Think back six weeks. The market was breaking records, but investors kept nervously scanning the skies.
After all, September is statistically the worst month of the year for Wall Street and October is no prize either. This can be a stormy season.
And then there was the drumbeat of dread echoing every day. Short-term interest rates remain too low to keep inflation in check, but long-term rates keep nudging too high for investors’ comfort.
Too much inflation theoretically heightens the Fed’s sense of urgency about interest rate policy, shortening the timeline before the flood of free money shudders to an end. Meanwhile, rising costs play havoc with corporate margins, tapping the brake on profit growth.
At least that’s the narrative. Add in a persistent pandemic, straining supply chains, a fractured labor market, the threat of higher taxes ahead, the federal credit ceiling fight and the occasional rumble out of China, and the bears have had their pick of scary stories this season.
But while it’s always good to temper optimism with caution, letting caution call the shots is almost always a fool’s game on Wall Street in the long term.
This week showed us how it works.
Don’t Sell The Rumor
I’ve spent a lot of time in my career chasing catalysts, the developments that transform Wall Street’s sense of what a stock is all about and where it’s going.
The right catalyst can compress months of hard work into minutes, forcing investors to move fast to avoid getting left completely behind the curve. The wrong one has the opposite effect, destroying hard work as a once-vibrant stock moves in reverse.
Either way, until you see the press release, it’s just a rumor . . . a theory, speculation. Stocks trade on hypotheticals all the time, but in the absence of confirmation, the rumor mill just keeps turning.
Right now, all the negatives arrayed against Wall Street are hypothetical. They aren’t real. They’re just anxieties with various probabilities of turning into realities.
Look at the earnings environment. This week provided clear evidence that the economy remains healthy enough to keep cash flowing for big companies.
If anything, cash is flowing faster than Wall Street predicted. While a lot can happen as earnings season progresses, we’re on track to see 30% more profit in the S&P 500 this quarter than we did last year.
That’s big. And guidance is coming in strong enough that there’s no compelling reason to lower the targets for 2022.
Two weeks ago, all the analysts put together thought we’d see a 42.6% earnings rebound this year, which would then feed into 9.6% bottom-line expansion next year.
Now, plugging in the latest inflation numbers suggests 43.2% earnings growth in 2021 followed by 9.5% in 2022, reflecting roughly a 57% boom compared to last year’s dismal COVID results.
While the Fed and its gusher of free money get a lot of the credit here, there’s no confirmation of economic disaster showing up in either the numbers or the projections. As yet, the fear factor is barely a rumor, far from a fact.
And the internal numbers look pretty good as well. Revenue across the S&P 500 looks like it will soar 15% this year and then another 6-7% next year, which gives corporate management a lot of options.
They aren’t likely to cut costs unless revenue dries up. And if this year is any guide, so far they’ve been able to pass rising costs on to their customers.
Net margins are tracking above 12%, down just a bit from last quarter’s post-2008 record. That’s plenty of room to absorb 5% inflation a little longer if it means defending market share or going after new business.
Maybe some day these calculations will point in the other direction. But right now, there’s plenty of cushion . . . and the results on their own would normally flash “buy.”
And As For Interest Rates . . .
Of course these aren’t normal conditions, with the Fed keeping interest rates so unnaturally low that stocks approach “bubble” valuations. In a zero-rate world, math stretches.
When the Fed tightens, valuations need to reset. But that’s probably at least nine months away, and until it happens, it’s all hypothetical.
A lot can happen in nine months. The economy could stagnate, in which case the rate decision gets put on hold. In that scenario, selling next year’s rate story looks shortsighted.
And while selling bad news before the fact is a great wealth preservation move, retreating to the sidelines is more likely to leave you with regrets than rich returns.
Go back and look at when 10-year Treasury bonds first crossed above 1.5% this year. It was back in February, almost eight months ago.
The world did not end eight months ago, did it? But if you dumped your stocks because someone told you it would, you’ve been watching on the sidelines while the S&P 500 rallied another 16%.
