21 Mar Capital 19 Catch-Up
Weekly Index Movement
|Aussie All Ords||-2.2%|
Apologies for being a day late with our Catch-Up this week but I’ve been hitting the buy button so much I broke it and then had to get a new keyboard before I could type this.
What a glorious week. I dream of events like this but always have to wait a long time for them.
It’s like the time your favourite red wine went on sale for 70% off and you bought 6 cases in excitement. Ok, maybe that was just me, but you get the idea.
The events of the past week are nothing short of ridiculous. But it is this that gives us opportunity.
Before I get into the ridiculousness of it all, I want to talk a bit of investing psychology.
Back when we were cavemen and running around hunting with our spears, we would sit by the fire at night and plan our food source. We knew the deer would be travelling through in about 2 months time so we would plan our approach to hunting them and get all our equipment ready to capitalise when they do. We would do this in a state of calm and logically put a plan together.
Much like we still do now as investors. When markets are smooth we plan the future. We look at sectors that should gain and calmly consider what actions to take.
But as cavemen, everything changes when a sabre-toothed tiger jumps out of a bush and starts chasing us.
We forget all about the future and our minds deal with the immediate threat. Our thinking goes from long-term to short-term survival. We forget all about our goals and focus on what is happening right now and how close those fangs are to our behinds. We make short-term decisions, like drop your spear and run, when our long-term plan was to use our spear to hunt the deer next week.
Investors do the same thing.
They see a nasty headline and forget everything about the future and focus on the right now. They make silly decisions, like dropping their long-term tool for survival (spear) and panic sell everything else.
As another hunter watching this unfold before my eyes, it makes my life very easy. All I need to do is wander over and pick up their dropped spear and then my future will look a lot brighter.
That’s why I couldn’t hit the buy button fast enough last week. The long-term assets were at fire sale prices. I’ll show you what I mean a bit later.
Back to what happened.
I wrote a bit about this last week (you can read that here) so I won’t go over all of it again.
A quick summary is a couple of small regional banks that didn’t have to meet large bank capital regulations had made very poor structural decisions which came back to bite them.
In response, the Fed guaranteed all depositors but took the bank out the back and shot it to put it out of its misery. Shareholders got smashed, but customers were fine.
They did this to stop the short-term panic reaction that has been built into us since we first emerged from making art with our handprints. And it worked.
There was no serious run on other banks.
One bank was looking a bit iffy, First Republic Bank. So the Fed forced 10 large banks to deposit $30bn with them to make sure they had enough liquidity to cover panic withdrawals.
I suspect Powell called them and said “look, things could get ugly here and if customers don’t trust the banking system how do you think your share price is going to react?” Putting a couple of bill into a competitors account is much better than everyone dropping their spears.
The Fed also put in place a mechanism for banks to get liquidity by giving the Fed back government bonds the Fed issued in the first place and then said, don’t worry Mr Taxpayer, you won’t have to pay for this, we are going to introduce a special levy on the banks to recover the costs from them.
You can only imagine how a bank who did the right thing and took little risk with customer money reacted to the news of being charged to bail out a competitor who had done the wrong thing.
Anyway, the net result is – the banking system is fine. It was only the small regional banks that were ever at risk and the Fed has guaranteed that risk now.
What happens from here? The news will probably go way over the next several weeks. Large banks were always unaffected, if anything, they might gain business as customers move to more established and less risky propositions.
Regional banks will no doubt take longer to recover. They will cop a load of new regulation and probably have to meet the same regulation the large banks do. What that does to their profits and dividends is yet to be seen.
I feel it is too early to buy these beaten down regional banks. Tempting as they might be. We could well see some consolidation in the sector over coming months and this could offer good upside. For example, New York Community Bank (NYCB) exploded higher by 35% in response to its purchase of Signature Bank assets reported over the weekend. But there is still too much risk to try and sort good from bad here.
You are much better off picking up larger banks that have seen their stocks also fall. I wrote about Charles Schwab (SCHW) last week (Read That Here). That idea still holds. It is a bargain right now.
I’ve also been looking at US Bancorp (USB). Stock down 30% from Feb highs and now trading on a PE of 7. Offers a dividend yield of 5.6% which is covered 2.6x and analysts have not changed earnings expectations for this year. They still sit at $4.92/share.
As you will be aware, it wasn’t just US banks that got in trouble. The 126 year old Swiss institution, Credit Suisse collapsed last week too.
