored oil companies to stop giving profits to shareholders and rather use the profits to explore for more oil to keep the oil price down.

What would you say if you ran an oil company? On one hand, Biden has just given your competitors a boost to put you out of business faster and then he asks you to not reward shareholders but instead help drive the oil price down so you make fewer profits.

I’m sure they will help him out. They are good guys who put his political career above their own profits, right?

Next Week

The coming week will be the biggest week for earnings with Alphabet (GOOG), Microsoft (MSFT), Meta (Meta), Apple (AAPL) and Amazon (AMZN) all announcing earnings.

These 5 companies make up 21% of the S&P500, so their results will largely determine market moves.

It is truly phenomenal that these 5 companies alone are worth more than the entire sectors of Financials (11% of index) and Industrials (8% of index) combined!

CatchUp Stock Tips

We often get asked which oil company we like best. That is hard as they all tend to move together as a sector, but if we had to pick one, we would go with Occidental Petroleum (OXY), which is the one Buffet picked and has been buying in a big way this year. The fact it trades on a PE of 7 when it’s competitors are trading on PE’s of 12 is probably the reason why.

Buy Occidental Petroleum (OXY) with a stop at $58

Buy DateBuy PriceCurrent PriceGain / LossStop Loss
TXN1 Aug 22177.94159.72-10.2%145.00
ASC8 Aug 228.5211.69+37.2%6.40
CDNS15 Aug 22188.83158.34-16.1%130.00
UNH22 Aug 22541.39533.73-1.4%450.00
GMS5 Sep 226.505.72-12.0%4.00
AAPL12 Sep 22159.59147.27-7.7%130.00
CRK19 Sep 2218.2216.53-9.3%12.00

All the stocks in the list above remain a buy. You can get them cheaper than we did at present so take advantage while you can.

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.