That’s a good season by market standards, racking up profit twice as fast as what investors usually expect in a typical year. Far from choking an overvalued market, interest rates have been neutral at worst.
Back in February, the S&P 500 traded at a lofty 21.5X projected earnings. Since then, the “price” side of the P/E calculation has climbed 16% . . . but the “earnings” side has actually increased so much faster that we’re now looking at a market multiple of 20.3X next year’s profit.
Why Stick To The Sidelines?
Fear comes and goes. The fundamentals are confirmed every three months. I trust the fundamentals because that’s how we make money, week after week and year after year.
I was just telling a few of my subscribers about this. The S&P 500 peaked about six weeks ago and has now recovered all but about 2% of that record-breaking level . . . great, right?
Historically, a bad September usually takes about 1% to 2% out of the index, so we’re right on track with the statistics. It’s just a seasonal drag.
However, someone who opted to avoid the scary season this year could have saved themselves that 2% paper decline and all the headaches along the way . . . but because we trade a lot of options in my world, staying in the market made my people a lot of money.
We bought calls on the fleeting rebounds and puts on the peaks. Basic, opportunistic, even a little boring . . . but tremendously profitable in a season when the index had trouble climbing the wall of worry.
It’s just worry. Step right through it. We can make a similar argument about taxes, China or anything else that keeps other traders awake at night.
Cannabis Corner: Waiting For Premium Pricing
The most essential lesson for cannabis investors this week came from a company on the fringes: Canopy Growth parent Constellation Brands.
Constellation makes beer. It isn’t sitting around passively waiting for higher input costs to wreck its profit margins.
Instead, management is working to raise prices in order to pass inflation back to the people who buy Constellation products.
While it’s still early in the cycle, the program seems to be working. There’s no backlash from consumers and very little brand switching in favor of rivals who have yet to follow suit.
The fact is, people who drink Corona and other Constellation products know what they like and they’re willing to pay a little bit more to get it. They aren’t dropping their favorite brands for a few cents a bottle.
And that’s where cannabis needs to be. Without clearly defined branding, it’s impossible to differentiate between raw plant product grown by Tilray or Aurora or Canopy, for that matter.
That means you’re selling a commodity, and in that scenario, you can only compete by selling at a lower price . . . which is why, perversely, the big growers have been booking bigger and bigger volume while actual revenue trends flatten out.
Price per gram has simply fallen too far as new sources of supply come online. And again, when one gram looks like the next, raising prices is a sure recipe for losing market share.
We need Cannabis 2.0 . . . real differentiated products that consumers can sample and decide for themselves which experience they prefer. Until that happens, Canopy is moving in the wrong direction while its parent becomes more interesting as an investment.
GreenTech Opportunities: Too Many Green Funds?
It’s been a great week for both green and dirty energy. Oil and natural gas prices are both up 1% but they still have a long way to go before they even test 2018 levels.
The truly giddy pre-2008 peaks now seem like a dream. That’s actually due to rising interest in more sustainable alternatives that can now compete better with the entrenched hydrocarbon economy.
Expensive fuel makes alternatives more attractive, driving money into R&D and sales onto green producers’ balance sheets. Scale feeds itself as niche renewable technologies hit the mainstream.
And innovation takes care of the rest. Already, a lot of money is flooding into green stocks in the hope that the future is coming fast. The longer oil rallies, the faster that green money will flow.
But as it is, there are arguably too many green portfolios, all of which look more or less alike. Let’s start our journey into this world by breaking down one index fund and seeing which stocks are most relevant.
The answer: utilities. Orsted, Nexterra, Xcel, Iberdola, Enel, SSE and others run dams, wind and solar farms. They’re where the heart of the new energy ecosystem is already starting to beat.
Don’t get me wrong. I love a cutting-edge technology stock. Names like Enphase and SolarEdge are interesting. But they’re for the long haul.
If you’re just looking for green exposure in the here and now, skip the developers and build your own ESG fund . . . out of green utilities.
After that, you can get fancy. We’ll talk more about that next week.