DFAS - Which Stocks Will Win (Or Lose) This Earnings Season?
Summary
- The overall stock market is grossly oversold, and my small- to mid-cap stocks are trading at 6.8 times median current earnings and just 2.8 times median forecasted 2023 earnings. Clearly, the price-to-earnings compression has become ridiculous and relentless.
- We are now at the time of year when a January effect often occurs and small- to mid-cap stocks become new market leaders. 2023 is shaping up to be a potentially incredible year for my small- to mid-cap stocks.
- Economic statistics are pointing towards a possible recession. ISM reported that its manufacturing index declined to 48.4 in December, down from 49 in November, and the non-manufacturing (service) index plunged to 49.6% in December, down substantially from 56.5 in November.
- Crude oil prices declined last week, due partly to China demand fears; but when seasonal demand picks up in the upcoming months, crude oil prices should rise steadily.
You may have noticed in December how illiquid the overall stock market has been. This is a good time to warn you that many small- to mid-capitalization stocks are “bunny stocks,” that is, they like to “sit” a spell and then “hop” four times a year around their quarterly earnings announcements. The rest of the time, algorithmic trading systems from Citadel and Virtu Financial are running “mean reversion” programs to create stock movement to stimulate trading and “shake out” uncertain investors. The good news is that these stock market algorithms tend to disappear around earnings announcement season!
I want you to enjoy the upcoming earnings announcement season, since I expect that it will be every stock for itself in the upcoming weeks. The overall stock market is grossly oversold, as demonstrated by the fact that my small- to mid-capitalization stocks are trading at 6.8 times median current earnings and just 2.8 times median forecasted 2023 earnings. Clearly, the price-to-earnings (P/E) compression has become ridiculous and relentless, as many Tesla ( TSLA ) shareholders have learned since last May, when Tesla was kicked out of the S&P 500 ESG index, which resulted in relentless institutional selling pressure.
As major tech stocks fall in weight in the S&P 500, it triggers more systematic selling pressure as the tracking managers that dominate Wall Street trading are forced to cut their technology exposure. When the technology bubble burst back in March 2000, the institutional selling pressure persisted for seven years. Back then, small- to mid-capitalization stocks in the tail end of the S&P 500 became new market leaders. That is effectively where we are now, since I expect small- to mid-cap stocks to lead the way!
We are now at the time of year when a January effect often occurs and small- to mid-cap stocks become new market leaders. If my small- to mid-cap stocks follow their forecasted earnings higher, they could easily appreciate 100% or more in 2023. If forecasted median 2023 price-to-earnings ratios expanded from 2.8 to 5.6 times earnings, then our small- to mid-cap stocks could appreciate 200% or higher. As a result, 2023 is shaping up to be a potentially incredible year for my small- to mid-cap stocks! I should add that both Perion Network Ltd. ( PERI ) and Lamb Weston Holdings ( LW ) surged in the wake of their quarterly earnings announcements last week, so we have a lot to look forward to in the upcoming weeks!
Economic Statistics Point Toward Possible Recession
The economic weathervane is pointing more toward recession. Last Wednesday, the Institute of Supply Management (ISM) reported that its manufacturing index declined to 48.4 in December, down from 49 in November, for the second straight month that the ISM manufacturing index has been below 50, which signals a contraction after 30 straight months of expansion. Only 2 of the 15 industries surveyed reported expanding in December. They were Primary Metals and Petroleum & Coal Products.
On Friday, ISM announced that its non-manufacturing (service) index plunged to 49.6% in December, down substantially from 56.5 in November. This is the first time in 30 months that the ISM service index fell below 50, signaling a contraction. Some of the ISM service components than plunged were the new orders component, dropping to 45.2 in December, down from 56 in November, while business activity slipped to 54.7 in December, down from 64.7 in November. In the wake of this ISM data, Treasury yields fell and there were rumblings that the Fed may stop raising interest rates sooner than previously expected.
