Hope everyone had a nice weekend!
While markets continue to be highly volatile, the trend line support for 20WK EMA for both the QQQ and SPY had an undercut and bounce this week culminating in a strong day on Friday to begin October. The next few weeks will be important to see if this support level continues to hold or we have a deeper correction before earnings season picks up. The debt ceiling raise jitters could put more stress on Treasury yields and growth names in coming weeks as well. The good news this week is that pharmaceutical company Merck announced a new oral anti-viral COVID pill on Friday that reportedly cuts risk of hospitalization and death in half and could be approved for emergency use by the end of the year. In addition, pharma companies Pfizer and Roche are also working on an oral anti-viral COVID-19 pill that is expected to have readouts on their trial results by the end of the year. COVID-19 cases are down 27% over the past 2 weeks in the US but there are emerging troubling signs in states that are now starting to experience colder weather, like Michigan, Wisconsin, and Minnesota which are seeing 20%+ increases over the same period. It’s too early to tell whether the case declines in the southern states likes Florida, Louisiana, etc. will give way to new delta variant waves in the midwest and northeast states once the colder weather sets in. Unfortunately, the state of Alaska is going through a terrible COVID-19 delta variant wave at the moment with cases up 54% in the past two weeks.
On the political front, President Biden and Democrats struggled this past week to figure out a compromise and path forward on infrastructure and social spending legislation initiatives. President Biden and even Nancy Pelosi are both quickly coming to realize that uniting party moderates and an up and coming powerful progressive wing of their parties will be harder than initially thought given the razor thin majorities in both the house and senate. So far, Nancy’s “last dance” as I alluded to a few weeks ago is off to a rocky start since she promised a vote on the bipartisan bill this week (which obviously didn’t happen since it didn’t have the votes to pass). There were rumors on Friday that Biden’s visit to the house democrats was to temper their expectations and alert them to be prepared to accept a far smaller reconciliation package than the $3.5T spending amount that has been trumpeted and envisioned. With no specific deadlines in place, its anyone’s best guess as to what the next steps are at this point. I would argue that the events of this past week are market positive as it is likely that any significant tax increases in the bill will be neutered in order to get something that is able to passed by Congress.
Be Prepared for Earnings Misses
According to FactSet data, 87% of S&P 500 companies reported both revenue and earnings surprises for the second quarter. This marks the highest percentage of S&P 500 companies reporting revenues above estimates (87%) and the highest revenue surprise percentage (4.9%) for a quarter since FactSet began tracking these metrics in 2008. In addition, according to FactSet data, S&P 500 companies on average over the past five quarters (Q2’20–Q2’21) are reporting earnings that are 19.3% above analysts’ expectations — an earnings surprise percentage notably above the 5-year average of 7.8%. Part of the issue the past few quarters is that analysts have had a tough time modeling earnings estimates given all of the COVID-19 factors and the fact that earnings were massively depressed in 2Q and 3Q20 as lockdowns happened.
Is the earnings “gravy train” over or are we due for just some “sand in the gears?”
I would suggest that multinational companies like Nike, FedEx, and Sherwin Williams and even Bed, Bath, and Beyond have provided a clear “canary in the coal mine” that the upcoming third quarter earnings season could get very rocky due to cost pressures and continued (and even worsening) supply chain woes. Already, all of these companies have indicated that labor shortages, skyrocketing supply chain costs, delays, and interruptions have wreaked havoc on their sales and earnings reports and forecasts. In fact, Sherwin Williams has already guided down twice for the upcoming quarter within a single month! Given that earnings revisions have not yet been adjusted down to account for these cost and supply chain pressures that ramped up in the third quarter, I suspect we will be seeing many more companies reporting earnings misses and selloffs (some nasty) as a result of third quarter earnings estimates not baking in these factors and just simply being too high.
