2022 First Half in Review: Jarvis (R) Update

This week marks the end of the worst half of the year for the market since 1970. Are there signs the second half could be better? We cover this and more in this week's Jarvis Update. I'm your host, Brian Dress, Director of Research here at Left Brain, joined as always by our CEO and Chief Investment Officer, Nolan Langford. Nolan, welcome to the program.

Thank you, Brian. Looking forward to it.

Um, 3 topics we're going to cover this week. First, we're going to have a sector breakdown. That's the first of all of the week and also year to date. In the second topic, we're going to talk about Bitcoin and cryptocurrencies. And the third topic, we're going to talk about lower risk ways to gain exposure. Um, before we get into that, a couple of announcements for the subscribers among us. We've got 2 new reports from our analyst Madhu Chaudhary. We got a player in the diagnostic space in healthcare and also a small-cap company involved in marketing automation. So check that out if you're a subscriber. If you're not, we'll put the details below so you can become a subscriber. It's also an off week for the newsletters. We've got the long weekend. We'll be back next week. And then finally, get on the mailing list, uh, if you want to get our content each week in your inbox every Saturday morning. And also, before we get started, let's— we'll ask you to like and share the video if you liked it. Uh, get— send it to your network, subscribe to get notifications each time we come out with a new video. So we'll jump into the market recap. First of all, S&P 500 was, uh, was down 0.3%. NASDAQ was down just about 1.8%, and then the Russell was down 0.2%. Interest rates are continuing to fall over the last month. The 10-year dropped from 3.5% to 3% pretty rapidly. After a big run-up early in the year. And, uh, the volatility index, the VIX, still up near 30. So elevated levels of volatility in the market. Nolan, with all that as a backdrop, what are your general thoughts this week?

More weakness underneath the surface, just more of a continuing trend. And, you know, I heard what you said about this being the worst first half of the year since the '70s, and you can actually see that in no matter what you look at— stock prices, bond prices, etc. My general thought is when we've seen strength, we've also seen weakness follow shortly thereafter. And this does mark the end of the first half of the year. Starting tomorrow, we get the first part of the second half of the year, and we also get the first day of the new month. And we've seen historically fund flows come in at the first of the month. So we're used to seeing strength at the first of the month. So it'll be interesting to me what happens as July kicks off.

You know, Nolan, it's also the first day of the rest of our lives. So that's the good news. All right, we'll jump into the first topic. So topic 1 is our sector breakdown. We're going to talk about 2 time frames. We're going to talk about the last week, and then we're going to zoom out and talk about year-to-date. Um, so the first part, let's talk about this week. Utilities, healthcare, and stables were the strongest this week. So some of the defensive sectors were really leading, and then energy and tech were the laggards. Um, that's been sort of a theme, especially with energy, over the last month. Holden, any thoughts on this week's winners and losers? Any names stand out, or any thoughts on kind of the sector breakdown?

Yeah, the two laggards I think that's noteworthy— the strength that you mentioned probably was propping up the S&P. Those were all defensives. That's where people go when they want to hide or stash cash, and it masks the weakness underneath. What's more illuminating is what was on the bottom— tech Kind of not that surprised technology's been weak. We've seen estimates come down. We've seen some analysts cut, uh, their expectations somewhat, and it's considered a risk-on sector. The only thing really to note there is interest rates have finally decoupled from stock prices in tech land, and it had been earlier in the year, hey, interest rates are up, it's a bigger drag on earnings, and so tech needs to fall. But We've seen the bond price actually starting to strengthen. I think what the bond market is probably saying is there's going to be some economic weakness at some point, the Fed's going to have to come to the rescue. And so you're not seeing that relationship between the interest rates and, uh, and tech. The other one that you mentioned that we've had weakness is energy, and that one, you know, obviously has my attention more. Obviously, you know, we're huge energy bulls here. And if there's one thing that's really hurt here recently is the energy prices having rolled over a little bit. But I think that's where the opportunity lies, because there's still so much fundamental strength in these individual companies. Leverage ratios are very low. That's going to be one of the areas that you will see quarter over quarter and year over year revenue and earnings growth.

