Markets Happy Canadian Thanksgiving Day! The weekly update is coming to you a little late this week as it was a little hard finding the time to get this out amongst all the turkey this weekend. Canadian markets are closed Monday.
Equity markets managed to gain some ground last week although were down hard on Friday. The DOW was able to gain 2.0% while Nasdaq was higher by 0.7% and the TSX was up 0.8%.
Strong US employment data, once again, ruined the equity party on Friday. The unemployment rate fell from 3.7% to 3.5% as the US labour market continues to stay strong. This labour data continues to give the Fed the ammunition it needs to continue to keep monetary policy tight. Good economic news continues to be bad news for the equity markets.
On the back of the strong employment data US treasuries were back on the move higher and the 2-year treasury notes are back testing the recent highs.
Major economic data this coming week will keep investors on their toes, and we likely continue to see volatility as all major markets continue to test their year lows. We’ll have September’s producer price index (Wednesday) and consumer price index (Thursday) followed by retail sales and University of Michigan’s preliminary consumer confidence index for October (Friday).
One thing Canadians can be thankful for is that the TSX has outperformed both the DOW and Nasdaq over the past year. The TSX has dropped 9.1% from a year ago and is down 16.3% from its year high. The DOW is down 15.1% over the year and down 20.7% from its high while Nasdaq has taken the biggest beating down 26.2% from a year ago and 34.3% from its year high. |
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We can thank energy stock for the bulk of the TSX outperformance.
Inflation continues to be the headline driver of the markets. Any signs of inflation cooling and the markets rally. Any signs of the economy maintaining strength and the markets head lower. It’s clear that inflation is slowing but the market bulls need to see it cool faster, and a number of leading indicators continues to suggest that inflation should start colling much faster.
Auto sales and used auto prices are declining rapidly. |
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Housing
Higher interest rates are finally affecting stubborn home prices in the US. US home prices saw their biggest monthly decline since 2009. And while rents saw a meteoric rise along with house prices, they too are starting to cool albeit rents continue to climb as demand from those priced out of the home buying market turn to renting to have a roof over their heads. |
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Global shipping prices continue to fall sharply and are nearing pre pandemic levels. |
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Global food prices have seen 6 months of declines. |
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The economy is cooling and with time we should see a more rapid effect on prices for goods and services. |
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Unfortunately, lagging indicators such as labour are not there yet, and it looks like the Fed wants to see this kind of lagging indicators confirm the leading indicators direction. Inflation is cooling but we need to see it cool faster to keep rates from staying elevated. A strong US job market is keeping the US economy just a bit too hot….. for now.
We need to see bad economic news to get the equity markets heading higher.
Energy OPEC+ surprised the market but planning to reduce oil production by 2 million barrels, a larger cut than many were expecting. The Biden administration is looking to release an extra 10 million barrels from their Strategic Petroleum Reserve (SPR). Volatility ensued.
WTI oil ended the week up 13.5%, one of the largest weekly gains in a long time. |
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It’s clear that OPEC+ wants to put a floor on energy prices and while I expect prices to continue to be volatile I think we are closer to a bottom in prices than we are to the top. I’m starting to look at some of the North American oil service companies again as I would not be surprised to see a much more pro drilling narrative come out of the US government. At some point the US SPR could get low enough that it would be “strategic” to protect the US against further draw downs in global supplies. Even with the recent drop in oil prices drilling activity has remained robust and we saw last week the Biden administration is trying to find ways to entice more domestic supply.
We saw a net drop of 1 North American rig this past week according to the Baker Hughes drilling data.
Natural gas prices closed mostly unchanged on the week while unleaded gasoline was higher closing at its highest levels in over a month. |
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Commodities
Gold was higher having traded above $1700 for most of the week joining the markets sharply lower on Friday’s trading session. Gold will likely continue trade in the opposite direction of the US dollar and higher interest rates.
Grains were mostly unchanged for the week but the news of Ukraine military success in Crimea and Russian reprisals have spiked wheat and corn prices higher. Wheat prices are at 3-month highs. |
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Stocks The major equity indexes have been in decline for almost a year. The DOW and Nasdaq are in bear territory if we use the -20%+ definition. Big stocks get all the attention and drive investor sentiment.
While the major global equity markets continue to test year lows there continue to be smaller companies generating good returns.
I’ve been stressing that more and more we believe we are seeing two equity markets. The big stocks and the small stocks.