This was for different reasons, mainly because an Aussie Farmer caused them so many losses.
Lex Greensill grew up on Australia’s largest potato farm and decided to open a finance company in London called Greensill. Apparently, potatoes and credit finance have a lot in common because Greensill did very well and became very big. Credit Suisse lent them an awful lot of money.
Then Greensill blew up all their potato chips and went into liquidation. Maybe knowing how to grow potatoes does not qualify you to run a multi-billion-dollar credit finance business.
The problem for Credit Suisse was this wasn’t their only bad investment. They had a similar story with a company called Archegos Capital and there was the accounting scandal at Lukin Coffee.
They lost $8 billion last year. When the Saudi Bank said they would not lend them any more money the chips hit the fan and over the weekend their main competitor, UBS has agreed to buy them for $3billion, which is about 40% of their market capitalisation.
As you can see, this is a very different situation and does not mean there are systemic problems with worldwide banks.
The upshot of all this is where things get ridiculous.
Prior to last week, according to the CME Fed Funds Watch Tool, markets were expecting the Fed to deliver a 50bps rise on Wednesday this week with 78% certainty.
That in itself was ridiculous because the Fed were obviously going to go for a 25bps rise.
The Fed has several charters and one of them is the stability of the financial system.
When those high-risk and irresponsible banks collapsed last week the market decided the Fed can’t raise rates any more because it could lead to more bank failures.
Expectations swung from 78% chance of a 50bps rise to 50% chance of no rise at all. The 10yr and 2yr bond yields collapsed by over 1% and began factoring in 3 rate cuts this year.
The Fed just backstopped bank liquidity. That stops the financial system problem and they have been saying the same message for over 12 months now – they will raise rates until inflation is under control.
The Fed will absolutely deliver a 25bps rise tomorrow. Their message will be although there are signs of disinflation the labour market is still too tight and they will monitor economic signals before deciding on their next course of action.
The tech sector had a good move last week. AMD was up 17%. Nvidia (NVDA) was up +13%, Microsoft (MSFT) was up +12.1%. All on the back of those lower interest rate expectations.
It won’t last. Powell is going to dispel this illusion when he speaks and interest rates will revert higher whilst tech will fall.
Adding to the ridiculous is even now, the market is looking for 3 rate cuts this year. The only way that happens is if the US falls into a recession.
That’s not going to happen either because the economy is still strong. 3 small regional banks going out of business and all customer’s assets made whole does not equal recession.
Clearly the market thinks in a recession we use less oil and coal because the oil price fell to $64 dragging the energy sector down with it. Would you believe the energy sector performed worse than the financial sector last week?
And this is where smashing the buy button started.
One of my favourite stocks, Ardmore Shipping (ASC) fell to $14.62 on Friday. It will pay $1.80 in dividends over the next 12 months which puts it on a yield of 12%. I’ll take as much of that as I can thank you. The stock was closing in on $19 before markets started resembling a Salvador Dali painting.
In Australia, New Hope Coal (NHC) fell to $4.90. (this is when my buy button broke). NHC went and announced profits this morning, before I could get this note out to you. Profit after tax more than doubled to $668.6m. They will pay a dividend on May 3rd of 40c. Add in your franking and it becomes 57 cents which makes this single dividend a yield of 11% on Monday’s closing price. It has jumped to $5.33 today but that is still over 10% in a single payment.
We aren’t supposed to like coal because a Swedish teenager tells us so. But I love 20% yearly yields and am willing to get my hands dirty for it.
Then there is Nine Energy Services (NINE). You know how much this stock has given me the run around. Well, it is now at $5.54. It was at $16 in January.
Nine is a contracting company that helps oil drillers get oil out of difficult wells. When Oil is up at $80 it is worth the driller paying Nine to get the oil out. At $64 it becomes more of a question.
But I suspect Oil will head back up. Nine thinks drillers will need to open new wells to keep production flat and capex will double over 2022. If that’s the case, Nine is a bargain now.
The way to trade these cyclical names is to buy when things look terrible and sell when things look rosy. They are not like consistently growing tech companies. Their profits shoot up and down based on the price of oil. Now is the time to buy oil stocks again and then be patient and wait for oil to recover.
All eyes this week will be on Powell and the interest announcement on Wednesday. You know what he will say and tech stocks will fall, so if you want to lock in your recent profits do so before then. You can always buy them back lower next week.
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.