Q3 2019 Earnings, What We’ve Learned

On the 10/25/2019 episode of Stock Talk, CIO Chris Perras takes a look at the recent earnings seasons, what we have learned, and our view for the coming weeks.

Chris Perras: Good morning. My name is Chris Perras. I’m Chief Investment Officer here at Oak Harvest Financial Group in Houston, Texas. Welcome to the October 25th edition of our weekly Stock Talk Podcast: Keeping you connected to your money. I bring to you a brief review of the third-quarter earnings reports that we have seen so far, what we have learned, and what we expect in the week ahead. Rightly so, this podcast is entitled, What I Learned in the Markets the Past Two Weeks.

As of this morning, the S&P 500 sits almost exactly at 3,010. We were about halfway through the third-quarter earnings reports, and it’s been a mixed bag so far in the third quarter, as it normally is 9 out of 10 years in both the economy and the stock market. At the risk of repeating myself for the 100th time so far this year, this is a normal year in the ongoing 10-year bull market. We laid this out in early January, and it continues to play out.

What have we learned so far in the third-quarter earnings, through companies like Taiwan Semi and Lam Research, we learned that semiconductor spending is picking up in cellphones, data centers, and equipment. That’s great news and it’s an inflection point, however, industrial spending in the same area remains weak. Is this new news to the team at Oak Harvest? No, it’s not. We learned that the drop in long-term interest rates that has occurred during the past year hasn’t hurt financial companies’ earnings, like JPMorgan and Morgan Stanley, as much as the market had expected, and it was already factored into the stocks.

We learned that the industrial and manufacturing economy is weak due to the ongoing trade issues with China, labor union strike at auto manufacturing at General Motors, and weakness in Europe due to Brexit. These issues have been out there for over 18 months now, these are not new revelations to the team at Oak Harvest. We learned that consumer spending is strong and people are eating lots of chocolate, drinking lots of soda, and eating lots of fast food and chips due to the millennial generation and due to unemployment in America sitting near historic lows at 3.5%. However, what is more interesting to us as investors is what did the stocks do with this information and how did the stock react to this news?

Herein, lies the art of investing. That art is determining how much is too much. That is, how much good news is too much good news? When is a good news fully factored into the valuation and price of a stock? An example of this, take Hershey foods. Now this is a great American company with a great business. Heck, they sell chocolate and candy. This is a great business. The company beat earnings and revenue estimates, however, the stock dropped 10%. Why? Because a year ago, investors could have bought Hershey stock for under $90 a share or about 15 times earnings.

Over the past year, as investors have flocked to safety and predictable companies, the stock has risen to $160 a share and a valuation of 28 times earnings. This is for a company that is growing revenue at 2% per year. As good as a business that candy is, this is overvalued by any stretch of the imagination. There are growth companies in the market growing revenue at 15% to 20% a year, trading at less than 20 times earnings.

On the flip side of this, is when is bad news actually good news? That is, when is all the bad news factored into a stock? A great example of this is the big construction and mining equipment company, Caterpillar. Since the first quarter of 2018, when Caterpillar’s business and stock peaked, they have been afflicted with almost every headwind one could imagine in their business. A stronger dollar hurts Cat’s earnings. Higher tariffs on steel, hurts Cat’s business and earnings. Lower mining demand in emerging market countries, hurts Cat’s business and earnings. Lower energy demand globally, hurts Cat’s business end earnings.

When Caterpillar reported earnings last week, management announced that they would slow manufacturing and continue to let inventory at the distributors be drawn down. The stock initially traded down about 8% in after-hours trading on this bad news. 24 hours later, the stock was up on the day, and it looks to Oak Harvest as if businesses has troughed and both the business and stock are headed much higher over the next year or two.

What other things that we learned in the first two weeks of earnings? We have learned that almost no one in the investment world is playing offense. What do we mean by this? Playing offense in the investment world means buying companies with a cyclical tilt to them. It means believing that the economy is about to improve or is already in an upturn. It means buying small cap stocks, emerging market assets, industrial companies, financial stocks, emerging market assets, and banks, and brokerage, and yes, technology firms. It means foregoing investments in bonds, and utilities, and staples, and real estate for a while, and looking for value elsewhere.

You have to look carefully behind the scenes to see it, but these things have started slowly already. How do we know? Because the relative performance of all of these assets burst to market, started turning up between August 15th and September 3rd, and are slowly gaining traction. Not coincidentally, this was the absolute low in treasury yields. This is just the same as it was in the summer of 2016.

Oak Harvest sees these rotations that most of the financial press has been poo-pooing as just starting, and these are legitimate moves that most investors will be chasing for the next six months to a year. I do want to comment on the week ahead. For investors who look at things short term, the team here at Oak Harvest is expecting one last bout of short-term volatility next week. Why do we see this? First and foremost, it’s the end of the fiscal year for about 30% of financial companies. That means they’re still in tax harvesting mode and still hoarding cash and bonds to show their investors how conservative or smart they were year to date.

Secondly, there is a Federal Reserve meeting later in the week, and we expect a number of investors to misread what the Fed is saying, and it will cause some short-term volatility. What will the team here be doing? We will be sticking to our process and buying high-quality companies and areas in the market that are not overvalued and we see benefiting from the upturn in the economy in the fourth quarter of this year and easier comps in 2020.

I repeat, year to date, this is a very normal year in an ongoing 10-year bull market. The economy and stock market structure look nothing like the 1930 depression times being touted for the past two years by a billionaire hedge fund manager. We continue to see a year-end move in the S&P 500 to new all-time highs that are sustained into year end and even higher in 2020. If you find this content helpful, please forward it to friends and have them give us a call at 281-822-1350. Browse our website at oakharvestfg.com. Our main job at Oak Harvest is to have you retire only once in your life with a customized retirement planning. Many blessings. This is Chris Perras.

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