Speaking of the Fed, the latest FOMC minutes were released on Wednesday, including the shocking statement that, “An unwarranted easing in financial conditions,” especially if driven by a misperception by the public of how the Fed would react to economic developments, “would complicate the committee’s effort to restore price stability.” Translated from Fedspeak, the FOMC members do not like stock market rallies, since they fear it could result in potentially inflationary consumer spending.
The FOMC minutes also revealed that the Fed foresees inflation staying higher, and 17 of 19 FOMC members in their “dot plots” favored raising the Fed funds rate to 5% in 2023. So overall, it appears that the Fed will raise key rates to 5% and then hold them there for all of 2023. I should add that the FOMC minutes provided no insight on whether the Fed would raise rates by 0.25% or 0.5% on February 1.
Interestingly, Minneapolis Fed President Neel Kashkari, in an essay published on Wednesday, said that the FOMC could pause after reaching a peak rate of 5.4%. Specifically, Kashkari said, “Wherever that end point is, we won’t immediately know if it is high enough to bring inflation back down to 2% in a reasonable period of time,” and added, “Any sign of slow progress that keeps inflation elevated for longer will warrant, in my view, taking the policy rate potentially much higher.” (What is most interesting to me about Fed President Kashkari, other than he used to run the TARP program after the 2008 financial crisis, is that he used to be a dove but has clearly turned into a hawk.)
In other financial news, ADP reported on Thursday that private payrolls rose by 235,000 in December, which was substantially better than the economists’ consensus expectation of 153,000. Leisure and hospitality jobs led the way as service industries added 213,000 jobs, while the goods producing, manufacturing sector added 22,000 jobs. Interestingly, ADP also reported that pay rose by 7.3% in 2022, led by a 10.1% increase in leisure and hospitality jobs.
In the more widely followed Friday jobs report, the Labor Department announced that 223,000 payroll jobs were created in December, which was better than the economists’ consensus expectation of 203,000. The unemployment rate declined to 3.5% in December from a revised 3.6% in November, due predominantly to a shrinking workforce, as 231,000 workers actively looking for a job left the workforce.
In addition, the November job total was revised down to a 256,000 increase from 263,000. Average hourly earnings improved by 0.3%, or 9 cents, to $32.82 per hour. Over the past 12 months, average hourly earnings rose 4.6%. Interestingly, the average hourly workweek declined to 34.3 hours, while the labor force participation rate was 62.3%. Overall, slower average hourly earnings are indicative that wage inflation is continuing to cool off, so the December payroll report was well-received by financial markets.
The Commerce Department announced on Thursday that the U.S. trade deficit posted the steepest monthly decline (since February 2009) in almost 14 years, as imports declined 6.4% to $313.37 billion and exports fell by 2% to $251.86 billion. Clearly, the “velocity of money” is grinding to a halt as many overseas nations slip into a recession. Ironically, a shrinking trade deficit boosts U.S. GDP growth, so the Atlanta Fed is now estimating that the U.S. economy grew at a 3.9% annual pace in the fourth quarter.
The Labor Department reported on Thursday that weekly jobless claims declined to a 3-month low of 204,000 in the latest week, compared to 225,000 in the previous week. Continuing unemployment claims declined to 1.694 million, compared to 1.718 in the previous week. I should add that Amazon’s ( AMZN ) announced 18,000 job cuts were not reflected in these jobless claims and could show up in the upcoming weeks. I suspect that as long as unemployment remains low, the Fed will keep its focus on the inflation front.
The Many Reasons for a Contracting Crude Oil Price
China’s economic activity is still contracting, based on its official Caixin Purchasing Managers’ Index (PMI), which slipped to 49 in December, down from 49.4 in November. Analysts at Nomura said, “A large wave of Covid inflections has swept across the country since early December, which resulted in a sharp disruption to mobility, shipment and business activity.” This all puts a damper on energy demand.