Yeah, Nolan, I mean, from my perspective on energy, it's been painful the last month. Um, but we really got to sit back and think about what, what are the fundamentals of the energy space. They're definitely in the favor of these companies, and we've got to stick with it. It can be difficult from day to day, and that's kind of the downside of being able to access the stock prices from minute to minute. So we've got to make sure we maintain perspective. With that being said, energy is the only sector that's up this year. Utilities are number 2 on the sector board. I think they're down 3 or 4%. So we only got 1 winner out of 11. Tech and retail, we've talked about this ad nauseam, are the worst performers. Some household name stocks have collapsed in the first half of the year. NVIDIA comes to mind, Netflix. There are quite a few that are down 60% and 70%, and it's shocking to see it on paper. What stood out for you in the first half, Nolan, and what are you looking for as we move into the second half?

Well, I can take the latter part of that question first. What I'm going to look for in a couple of weeks, we have earnings. And as you know, we get 4 of these per year. It's our Super Bowl. Really, really excited to hear not only what companies reported in the second quarter, but what their guidance is, uh, going forward and what they're saying. They'll give us up-to-the-minute looks at what their businesses are doing, where they're seeing strength, where they're seeing weaknesses, and their perception of if there is going to be a recession or whether or not we're in one. So I know right away the things that I'm going to be interested in. And speaking of earnings, we've had a couple of companies here recently that have had really negative pre-announcements. Today we had one from RH, which is the former Restoration Hardware, and a month or so ago they came out with earnings, and just today, uh, or yesterday, they guided down. We had Bed Bath Beyond yesterday. And so a lot of these companies, you know, the deterioration has happened very rapidly. And so that would be the other thing. If you're an industry and, you know, you have to accumulate supplies or inventory and you were wrong-footed, whether it was supply chains or just your end markets are changing that rapidly, and now you have old inventory— either it's mispriced or the wrong inventory— and now you have to do write-downs, and that further causes your margins to shrink. That is a really bad combination.

It's interesting that, um, inventories were pretty low for a long time there, so It's almost kind of like, uh, it felt like retailers had kind of gotten it together, were making all the right moves, and then all of a sudden that narrative changed completely and they have been in the tank ever since. So it's something you've got to keep an eye on if you're looking to be an investor in retail, and we certainly aren't. That's going to have to change. That dynamic must change. So we'll move on to topic 2. So topic 2 is Bitcoin and cryptos. I think almost everyone kind of knows what's going on there. Bitcoin has been absolutely thrashed in the beginning of this year. Bitcoin's down 60% year-to-date, Ethereum's down more than 70%. There are a lot of other coins people were invested in that have, uh, fallen further than that. Um, so just a simple question, Nolan, what can crypto holders do from here? What should they do? And then how does that impact everything else?

You know, you're not going to shake the, um, Bitcoin and digital asset evangelist. You're just not going to. I learned my lesson the hard way. We had a an investor event at one of our sister businesses, Wealth Management, this weekend where we just talked about the traditional assets. But during the Q&A session, we got a lot of discussion points on digital assets and Bitcoin in particular, and it was very spirited. Matter of fact, we got more questions and more reaction on the digital space than we did on traditional assets. You're going to have a hard time convincing these digital asset holders to sell. You know, they have that phrase in digital asset land, HODL, H-O-D-L, hold on for dear life. And so as the prices go lower, I don't think you're seeing a big shakeout yet. You know, as a matter of fact, the biggest holder of Bitcoin is a publicly traded company, MicroStrategy, ticker MSTR, and they just put out a note, uh, this week that they added to their Bitcoin stake at right around the $20,000 level. What I'm watching for is there's a lot of publicly traded companies that get their revenues from Bitcoin. Square, PayPal comes to mind. There's certain other companies that have Bitcoin on their balance sheet as an asset. Tesla's the name that comes to mind. The ramifications of that certainly has my attention much more, especially if prices continue to weaken. And I think the Bitcoin and the digital asset bulls will say at some point you're going to expect a decoupling from the rest of the investment markets in Bitcoin, where if it is digital gold, it should act differently. And right now it's acting like the riskiest asset, not the most independent. So we'll have to watch where that goes. I am concerned if that— if it continues to go down and we're continuing to see some of these exchanges have problems and go out of business and have liquidations. I'm hoping that doesn't cause a contagion effect with the stock market. That is my hope, but it's also my concern.

