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| Fundamentals are key: energy usage and oil prices are again dominating discussions as energy has roared back to reclaim the mantle of best sector performer in the S&P 500. [Image ©torwaiphoto/ Adobe Stock. Modified for The Ignorant Investor: www.theignorantinvestor.com] |
Sometimes things that look too good to be true can yet be true. When the world seemed to be ending in the depths of 2020’s economic lockdowns (okay, I’m taking some literary privilege here), who could have possibly imagined life beyond those slow, painful days indoors when societies and economies would get back to a new normal? Let alone predict just how quickly and powerfully the stock market would come back. It’s truly incredible. As 2021 marches onward, this will likely be The Ignorant Investor’s final substantive post to wrap up the year, and which, as a warning, contains four-months’ worth of commentary!
First, let’s see where we are today. Incredible economic growth, partially in response to expansive global stimulus measures, and the accompanying strong global energy consumption have propelling energy to again reclaim the mantle of best sector performer in the S&P 500 for 2021 (to be expected with oil prices hovering near multi-year highs!). It took an absurd amount of time, with The Ignorant Investor left scratching his head in disbelief as he began building extensive positions even as the sector sold off as recently as July- but eventually the market did catch up to the reality on the ground.
But that’s not all! Yes, Energy is up an astounding 51.9% year-to-date, but this is closely followed by Financials at 35.9% and Real Estate at 32.1%, both over the same time frame. Fairly incredible stuff, especially when contrasted to Big Tech’s powerful moves last year (which could indicate these are more “catch up” moves coinciding with resumption of normal economic activity). These themes are likely to continue to shift and jostle each other through the end of the year, however, as more post-pandemic clarity is obtained. Many of 2021’s moves can be attributed to policy shifts, geopolitics, and fundamentals (want the laundry list? Vaccine efficacy, stubbornly high inflation, rising yields tethered to the Fed, passage of the infrastructure bill through Congress, solid retail data, etc). After all, investing in the stock market is essentially a bet on the future- and that future is ever changing! Speaking of the future, let’s examine some things that may affect the stock market in 2022.
The Crystal Ball: future themes affecting the S&P 500
The S&P 500 looks richly valued by many historic metrics but may yet have some room to run. Goldman Sachs in recent months had set a year-end closing target for the S&P 500 of 4,700, just a handful of points (not even percentage points!) above where we sat on Friday. Now, specific companies within component sectors? That is where one may still find the proverbial “diamonds in the rough.” Selective stock picking of quality companies from specific sectors, done in close collaboration with a trusted financial advisor, may be the best way forward for the new year! Just keep in mind some of the themes outlined below.
1. Fed will begin stimulus tapering. Next up, interest rate increases?
As widely expected, the Fed announced a plan earlier this month to cut $15 billion per month from its existing $120 billion per month pandemic stimulus program. While that statement in and of itself sounds pessimistic for the stock market, let’s focus on that phrase: BEGIN tapering. And why is the Fed beginning to taper? Well, basically, life is returning to normal, and inflation is looking to be quite stubborn this time around.
By the numbers: the initial rate posited by the Fed of reducing the $120-billion-per-month spigot by $15-billion-per-month still leaves the Central Bank supporting the US economy with $540 billion in additional purchases by the expiration date of July 2022. Compare this with the $1 trillion spending bill that just meandered through Congress, and you can see just how far the Fed went to support the US economy through the pandemic. And why equities, even at current lofty valuations, may not be too overvalued (at least while the music is still playing).
But what if inflation is not as “transitory” as the central bank appears to think? Those interest rate increases may be much closer than projected- and history can be important. Keep in mind that several vicious taper tantrums occurred in 2015 following years of low interest rate policy first adopted by the Fed in the Great Recession.
2. Inflation is “here to stay”, NOT “transitory”
Wow, talk about full circle: read the last paragraph and then the above headline. Case in point, the consumer price index came in at a sizzling 6.2% year-on-year reading on Wednesday (and hey, should you prefer the flavor of the producer price index, that reading was up an astounding 8.6% over the same period). Among the breakdowns, we see fuel prices and food rocketing higher to send the headline number to a multi-decade high. Companies have broadly passed rising costs to consumers with little pushback. However, as stimulus checks continue to fade into the rear-view mirror and should inflation be allowed to continue (more likely if Lael Brainard is selected to supplant existing Federal Reserve Chair Jerome Powell, for example), then this level of inflation will eventual start hitting the bottom line for companies in certain “consumer-facing” sectors. And if inflation is NOT allowed to continue unchecked, well, that means the Fed is raising interest rates and pushing players back down the risk curve- also not exactly friendly to stocks.