To be clear a slowing economy will impact revenues and earnings of almost every company regardless of size, but the liquidity concerns of so many investors and the passive investing vehicles of the last few years have continued to drive capital to bigger stocks inflating so many of the valuations. Small, illiquid stocks have been mostly left alone. But value is value and when big stocks lower earnings forecasts down go their stocks and the bigger the company the bigger their impact on the indexes. Think Apple, Amazon, Facebook and Tesla.
Small stocks got their pricing revisions over the past 2 years and most of that I would argue was due to a move away from illiquidity. Most small companies regardless of their outlook saw their share prices decline as investors and institutions pulled capital out and moved it into the “safety” of the big stocks. “You can’t go wrong by buying big, dividend paying stocks” was something I heard a fair bit over the past year. You can’t go wrong owning Amazon, right? Amazon is down 39% from it’s November high. According to Yahoo Finance, Amazon trades at a PE of 107 and an EV/EBITDA of 24 times. |
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Google (Alphabet) is down 34.9% from its high. It currently trades at the “low, low valuation of only 18.9 times earnings”. Some are saying that Google is in “value” territory. A value stock that trades at 18.9 times earnings? Revenue, in their latest quarter was up 13%. Not bad but does it justify 18.9 times earnings multiple in this environment?
How about Apple? Trades at 23.2 times earnings and an EV/EBITDA of 17.6 times. Apple grew its revenues by 2% last quarter and analysts are forecasting a drop in revenues in the coming quarters. It’s a great company but why should it trade at 23 times earnings?
Facebook (META) has seen its stock drop 62% this year on lower revenues. It still trades with an 11.6 times PE. |
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Think of the influence these stocks have had on the indexes and the sentiment of investors. What chance does a microcap stock have of going higher when the big boys are having so much trouble. The big stocks are getting punished so why won’t the small stocks? It is all about price….
Big stocks have been going down, but certain kinds of microcaps have been performing quite well, especially over the last few months.
Think of the theme I’ve been pushing in our microcap universe. Double digit revenue growth and single digit PE ratios. Most of the big stocks are the other way around. Single digit revenue growth at double digit (or triple digit) PE ratios. Big stocks still appear over valued in this environment and I blame the passive funds and institutions that want or need the liquidity of these big names. Smaller stocks, select smaller stocks that is, appear to be cheap. And some have been doing very well. Think Inventronics (IVX.V) and Fab-Form (FBF.V).
I’ve always believed that the best insurance in the equity markets is buying low valuations. Finding stuff that’s cheap is where you get the best protection. Some will say liquidity is safety but if you pay too much for a liquid stock there isn’t much safety when the bear market shows up unless you decide to unload quickly.
The indexes and most big stocks will see revenues slow, and earnings drop as the global recession takes hold. Company guidance and analyst forecasts are already being lowered. |
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With high valuations still the norm with many of the large market components it’s not hard to see how we may be in for more downside for many larger stocks and the indexes. And as go the big names and the indexes, so likely goes investor sentiment.
Small stocks, over time, far outperform large stocks, and because of this, small stocks should trade at a premium to big stocks, yet it is the other way around right now. |
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Investors who don’t understand this dynamic are missing out on a massive advantage that small retail investors have over the big institutions. They also have history on their side. Small stocks outperform big stocks and with the extra discount currently present they are due to far outperform the big guys yet many investors continue to move capital away from the small stocks and into the bigger ones or out of equities all together. I think this is a big mistake.
This week I took advantage of what I believe to be another mispriced nanocap opportunity. I bought shares in Circa Enterprises (CTO.V). This company grew it’s revenues by 30.5% last quarter yet trades with a trailing 12-month PE of 7.1 times and an EV/EBITDA of only 4.4 times. A huge discount to the valuations of market darlings like Facebook and Apple. I feel safer owning a company like Circa than Facebook.
There are always plenty of microcap and nanocap stocks that offer patient investors great long-term risk/reward opportunities. But right now, the deep discount to the big stocks gives savvy retail investors the best opportunities I’ve seen in over a decade.
Other Stuff The kind of artificial intelligence deal I’m hoping to see with IPA and Biostrand… Lilly inks $425M biobuck drug discovery pact with Schrödinger (fiercebiotech.com)
I follow shipping rates and data closely as it’s a early indication of deteriorating global economy. Global shippers cancel sailings.
Ian Cassel, founder of the MicrocapClub always gives great interviews. He’s done it again here.
I’ll be doing a Twitter Spaces with Michael Gayed of the Lead-Lag Report on Thursday October 13 at 9am PST. https://twitter.com/leadlagreport
Canslim Contender Sorry, I couldn’t find the time to pick one this week. |