Federal Reserve Reverses Market Rally as Earnings Roll On: Jarvis® Update November 3, 2022

The joy of market joys. We heard from the Federal Reserve this week and the reaction was less than positive. We cover those developments and more on this week's Jarvis Update. I'm your host, Brian Drost, 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. It's always exciting to be here talking stocks, talking markets.

Well, markets moved broadly lower this week, especially after, after some disappointment after the Federal Reserve announcement. We've got two topics for you, as we usually do. The first is earnings that impressed and didn't. And the second is insurance plus bonds equals insurance bonds. Before that, we've got a few announcements. First of all, we produce this show for you, the everyday investor, whether you have a 401(k) or an IRA. If you manage your own money or you work with an advisor, we'd love to be a resource for you and give you a second opinion. If you need some help in a volatile market and want to hear more about the opportunities we're finding in securities, both with fixed payouts and in a few sectors in the stock market where we're actually seeing them hold up, we'd love to talk. Make sure to give us a call on the number below. Also, if you're an institutional investor, we've got something for you as well, and that's our research service, Left Brain Investment Research. For subscribers, that's 8 to 10 full-length stock reports each month, plus The Chosen. That's our favorite stock and favorite income security each month. If you're interested in that, in our library of hundreds of reports, click the link below. Either way, we'd love to have you sign up for our biweekly newsletter. We're off this week, but we've got plenty of investment content for you. So click the link below to get on our mailing list. And of course, please like and share the video if you find it useful. We'd like to have other investors find it and also subscribe so you know that when the next video comes out. And then we're out every Friday morning with these videos. So we'll jump right into the market recap. So first of all, the S&P 500 was down about 2.75% for the week. The Nasdaq was down 4.4%. The Russell 2000, that's a small-cap index, actually outperformed as it has for many weeks over the last few months, down just 1.9%. But it was a reversal from last week where we had quite a nice up week in all markets. Interest rates are back on the rise after the Fed's announcement. The 10-year US Treasury is back above 4.1% again after a quick pop to 4.25%. After the Fed meeting. And then also the VIX, the volatility index, actually spiked down to 25 this week. We thought that was a little bit unusual given the fact that markets were down. Nolan, I wanted to have you give us a quick debrief on the Fed meeting, what your thoughts were, and any other initial thoughts that you had on the market this week.

Talk about reversals. This is a reversal where the firm that loves to talk microeconomics and not macro, and here we are pontificating on the Fed and the Fed meeting. But you're right, I did tune in yesterday. I know the market took it as being hawkish. They have— the investors had a negative slant. I think the takeaway for most investors is maybe inflation's becoming a little bit more entrenched. And so far, what the Fed has done, raising interest rates at consecutive meetings, has not been enough. And I think investors expect that they're going to continue for quite some time. And I think for most investors, by this— judging by the sell-off yesterday and again today, that was a disappointment.

Of course, Nolan, any other thoughts on the market action this week?

Going back to the Fed and the Fed meeting, I listened in. A couple of things struck me. One is the fact that they don't have their minds made up. They are data dependent. There was many times that Chairman Powell just spoke about the uncertainty and the fact the circumstances we find ourselves in don't map quite nicely to past historic models. That's probably why we've seen this unbelievable volatility and this whipsawing effect in the market, because investors hate uncertainty. The man himself, Chairman Powell, he's reading data and it's full of uncertainty and the Fed doesn't have a good handle on what's happening. So it's very difficult for investors to have a handle on it.