Due to a number of factors, commodities, especially oil and natural gas are skyrocketing putting pressure on profit margins and consumer wallets. In addition, the US dollar continues its climb which will put foreign currency pressure emerging markets and international companies earnings. The Bloomberg Commodity Spot index, a broadly diversified commodity price index that tracks futures contracts on physical commodities, has now soared back to all time high levels which could lead to future weak or depressed levels of future economic growth in subsequent quarters. The global energy shock is here and the only question is how long will it be until it rolls over and subsides. Take a look at the parabolic rise of natural gas below just as colder weather will be setting in over the coming months. It is hard to discern at the moment how rising energy bills for consumers, especially in Europe, will dent consumer spending in the fourth quarter and into 2022 if these prices stay at these extreme levels. Already we are seeing signs of plants curtailing production or shutting down due to the energy crisis and China implementing energy caps to preserve energy usage which will hurt global growth.
Here are some recent quotes illustrating this point:
Federal Reserve Chairman Jay Powell:
“The combination of strong demand for goods and the bottlenecks has meant that inflation is running well above target. What people didn’t see coming was the supply-side constraints . . . that was a surprise….It’s not that our inflation models are wrong, although they certainly are not perfect, but just the scope and persistence of the supply-side constraints were missed.”
Sherwin Williams (SHW):
“At the same time, the persistent and industry-wide raw material availability constraints and pricing inflation we have previously reported have worsened, and we do not expect to see improved supply or lower raw material pricing in our fourth quarter as anticipated. As a result of these headwinds, we are narrowing our third quarter sales expectations and establishing third quarter earnings guidance.”
Nike (NKE):
“Consumer demand for NIKE remains at an all-time high, and we are confident that our deep consumer connections and brand momentum will continue. However, we are not immune to the global supply chain headwinds that are challenging the manufacture and movement of product around the world……Our experience with COVID-related factory closures suggest that reopening and ramping back to full production scale will take time…….We now expect fiscal ‘22 revenue to grow mid-single digits versus the prior year versus our prior guidance of low double-digit growth, due solely to the supply chain impacts that I just described. Lost weeks of production, combined with longer transit times, will lead to short-term inventory shortages in the marketplace for the next few quarters.”
FedEx (FDX):
“…The impact of constrained labor markets remains the biggest issue facing our business as with many other companies around the world and was a key driver of our lower than expected results in the first quarter..…our first quarter results did come in lower than our own expectations as difficult labor conditions persisted throughout the quarter…Labor shortages have had two distinct impacts on our business. The competition for talent, particularly for our frontline workers have driven wage rates higher and pay premiums higher...Overall for the second quarter, we anticipate a similar level of headwinds in Q2 as we experienced in the first quarter as the challenges and impacts to our operations from the labor shortages are expected to persist in the rest of calendar twenty twenty one.”
Bed Bath and Beyond:
“….unprecedented supply chain challenges have been impacting the industry pervasively, and we saw steeper cost inflation escalating by month, especially later in the quarter, beyond the significant increases that we had already anticipated. This outpaced our plans to offset these headwinds. These factors impacted sales and gross margin.”
Some interesting charts from this past week:
1) TikTok Explosive User Growth
Social media use continues to expand and check out the explosive user growth in TikTok. Companies like Shopify are racing to partner with TikTok to experiment with social e-commerce and “picks and shovels” ad-tech partners like Digital Turbine (APPS) and Entravision (EVC), among others, stand to benefit.
2) Apple Stock Buybacks
I thought this chart was pretty remarkable to show the massive relative power of Apple’s cash hoard used for stock buybacks relative to other notable S&P companies.
3) 3rd Quarter GDP Downgrade- Yet Again
Sorry for the “bear meat” but I can’t help but ignore the steady drumbeat of continued downgrades of third quarter GDP estimates by the Atlanta Fed relative to consensus street estimates. In addition, the trend divergence between the two is also very notable with street estimates actually being raised the past month while the Atlanta Fed has been slashing their estimates. With economic data releases this past week now factored in to their modeling, the Atlanta Fed has now downgraded their third quarter GDP estimate all the way down to just 2.3% for the third quarter. This is a shocking decline in the face of 2nd quarter GDP confirmed at 6.7% this past week. If the Atlanta Fed GDP estimate is to be believed, there could be big reset to global growth expectations for the 4th quarter and into 2022 as stagflation fears set in.
