Profit Growth Returns
We dig much deeper into earnings season this week and wow has this been a unique quarter. Results are all over the map with many companies reporting stellar results and others falling quite flat. This “high dispersion” is the stuff markets are made of, and we are enjoying it very much. We are coming up on the end of the election season and in less than two weeks will know the fate of the U.S. Senate and so much more. In the meantime, we think there is a lot of good stuff here this week on natural gas, market sentiment, oil prices, the dollar, and much more, so let’s get into it …
Watch this week’s Video Executive Summary on our YouTube Channel (different content).
So you got what you wanted. What’s the big deal?
Earnings season thus far has been the most interesting of environments whether one has been a bear or a bull. For bears, the results have been way too positive to allow a big sell-off, with 76% of companies outperforming expectations so far and earnings set to actually grow quarter-over-quarter for the first time in 18 months! But for bulls, valuations were full enough coming in that no major rally has been warranted.
The three most powerful words in investing
“I don’t know.” I am borrowing this piece of brilliance from Charles Bilello, who essentially made an investment presentation out of the famous Mark Twain quote, “It ain’t what you don’t know that gets you in trouble. It’s what you know for sure that just ain’t so.” Very often the worst things investment professionals do is act on information or outlook that is wrong. When someone says, “what will oil prices do next?”, it is one thing to speculate what could or could not happen based on probabilities and trends and varying perspectives; it is another thing altogether to actually act on it! The vast, vast majority of things investors want to know to feed their decision making are things that I don’t know, and things no one else knows either. Where there is conviction and fundamentally sensible actions to take (asset allocation, dividend growth, value investing, non-correlation, contrarianism, etc.), a well-constructed plan becomes the key to financial success. Along the way, the questions that so often get in the way are best answered with the truthful (and profitable words) – “I don’t know.”
What a difference a regulatory mood makes
Several years ago the feeling was large financial firms with a big wealth management business would be more stable businesses post-financial crisis because those businesses would have less reliance and place less strain on their own balance sheets, and because they would benefit from the ability to “cross-sell,” driving wealth management customers to their myriad of banking and investment products. This aspect was why Bank of America bought Merrill Lynch, for example, why Morgan Stanley was so excited to buy Smith Barney, and why Wells Fargo jumped at Wachovia. The environment now in light of recent scandals and headlines has dramatically changed, where such cross-selling situations she being viewed very skeptically by regulators and legislators. The sweet spot for the financial industry continues to be a moving target!
Three reasons should be enough
With deference to industry legend, Rich Kinder, who doesn’t cease to remind the world of the natural gas thesis, there are three reasons to continue to believe: (1) Natural gas is surpassing coal as the number one source of electricity power generation; (2) We are exporting it to Mexico now, and will continue to do so at growing levels; and (3) Natural gas liquids have become a worldwide commodity, creating massive production demand, and need for export infrastructure. The following chart brings true life to point #1.
What is wrong with this picture?
The question here is whether or not things revert to the mean via oil prices moving higher, or the dollar moving lower.
Is the latest excuse, I mean explanation, about to need updating?
For many years the Fed said they would normalize interest rates once unemployment came down. The rate dropped, and they moved the desired in employment rate down several times before abandoning that rationale altogether. A few times they even alluded to the quality of the employment, a never-before-cited factor in monetary policy. Once that had to be abandoned, we heard discussion about interaction with global central banks and even stability in emerging markets, a mandate that shocked even Fed critics at its audacity. Lately, the reason for unprecedented monetary accommodation has been “below target inflation.” We suspect that oil prices being up 100% since February of this year, and the recent announcement that ObamaCare premiums are expected to rise by 25% year-over-year will result in higher headline inflation than we have seen in some time, and therefore a new reason to keep interest rates extremely low. We should add, we do agree inflation is quite low; our comment just addresses the lack of a coherent standard for present monetary policy.
Beware Trojans Bearing Gifts, and Politicians Cutting Deals
Many have heard my general feeling that a sort of divided government scenario is the most likely political outcome from this current election (status quo), and yet I have also expressed a concern over how the post-election environment may play out for the drug industry (based on the political sentiment against the pharma companies and their pricing). I do happen to think government will stay divided after the election, but I also see a lot of plausible scenarios whereby a drug pricing policy could be horse-traded for some other concession to House Republicans, and I do not think the political calculus suggests that it would fail.
We use the scale in our doctor’s office to weigh ourselves
I have a scale at my house that I happen to know is broken to some degree, because it consistently gives me a lower reading than the one that the scale at my desert house, the scales in different hotels I use, and of course the scale in my doctor’s office. Don’t get me wrong – I like the inaccuracy of the scale in my house – it often tells me what I want to hear, but I do know it is unreliable and inaccurate, just as relying on randomly located different scales around various places I find myself is likely unreliable. The one in my doctor’s office, though, I take to be accurate, reliable, and consistent (if my objective is getting an accurate reading on my weight, and not merely telling me what I want to hear). Getting a read on stock price valuations is tricky, because the scale is constantly changing. People love using the P/E ratio, but the strength (or weakness) of the dollar has a big impact on earnings, and certainly things like the energy sector last year had an exceptional impact. Additionally, different interest rates and different earnings measurements mean different things at different times (legitimately). But what we believe is extremely reliable for us measuring the value of what we are buying, selling, and holding, with consistency in rationale and criteria, is dividend growth, and put differently, price-to-dividend. The yield to shareholders – the combination of stock buybacks and dividends paid – is measurable and repeatable, and a great way to measure cash flows as one determines the proper valuation of an investment.
Chart of the Week
In 2014 the Saudi-led OPEC cartel went to economic war to protect their monopoly over world oil prices and delivery. The stated intention to flood the world with supply and take out weaker players (who had higher production cuts) worked with the mostly irrelevant countries of Venezuela and Libya, but had no such impact on the U.S. shale industry. Saudi Arabia has since capitulated and begun what we suspect will be a long but gradual effort to control production so as to create price recovery. How did U.S. shale stare them down and win? Market innovations, period. This chart tells it all!
Quote of the Week
“Change is the law of life. And those who look only to the past or present are certain to miss the future.”
– John F. Kennedy
Originally published on the Bahnsen Viewpoint.