Yeah, no, I think you made a great case for why we don't, you know, try to read the tea leaves in the macro. If we're all relying on the Fed and what they're going to do and they don't know what they're going to do, Makes it sort of a fool's errand, doesn't it? With that, we'll jump right into the first topic. So topic 1 is earnings that impressed and those that didn't. So first of all, tech. We've talked to you over the last few months. We've seen a lot of weakness in tech. That's a big reversal from what we've seen over the past decade. Of course, tech has led the markets, but as we come out of this bear market and look for a new bull, we expect new market leadership. Here are a number of those firms reported this week. The first was Qualcomm. Qualcomm, that's a chip maker, one of the biggest chip makers in the world. We also heard from Roku, ticker ROKU. They're in the advertising space and also in the connected TV space. And we also heard from Fortinet, FTNT. They're in the cybersecurity space. 3 different companies, but one commonality, tough reports and tough reactions after. In terms of what is working, of course, energy, we've spoken about that ad nauseam for the last year. A number of those companies reported and reported well. The first was Williams, a pipeline operator, WMB. We also heard from Transocean, RIG. They're in the offshore drilling space. And we also have seen a lot of strength in healthcare over the last few weeks. Further evidence of that came from CVS in their earnings report and also Humana, HUM. And also in healthcare, I— Biomed was taken over by J&J, Johnson Johnson. Some investors are finding value in the healthcare space. Finally, travel companies. We heard from a number of travel companies this week with mixed results. We heard from Royal Caribbean, RCL, strong report. Also heard from Booking Holdings. That's the old bookings.com, BKNG. And finally, Airbnb, ABNB. Uh, they had a strong report, but the reaction wasn't so strong. Colin, what did you like about earnings this week and what did you not like?

Yeah, I think you hit the highlights. I'm just going to reiterate the point that tech is going to struggle for a while. We've seen weakness in the chip stocks. We've seen weakness in software. Uh, you're talking about some of these enterprise companies. Datadog, which is a company that does enterprise monitoring, had an unbelievably strong report. They had a beat and guide up. The stock was up in the after hours and, um, through trading today, it traded about flat. It just tells you that there's a very high bar, uh, for the tech sector and technology. And if you meet the bar, maybe you're flat, maybe you'll go up a little. If not, they're going to take you out back if there's any disappointment whatsoever in the report. So you have a lot of headwinds in the technology space. I would just be careful. Really surprised to see weakness in cybersecurity. It's the one area in technology that is mission critical. CIO budgets continue to increase upward and investors don't really care. The stocks are starting to roll over, so that's a problem. The other side of that is where we're starting to see or continuing to see strength. You mentioned it earlier about the Russell 2000. Just for the viewers, this is an index of companies size up to about $10 billion, uh, is the cutoff for the Russell 2000. So we'll consider that all small cap. We continue to see strength there. Uh, we had earnings report— I know last week on this call we talked about a company Inmode in the healthcare space. They reported this week very strong earnings and a good reaction. And just this morning we got, uh, another small cap that we like company called Zeta. They're involved in the digital ad space. They have first-party data that marketers use to target people for services and sales. Really strong report, beat and a guide up, and a nice strong stock reaction. Again, we're gonna reiterate the point, there's a lot to like in the small cap space.

So Nolan, we're, I think, 3 weeks through earnings. Do you have any conclusions that you're drawing from earnings after the companies we have heard from?

I do. So there's a few things that stick out. One is these companies, like everybody, is dealing with inflation. What we're listening for is how they're handling it. And each company is different. You know, again, if your input costs go up, whether it be labor, supplies, or transportations, then they have two options. One, they can pass them along to customers. We've seen that in the consumer staples space. And there you haven't seen a lot of volume growth, but you've seen price growth. So revenue goes up. The downside of that is your sales are probably going to suffer. The second thing that you can do as a company is eat the higher cost, which means your margins suffer. And during this earnings season, um, one of the things that have stood out is how each company is handling it differently based off of their strategy. I think what investors have been rewarding is higher margins across the board. What, um, investors don't want to see is lower margins, no matter which way they cut. The other thing is it's not universal. The, the market is very undecided about whether we're going to have a recession, when it's going to happen, and how long and how deep. So a lot of these companies' CFOs and CEOs have to determine their corporate strategy given the uncertainty in economic conditions. So it stands out to me how companies are positioning themselves because there's not a universal answer. And some companies are doing just fine in this this economy. The economy is still really strong. The labor market is really, really strong. Consumer spending is strong. Travel is strong. That's one of the reasons that the Fed has continued to raise rates, because the economy is not weakening like they forecast. So in this environment, Brian, a lot of businesses are doing just fine. Our favorite sectors continue to be the companies where you see sales, revenue, and earnings continue to trend upward. Led by energy. I'll throw healthcare in there. And then the third one to round it out will be insurance. Those areas have continued to perform exceptionally well.

