U.S. Economic And Financial Markets Outlook
Inflation And Recession Fears Ramp Up Market Volatility As Energy Prices Soar!
(Return figures in this section come from the May 30, 2022, editions of the Wall St. Journal. Y H & C Investments may have positions in companies mentioned in this newsletter. It is the responsibility of each investor to research investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives)
In May, the Dow Jones Industrial Average lost .22%, the S&P 500 fell .56%, and the NASDAQ dropped 3.63%. May is usually a month in markets where volumes start to dry up. The adage of ‘Sell in May and go Away,’ has a grain of truth to it. Investors often find the summer months very volatile but on light volumes.
With little activity, prices get whipsawed quite a bit because one side of a trade tends to dominate. We certainly did see quite a bit of volatility in the last month as high-profile earnings misses from retail giants Target (NYSE:TGT), Walmart (NYSE:WMT), and Dick’s Sporting Goods (NYSE:DKS) suggested supply chain issues remain problematic for retail margins.
Snap (NYSE:SNAP), the technology company, also was taken to the woodshed for warning of a dramatic slowdown in advertising.
Concerns about the economy moving into a low or no growth environment weigh heavily on trading sentiment, but inflation levels remain the biggest obstacle.
Continued upward pressure on prices could force the Federal Reserve into a much longer period of interest rate hikes. When we last looked at analyst estimates for Fed Fund rates, most believe the Fed will hike rates anywhere from the next seven to ten meetings.
Faced with much tighter monetary policy, investors don’t know how high interest rates will go. If it’s one or two 50 basis point raises and then the Fed stops, that is an entirely different circumstance then 10 straight 50 basis point increases.
All of this depends on inflation levels and on that point, the big one to focus on is energy.
With oil prices sitting at over $110 a barrel, the biggest issue the country and globe faces is a lack of refining capacity. With green policies all the rage, the number of oil refineries operating both in the United States and globally is down dramatically.
Unfortunately, policy makers don’t realize it takes five years or more to build a new refinery. Mr. Biden is now asking existing owners to restart idle plants to find a solution to the problem.
There just aren’t many available. Poorly considered policy leads to tough economic circumstances for the consuming public, but excellent economics for owners of these valuable assets.
The other major consideration is energy impacts so many other inputs, especially related to transportation. If you need an example, look at airline ticket prices. They are up dramatically since 2021, and a big reason is because of the energy situation.
As for stock prices, one must consider if a one percent increase in interest rates justifies 50 to 80 percent selloffs? The important question is will it only be a one percent increase, or much more?
Global Economic And Financial Markets Outlook
Oil Producing Countries Post Gains As The Rest Of The World Remains Mired In Red!
(All country index data provided by countryeconomy.com, May 27, 2022)
With oil prices up 50% in 2022, oil producing country indexes show strong year to date results. Non-oil producing indexes are typically mired in misery with most showing five to 10 percent losses.
The Eurozone index is consistent with that range, showing a -12% number. Interestingly, the FTSE index, which represents the UK, is ahead by 3%.
Within the country, the political leadership has decided to impose a ‘Windfall Profits’ tax on energy companies. The purpose is to help the citizenry pay for the large rise in living costs.
Electricity costs have soared and the inflation rate in the UK for April showed a 9% jump in the Consumer Price Index. I would note there was not a windfall loss subsidy for the energy companies a few years ago when oil went to minus $37 during the height of the pandemic scare.
From a long-term perspective, the tax certainly won’t make reinvestment in the North Sea by energy entities more attractive. With scarce refining capacity across the globe, Europe and the UK need a thoughtful reexamination of how they approach energy sourcing.
Here in the United States, don’t be surprised if we see calls for a windfall profits tax soon. With little chance of passage in the current Congress, a sober approach to energy is going to take a higher priority as energy prices keep escalating, maybe to astronomical levels.
Just to give you a taste of the strong results from the oil producing countries, Jordan is ahead by 16.7%, Kuwait, 13.57%, Qatar, 11.13%, Saudi Arabia, 14.41%, Norway, 7.15%, and the Emirates +16.72%. Of note, South American countries Brazil (+6.37%), Chile (+22.51%), and Columbia (+8.60%) all show nice results.
The Art Of Contrarian Thinking
Understanding The Investment Thesis: Change In Earnings Power And Balance Sheet Arbitrage!
(YH & C Investments may have positions in companies mentioned in this newsletter. It is the responsibility of each investor to research investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives)
Over the last 10 years, the performance of a vast majority of stocks was related to their increase in earnings power. In most cases, operating income is the important measure.
When a company like Amazon (NASDAQ:AMZN), Google (NASDAQ:GOOGL), Facebook (NASDAQ:FB), Microsoft (NASDAQ:MSFT), or Netflix (NASDAQ:NFLX) goes from earning, say $500 million or a $1 billion per year, and five or 10 years later is earning five to 10 billion per year, the dramatic increase in income often justifies a large rise in the stock price.
The projected improvement in earnings power is what you are looking for in companies you are interested in buying. Specifically, what are the ways this will happen?
As an example, a position of the firm recently completed an acquisition. Prior to this purchase, the entity was earning about $150 million per year. Post the integration, earnings are estimated at $400-450 million per year.
The improvement should occur in 2023. The next six months will require cost cutting and streamlining. It has been a star performer over the last 20 years so waiting six months for management to integrate the assets is mandatory for long term shareholders.
It is why a great deal of investing is about having the patience to stick with companies you own.
Of course, not every investment thesis is centered around improvement in earnings power, though most should be. In a different example, a new position is based on the wide disparity between the value of the owned assets on the balance sheet versus the existing market value of the stock.
The question becomes, how does the value of the owned assets get realized? As these are mostly minority non controlled positions, management must collaborate with these companies to grow their earnings power.
It might be through an acquisition, cost cutting, or simply continuing the same business path and seeing a change in market sentiment. Balance sheet arbitrage can take longer, but with active and creative leadership, the returns can often prove worth the extra time waiting.
My point is to understand the investment thesis of each position so when you monitor the operational results, you know what you are looking for to judge the progress (or lack thereof).