That is the bad news. The good news is that as the Chinese population achieves “herd immunity” after recovering from the latest Covid variant, their economic activity should increase in the upcoming months.
Russia remains a wild card for the global economy and energy markets around the world. Despite an anticipated 12% Russian crude oil production cut, India has become the primary winner from the chaos, since India is refining Russian crude oil and exporting refined products (e.g., diesel, heating oil, jet fuel, and gasoline) back to Europe and other countries.
Turkey is another winner from the Russian chaos, since its exports rose 13% to $254 billion as Turkey refused to comply with Western sanctions on Russia. Inflation has been running at an 80% annual pace in Turkey, as the country’s unorthodox monetary policies have caused inflation to spiral out of control. However, a weak Turkish lira has also helped the country boost its exports. The U.S. has also been a winner from the Russian chaos, but the Biden Administration’s sale of over 180 million barrels of light sweet crude oil from the SPR is expected to cease abruptly, which I anticipate will cause oil prices to rise as seasonal demand picks up. As a result, I expect my big energy bet to pay off in the upcoming months.
Crude oil prices declined last week, due partly to China demand fears; but when seasonal demand picks up in the upcoming months, crude oil prices should rise steadily. The big energy story last week was that natural gas prices remain very low due to unseasonably warm winter weather in both Europe and the U.S. Outside of the energy sector, expectations for earnings remain very low due to difficult year-over-year comparisons as well as a strong U.S. dollar impeding multinational companies.
I also expect the blowback against ESG investing to persist, since all those ESG portfolios in blue states and at major universities that shunned fossil fuels had a rude awaking last year. Fossil fuels accounted for approximately 84% of the world’s energy output in 2022, up from 80% in 2020. The International Energy Agency said that coal consumption likely hit an all-time record in 2022, due somewhat to the fact that Germany reactivated many of its closed coal plants, plus all the new coal plants in China and India.
Some Product Highlights at the Las Vegas Consumer Electronics Show
The Consumer Electronics Show (CES) in Las Vegas can often help to boost the stock market as new consumer products and EVs are announced. Although consumer spending on big-ticket items is waning, companies keep trying to get folks excited. One product I found interesting is a new Samsung ( SSNLF ) 76-inch micro-LED television. Micro-LED TVs are supposed to replace OLED sets in the upcoming years as costs fall. China’s TCL ( TCLHF ) is following Samsung to develop micro-LED technology. In the meantime, more OLED televisions are now available, including a new 77-inch OLED from Samsung, so OLED televisions will continue to capture market share until micro-LED prices fall.
Nvidia ( NVDA ) is also making a splash at CES by showing off new graphics cards for gamers as well as teaming with Foxconn ( FXCOF ) on EVs. Specifically, Foxconn will be using Nvidia’s Drive Hyperion platform for the EVs it builds for Lordstown Motors ( RIDE ) and other companies. Nvidia is now making more sensors as well as the software auto manufacturers need for autonomous driving.
In my opinion, Nvidia systems that use LIDAR are superior to Tesla’s autonomous software that utilizes cameras (with no LIDAR) that do not work well in the snow, fog, smoke, or heavy rain. Here is a video that shows that Tesla’s autonomous software does not work well in the snow.
Navellier & Associates owns Nvidia Corp. ((NVDA)), Perion Network Ltd. ((PERI)), and Lamb Weston Holdings Inc. ((LW)) and a few accounts own Tesla ((TSLA)) per client request in managed accounts. Louis Navellier and his family own Nvidia Corp. ((NVDA)), Perion Network Ltd. ((PERI)), and Lamb Weston Holdings Inc. ((LW)) via a Navellier managed account and Nvidia ((NVDA)) in a personal account. He does not own Tesla ((TSLA)) personally .
All content above represents the opinion of Louis Navellier of Navellier & Associates, Inc.
Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.
Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.
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Which Stocks Will Win (Or Lose) This Earnings Season?