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Market Commentary

Capital 19 Catch-Up – Feb 19

Last week was a ripper for stocks as all of the major indices rose by 2.5% or more. The Dow and the Nasdaq both moved to their eighth winning week in a row while the S&P500 made it seven from eight. Bank stocks led the charge, rising across the board. While the much-maligned price of oil also started a comeback, finishing with a 2.2% bounce on Friday.

Most of the positivity on Wall St stemmed from increasing hopes of a deal between the US and China in their ongoing trade negotiations. The March 2 deadline is fast approaching while negotiators from both sides head back and forth across the Pacific at a furious pace. Both parties reported “progress has been made”, while Trump tweeted that talks were “very productive”. This, in reality, means nothing has been achieved, however stock markets lapped it up. The White House admitted later that “much work remained to be done” to force changes in China’s behaviour, and that the talks were “very complicated”.

Complicated is an understatement. The Chinese have been playing by their own rules for so long now that it will take a huge amount of time and effort to get them to change if it is at all possible. The US wants to put a stop to Chinese firms stealing intellectual property and forcing US companies to hand over trade secrets in exchange for market access. And on this, they may rightly get some action from Beijing who are looking to fast track a law which will ban forced technology transfers ( in name at least – they’ll surely keep doing it anyway, but at least it will look like a win for the US). They are also looking at decreasing the need for foreign companies to have to partner with a state-owned local company before being allowed to operate in the country.

But this may not be enough for a Trump administration who are looking for much more. The US already has a major issue with the trade deficit they have been running with China, which hit $323.3 billion last year. This makes China’s “made in China 2025” initiative a major sticking point. China feels that they need to be more self-sufficient – especially in regards to technology.  They are spooked by an incident last year when the US refused to sell phone chips to state-owned telecom ZTE which almost sent the company into oblivion. If the Chinese start making their own semi-conductors and the like, it’s going to be taking more US jobs and increasing the trade deficit even further. This is a major sticking point.

The US is also sick of the Chinese government’s use of state-owned companies – which are only increasing in dominance. It was one of President Xi’s major policy initiatives when he was “elected” in 2012. The US, obviously, prefer less state intrusion into the corporate world. Chinese companies receive generous subsidies to help them compete with foreign competitors which put US companies at a disadvantage. There won’t be any movement on this, however. The chances of Xi choosing to pull back this strategy will make him an unpopular man in China.

So what does the White House do? Take a watered down deal that will hopefully give the appearance of successful negotiations between the two parties, but then risk criticism from the Democrats and others who will accuse them of going soft, while China continues on with their shady practices. Or will they double down on their threats and walk away from negotiations with China, let the tariffs come into effect on March 2, maybe even increase them to other areas and really put some pressure on. In doing so of course, hurting the Chinese economy, but also the world economy, and then indirectly their own economy.

They can also postpone a decision by pushing the deadline back of course. Trump has suggested giving negotiators another 60 days if the talks are looking promising. This is possibly the most likely outcome. I can see China offering up just enough to keep the two parties at the table. It will be a fascinating week either way, and there will be much more to come on this topic no doubt.

The best news from last week was that the government is back up and running with full funding from Congress. Trump didn’t get his wall but he’s declared a national emergency to attempt to get funding by other measures –mainly by taking it out of military spending. Whether he gets it or not will be up to the Supreme court, but in the meantime, the US has a functioning and funded government which the markets will love.

In company news, the two biggest weed stocks went head to head last week and the results went pretty much as we suggested in last week’s Catch Up – higher revenues leading to increased profits – but all being brought down by paper losses from equity holdings from smaller pot companies in the last quarter of 2018. Aurora Cannabis (ACB) racked up a revenue increase of 363% selling almost 7,000 kilograms,  while Canopy Growth (WEED, CGC) managed 283% on the sale of 10,102 kgs. Both are looking at decreasing margins over the next few quarters which should give a jump to profitability. Investors favoured the Canopy numbers however with the stock rising  2.5% on Friday when reporting after the bell on Thursday. Aurora, however, struggled throughout the week falling from $7.30 on Monday to sit at $7.05 on Friday’s close.

Pot wasn’t the only battle on the earnings front last week. A much older war was also on show as the two largest soft drink manufacturers in the world, Pepsi and Coke, went head to head. The two don’t just make sugary drinks anymore though. They have both been forced, thanks to customer preferences for less calorie intense products, into branching out into tea, water, and juice brands.  Pepsi, besides its other Mountain Dew and 7 Up products, also does Gatorade, Aquafina Water, Lay’s, Doritos, Cheetos, Ruffles, Smith’s, Grain Waves, and Fritos. While Coke owns, Lift, Powerade, Fanta, Sprite, Costa Coffee, Mount Franklin water, Pump, and of course a massive collection of alcoholic beverages.

The two giants both reported similar earnings results in the end, yet were treated vastly differently by the stock market. Both grew organic sales by roughly 5% in the quarter, however, both were impacted by foreign currency headwinds which saw Coke’s sales flat, and Pepsi up by 1%. Pepsi, however, jumped 2% while Coke dropped 8%.

The difference in market reaction rested heavily on the post-earnings conference calls. Coke is worried about the global economy going forward. It derives more than half of its revenue from overseas sales, compared to Pepsi’s 38%, making it more susceptible to changing global trends and currency risk. Pepsi’s strategy of focusing on domestic products, where its Quaker and Frito-Lay business is proving particularly successful, sees it the top buy of the two going forward. Coke needs a firing global economy to get it out of the Wall St doldrums.

This week we’ll see 46 S&P 500 components providing earnings in what is a shortened trading week due to last night’s closure for President’s Day. Walmart (WMT) will be the biggest name and will report before the market opens tonight. Wednesday we’ll see CVS Health (CVS), with Kraft Heinz (KHC) and Hewlett Packard (HPE) on Thursday and Cabot Oil and Gas (COG) on Friday.

The Federal Reserve minutes from their January meeting will be released on Wednesday, and we know how hungry the market is for anything interest rate related. We’re expecting to hear that the Fed were keen to stay on hold again. It’s also a big week for housing stocks, with two big reports being released this week. You can see a list of all economic data below, along with a few more earnings highlights.

Have a great week everyone.

Cheers, Paul.

 

Earnings:

  • Tuesday 19th: Walmart (WMT), Herbalife (HLF), United Insurance Holdings Corp (UHC)
  • Wednesday 20th: CVS Health (CVS), Avis Budget Group (CAR), Boston Beer (SAM), Cheesecake Factory (CAKE), Gannett Co (GCI), GoDaddy (GDDY), Jack in the Box (JACK), Sturm Ruger (RGR)
  • Thursday 21st: Caesars Entertainment (CZR), Domino’s Pizza (DPZ), Dropbox (DBX), First Solar (FSLR), Hewlett Packard (HPE), Hormel Foods (HRL), Intuit (INTU), Kraft Heinz (KHC), Newmont Mining (NM), Wendy’s (WEN)
  • Friday 22nd: AutoNation (AN), Cabot Oil & Gas (COG)

 

Economic Data:

  • Tuesday: Home builder’s index
  • Wednesday: Housing Starts, Building permits, FOMC minutes
  • Thursday: Weekly jobless claims, Durable goods orders, Philly Fed, Markit manufacturing PMI, Markit services PMI, Existing home sales, leading economic indicators
  • Friday: Chicago Booth monetary forum

 

 


 

All views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of Capital 19.
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