3. Supply chain disruptions will continue for some time
Large shipping imbalances across the global economy have occurred as demand for goods exploded amid the pandemic lockdown, exasperated in the USA by a persistent labor shortage in the distribution network (see more information below under “Supply Chain Commentary”). A consensus among leading businesses appears to be forming around the expectations of everything coming back to normal sometime in the second half of 2022 (who would have guessed all those quarterly earnings reports would have been so informative?) as the disruptions transition away from bottlenecks at ports and move inland. This can create potential opportunities within several industries on either side of, or integrated with, the supply chain.
4. Will cyclicals benefit at the expense of growth as yields rise?
Value stocks have been generally scorned and derided by many investors for some time now as growth has far outperformed the sector in recent years or, um, decades. And by far outperformed, I mean crushed (the shining example is Tesla; $10,000 invested in early 2011 would be worth something like $2,000,000 as of Friday after an astounding 20,560% gain). Just look at Big Tech. These are true giants that march ever onwards, oblivious to viral pandemics while resiliently spewing out cash in vast enough quantities to make any investor starry eyed. Nevertheless, while cyclical stocks have been lagging growth, as the economy continues to charge forward - and as the central bank begins to contemplate interest rate hikes - these companies may finally be poised for a comeback (as demonstrated in recent months by the phenomenal gains in upstream energy companies).
Supply Chain Commentary
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| For now, global supply chain disruptions have been occurring primarily at ports (container ships) but are expected to eventually move inland before normalizing sometime next year [Image ©enanuchit/ Adobe Stock. Modified for The Ignorant Investor: www.theignorantinvestor.com] |
The integrated global supply chain is a thing of exquisite beauty to anyone that appreciates complexity. Take a banana, for example (bet you didn’t see that one coming!). Perhaps that banana is grown in Costa Rica by a producer. It’s then picked before being exported by a Costa Rican company and imported by an American one. It’s then ripened and distributed before being sold to a retailer in Manhattan. The floor trader then walks out of the New York Stock Exchange and buys the banana from the retailer- hopefully finding it ripe and delicious. Many people, multiple companies, and possibly trucks and cargo ships using specialized shipping containers are involved in the process. And if that isn’t complex enough, consider the supply chain of something like a hard disk drive, and its journey from raw materials found in the earth to final product in the hand of the consumer!
The point here is that during the economic shutdowns to contain the coronavirus in 2020, people, bored and sitting at home, started buying stuff online. Warehouses emptied as replacements stopped arriving (everyone the world around was under lockdown, remember); and ever since then the global supply chain has struggled to return to a normal balance. Further aggravating the situation, demand for goods has continued to increase. Shipping imbalances occurred as finished products steadily flowed to the US, where the cargo ships waited for days in a long line to unload their goods at overcrowded ports before returning empty to their port of origin to repeat the process over again (this is an oversimplification to make a point). What gave The Ignorant Investor pause was when he read in a Home Depot release that the company had acquired a ship and had even resorted to occasionally purchasing from the spot markets to help cope with heavy demand and constrained supply.
In addition to the physical aspects of the global supply chain, the current supply chain disruptions have been magnified in the US by a labor shortage. Now, what exactly has caused that shortage is in dispute (of note, Americans are quitting their jobs in huge numbers, with a near-record 4.2 million Americans quitting just last month) but rising wages in other areas of the economy may be attracting supply chain workers to other industries (restaurants, etc). Commentary by various large players in and benefiting from the supply chain during recent earnings reports show that these disruptions are expected to last well into next year.
Why do these things matter? Well, they might explain why your Butterball turkey will be more expensive for Thanksgiving dinner this year. Or why your favorite brand of fresh mincemeat from England is no longer in stock at the local supermarket. In the investment world, however, these inefficiencies result in opportunities across the entire space as the market struggles to accurately value quality companies. These are companies the avid investor can identify (as always, with the help of a professional financial advisor) and then potentially profit from.
An Energy Market Case Study
Mere months ago, media reports around the world were dismissing companies dealing with fossil fuels as members of an archaic and truly outdated industry. The argument was that Big Oil needed to transition away from the stuff ASAP, or they would go bankrupt as the world left them behind as countries transitioned to renewables. Big Oil was suffering setbacks in court rooms and even their own sacred board rooms were no longer safe. The solution? Sell off those dirty assets (a la Shell)! Whenever commentary like this (in any industry) becomes widespread, investors should pay close attention to what is being said, who is saying it, who is repeating it, and who the target audience for the message is. If there is a disconnect between commentary and underlying fundamentals, there will likely be inefficiencies created that investors could benefit from through deft positioning.
For his part, The Ignorant Investor was left shaking his head at these statements. Yes, the world should strive to move in a sustainable direction, but what about global oil demand sitting somewhere near one hundred million barrels per day? And sure, the developed world can start utilizing renewables, but globally, developing economies will be expanding their usage of fossil fuels for at least many decades to come- even to the point of (eventually) eclipsing current usage by “developed economies”. In the end, publications and pundits were rudely jolted back to the real world in recent months as energy usage and power production crunches forced oil prices higher and higher.