Stocks I’m Watching
1) Evolution Gaming (EVVTY)
Evolution AB (publ) develops, produces, markets, and licenses live casino and slots solutions to gaming operators primarily in Europe and the United States. The company runs the game from a casino gaming table, which is streamed in real time and end users make betting decisions on their devices, such as computers, smartphones, tablets, etc. It also runs on-premise studios at land-based casinos in Belgium, Romania, the United Kingdom, and Spain. The company’s portfolio of online live table games primarily includes Live Roulette, Blackjack, Baccarat, Super Sic Bo, Dragon Tiger, Craps, Live Casino Hold’em, Three Card Poker, and Ultimate Texas Hold’em.
I regard Evolution Gaming, a Weekly Stock Bullfinder 2021 Stock to Watch pick, as a “blue chip” growth company as it has consistently outperformed guidance and delivered enormous returns to shareholders. One of the reasons why is because its IP moat is strong, it has low operating and overhead costs, and it continues to expand to new markets as gaming is legalized around the world and in the US. How many other growth companies are out there are delivering 61% EBIT and 68% EBITDA margins while expecting 93% growth for FY2021? While trading at a forward 37X P/E multiple, Evolution trades at a premium like it should given its explosive and profitable growth. Although still up 60% YTD, Evolution has been consolidating sideways allowing key moving averages to catch up and finally touched down to its 200 day moving average this week where it saw a nice bounce on Friday. Assuming this level holds ahead of 3Q earnings, it could represent a good opportunity to get involved.
2) Jeffries Financial Group (JEF)
Jefferies Financial Group Inc. engages in the investment banking and capital markets, asset management, and direct investing businesses in the Americas, Europe, the Middle East, Africa, and Asia. It operates through Investment Banking and Capital Markets, Asset Management, Merchant Banking, and Corporate segments. The company offers financial advisory, equity underwriting, and debt underwriting, as well as corporate lending services; equities research, sales, and trading services; equity finance services comprising financing, securities lending, and other prime brokerage services; and wealth management services to high net worth individuals, their families and businesses, private equity and venture funds, and small institutions.
Jeffries reported strong earnings on Thursday and finished the week with a weekly breakout on higher volume. Jeffries reported net revenues of $1.65 billion, a record for a third quarter and up 19% over the prior year third quarter's then all-time record quarterly net revenues. In addition, Jeffries reported all-time record quarterly Investment Banking net revenues of $1.18 billion, up 100% over the prior year quarter and announced its Board of Directors decided to increase the share buyback authorization by $52 million back to a total of $250 million. With the financial sector catching a bid due to a rebound in Treasury yields, on the back of another strong earnings report, Jeffries looks like its primed to move higher.
3) Navios Maritime Partners (NMM)
Navios Maritime Partners L.P. owns and operates dry cargo vessels in Asia, Europe, North America, and Australia. The company offers seaborne transportation services for a range of dry cargo commodities, including iron ore, coal, grain, fertilizers, and containers, as well as charters its vessels under medium to long-term charters. As of March 24, 2021, it operated a fleet of 52 vessels.
In the midst of a volatile and choppy week in the markets, Navios managed to end the week actually up almost 13% and finished with a weekly breakout. This is the type of relative strength you want to see in companies that may serve as potential leadership when the market resumes its uptrend. The Breakwave Dry Bulk Shipping ETF (BDRY) continues to make new highs and (gasp!) the Baltic Exchange Dry Index rose 0.7% to 5,202 on Friday, its highest level since September of 2008 (up 30% alone in the month of September)! Shippers continue to be in a power uptrend and remain one industry group I believe will continue to outperform into at least early 2022 given the favorable pricing and industry tailwinds. Last quarter, Navios recorded revenue of $152.0 million (226% growth) and net income of $99.9 million. Navios looks to be coming up from the right side of its base and be setting up for a move higher.
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