I totally agree, Nolan, and a wonderful segue into our second topic. So topic 2 is insurance plus bonds equals insurance bonds. As Nolan alluded to briefly there, we really do like insurance companies. We've watched in wonder as insurance companies across the board have been making strides in an overall difficult stock market. You know, insurance has a lot going for it. First of all, it's indispensable. You know, no matter what the economic conditions are, you have to have insurance, whether it be health, whether it be life, whether it be property and casualty or anything along that spectrum. They also collect premiums. For those who are not familiar, insurance companies benefit from what we call the float. That means they take in premiums and they're able to reinvest those premiums in fixed income instruments and capture the spread between the two. So they're borrowing at a very low rate. And they're investing at a higher rate, they get to earn that spread. We call that the float. At the same time also, Nolan, we're concentrating squarely on income securities here, both bonds and other income securities. So first of all, Nolan, can you speak a little bit on what's going on with insurance?

So insurance is a very big market. If you just take a look at what's driving it, one, it's a non-discretionary purchase. So whether you're talking about home, auto, Health insurance is something that we all need. And in a market environment where there's so much uncertainty, investors prize certainty. The other side, I think about margins. We just talked about costs going up across the board. The insurance business in general is one that can pass along cost because the product itself and the service is non-discretionary. So I think those things lend themselves to investors gravitating toward the space. The third area that's driving earnings up is, quote unquote, insurance earnings— pardon the pun. And that is most of the insurance companies' reserves are held in fixed income instruments. And when interest rates go up, that means their future earnings are going to go up because that money that they have in reserve to pay future claims are going to be earning more money. And so they do get a boost from interest rates increasing.

All that sounds really strong in the current environment, Nolan. As you said, we prize certainty and, uh, insurance is one of the more certain businesses out there. Again, we wanted to talk more about fixed income. We really like fixed income. Interest rates are moving higher. That means that investors can lock in really generous rates of return in fixed income assets. So Nolan, to that end, what are some of the bonds you like in this insurance space?

So I like a company called Ginworth. Uh, most people probably don't know that name, but over 10 years or so ago, Genworth was a part of GE. It was in their financial and services business for insurance. And GE went independent several years ago, they had a long-term care business that for a while struggled, but is doing much better now. And then they had a mortgage insurance business that they've actually floated as a separate stock, Enact, which which is doing exceptionally well. Well, years ago, GE issued a bond. So they have a bond outstanding now that's a 6.5% coupon, matures in 2034. The bond trades at a yield to maturity, trades at a discount. So the yield to maturity is about 9%. At the same time, Genworth is very healthy, generating lots of cash, paying off a lot of debt, paying down debt, and the business is recovering and doing very well. It looks very attractive, investors can have exposure to. We can not only collect a good income from the coupon, but also possible capital gains as that bond returns to their maturity value.

Well, Nolan, I feel like investors would say 9% in the current environment of a yield sounds pretty nice, especially in a fixed income instrument where returns can be a lot more predictable than they are in the stock market. For those of you who are interested in, in adding securities like Genworth Financial bonds to your portfolio, we've got a huge list of bonds we've compiled. We're almost up to 1,000 bonds in our list. If you want to learn more about how you can put these in your portfolio and if they might be right for you, make sure to get in touch with us at the number below. With that, Nolan, we're going to close it out. Any final words for the investors out there?

Oh, you just have to be patient a little while longer. I know it looked like after October's run that these volatile days where we have these huge downsides were a thing of the past. But the Federal Reserve Board meeting really popped the balloon on that yesterday. I think the better times are ahead. I think we're getting to the end of the interest rate increases, and once that happens, I think investors will be much more comfortable putting money to work. Just gonna have to hang in there longer. I think we're closer to the end of the rate cycle than we are to the beginning. There's just the end of the year, start thinking about 2023, and there's a lot of opportunities to take advantage of, particularly in the small cap space and then the sectors that we mentioned earlier.

Thank you, Nolan, for that. Thanks to the viewers for being with us, and we'll see you again next week. [MUSIC] [MUSIC]