The underlying fundamentals (a simplified story): demand increased, and supply remained flat. A perfect storm for higher oil prices was created when societies and economies roared back to life thanks to the development and deployment of effective vaccines. Meanwhile, industries roared back to life, global demand for goods skyrocketed (requiring increased shipments which aggravated supply chain disruptions) and a combination of wary oil producers (think OPEC+, shale oil companies), still smarting from heavy losses incurred during last year’s deep bear market for fossil fuels, exercised strong production restraint at the behest of investors and other interested parties.
Stories of Note
Pfizer’s covid-19 drug is remarkably effective
Pfizer’s November 5th press release offered some remarkable information: clinical trials show that their antiviral cocktail (antiviral combined with HIV drug) administered in the form of an oral pill can reduce hospitalizations by up to 89%. Now THAT is remarkable. The first part of the solution for fighting Covid-19 has been to grant some level of resistance to the virus through vaccines. The second part of the solution is to easily treat people who come down with the virus so that it becomes more like a common case of the flu. You can read more details about the study directly from Pfizer.
US-listed Chinese stocks remain a risky proposition
As a follow-up to a previous post, US-Chinese brinkmanship on the world stage continues to be a cause for concern for investors considering new positions in US-listed Chinese companies. On the one side of the pond, China continues to crack down on Chinese companies and industries in the interest of a broad-based “reform.” In the crosshairs of this crackdown appears to be Chinese companies that flout local regulators or are listed on US stock exchanges.
This brings us to the other side of the pond. US regulators continue to chafe at the lack of clarity provided to them by Chinese companies- who, by state law, are not permitted to share information with US regulators. In the past, this has allowed several US-listed Chinese companies to commit outright fraud or hide material information from international investors. Tellingly, in late October, a member of the Congressional investor protection subcommittee stated he would like to introduce a law requiring foreign compliance with US regulators. This could effectively force Chinese companies to delist from US stock exchanges.
The Ignorant Investor is certain value does exist for investors in Chinese companies but 1) doesn’t know which companies would be “safe” from a crackdown by either player, and 2) expects the situation to remain highly volatile as the US and China continue to jostle each other on the international stage. I mean, at the core it seems as if China doesn’t want Chinese companies listed on US exchanges, and similarly US regulators don’t want Chinese companies listed on US exchanges. Perhaps the best path forward for investors is to buy some shares in safe, boring companies in unaffected regions, and grab a bucket of popcorn before sitting back to enjoy the show?
Still interested in Chinese stocks? To learn more, read this informative article by Morningstar on Chinese public companies; apparently, the type of stock you own may sometimes be more important than the type of company you own!
Alternative energy companies look promising
Alternative energy companies can refer to companies seeking to utilize renewables like solar and wind for power generation, companies seeking to utilize “clean” energy like electricity and hydrogen to power vehicles, and everything in between (oh, and if we want to remain practical, throw nuclear into that mix! There is no worldwide movement to renewables without nuclear- the numbers simply don’t add up). Tesla has done remarkably well in the eyes of stockholders in recent years and has even managed to hit its production targets in recent quarters as well. But Tesla as a car company remains remarkably miniscule when compared to the traditional car manufacturers (especially surprising when comparing volume of press coverage across all vehicle producers). This outsized news coverage has been very beneficial for all alternative energy companies as developed nations (ie USA) lurches back in the direction of renewables and away from fossil fuels. With such favorable tailwinds as policy changes, legislative initiatives (the so-called Infrastructure and “Build Back Better” bills), and increased investment as agreed upon by developed nations, the alternative energy space has grown rather crowded. Still, there are some quality names hidden among the throng- quality companies that provide excellent entry opportunities for investors over the long term (these investors should make sure to enlist the help of their trusted financial advisor in identifying these opportunities!). For more information, Bloomberg has a decent discussion on the recent power shortages in Europe and China and provides an argument for expanding clean power.
Shell sold Permian assets for the tidy sum of $9.5 billion
True to its word, and in the spirit of a “recent” European court ruling, Shell has decided to trim down dirty fossil fuel production so that they can become a cleaner energy company. What better way to accomplish this than to sell off some of that dirty fossil fuel to another company? ConocoPhillips stepped in to purchase Shell’s Permian assets for $9.5 billion. A smart move, expanding the company’s footprint in the best shale oil field in the USA. Doesn’t do much for global warming, but Shell is now a cleaner – and cash richer! – energy company in the eyes of the EU and ConocoPhillips is now a better oil company in the eyes of the investors- so I guess that means everybody wins! You can read ConocoPhillips triumphant announcement in their news release here.
Note that this is another update (old news, but recent compared to our last post). The previous rumor that Shell was shopping around its premium oil lands in Texas turned out to be accurate!