Absolutely. As you said, it's the riskiest risk asset, and, um, that's definitely distressing. We'll move on to topic 3. So in topic 3, we're talking about lower risk ways to play a bounce. I know a lot of investors— stocks are down huge. We've talked about buy the dip for years, and the general concept and the feeling people have is they want to buy. It feels like a bargain. But, you know, on the other hand, it doesn't seem like the right time. A lot of things are still in freefall. We don't want investors to catch a falling knife. We've looked at a number of different ways to get exposure to tech companies, other companies that have fallen far, retail. It doesn't feel good again in the stocks, but might be able to play it in the bond market. Well, and in tech, we see a couple of types of bonds. We have convertible bonds that have fallen precipitously, and now you can get a yield by buying those. And then there's straight bonds in a number of companies. Talk about those, the opportunity, and any names you might like in that space.

So as investors may or may not know, we are bulls here. And we think eventually you're going to get, at some point, 6 months, 9 months, 12 months, 18 months, 24 months past this. And then you're going to look back at these time frames like, wow, I could not have believed I could have purchased those shares at that price. We have no idea how close we are to a bottom. But at some point, we're going to get to a bottom. Question becomes, how do you play the recovery? An area that has our attention is this convertible space. So a lot of these technology companies, historically technology has not taken on a lot of debt. They generally have issued equity and then they live within cash flow. Last 4 or 5 years, a lot of technology and growth companies, instead of issuing stock, they've issued this convertible bond. And what that means is generally because interest rates have been low, unlike regular bonds, they pay a very low coupon, these convertibles, you know, in some cases 0 to 2%. So a negligible amount of interest expense. But the reason that investors would loan money at such low rates is you get an opportunity opportunity to convert those bonds to stocks if the stock share price goes up. So, in a simple example, a convertible bond is issued when the stock's at $100, and they may give the investor a chance to convert once the stock gets to $200. If I lose and the stock goes down, at least I get my monies back. But if the stock goes up, I get a chance to participate in the upside. That deal has broken a lot of these stocks, which you mentioned, a lot of these stocks being down 30%, 40%, 50%, 60%. The opportunity to convert to stock, probability I'm going to do that is very, very low. So we call these busted convertibles. And so what you end up with is some bond that at some point matures at face value, 100 cents on the dollar. And now in some cases, you can buy these bonds at 70 or 80 cents on the dollar 3, 4, or 5 years in the future. So now I have a zero-coupon bond, but I have a guaranteed yield to maturity if I can hold. And if this company doesn't go bankrupt, they have to pay me back at face value. And oh, by the way, I also get the upside that if that company is purchased by another company, a lot of these bonds have a change of control provision that makes them puttable. Company A gets purchased by Company B, and Company A issued this convertible bond and I bought it at 70 cents. Uh, there's a provision in there where I get to sell it back to that company at 101. These are very interesting ways to play a comeback. Ideas like that. Proliferate, especially when you get these markets where you have this indiscriminate, violent selling. Those are the type of ideas we've really been working around the office to drum up for investors.

I think investors should contact us if they want to learn more about what we're doing with convertibles. We're putting together a list, and, uh, we'd be happy to talk a little bit more in depth.

So they should contact us for names. However, there's a lot of straight Technology bonds that are in the 6% to 8% range where we have no doubt that they're going to be able to repay their interest and principal unless things go horribly wrong. But the financials look very, very strong. They may not be growing strongly, but they certainly have enough business momentum and to pay their debts. So we encourage investors to reach out to us and we'd be happy to discuss the opportunities.

It's been a tough first half of the year in 2022. We see reasons for optimism in the second half of the year, but we've got to pick through the wreckage and find the best places to play. So thank you, Nolan. Thanks to the audience for being with us, and we'll be seeing you again next week.

Happy Fourth!