Interest Rates Weigh on Markets; Is There Hope for the 4th Quarter? Jarvis® Update 9-29-23

Markets have been soft for the last 2 months. Should long-term investors be worried? We answer that question and much 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, the always dapper Nolan Langford. Nolan, thank you for being with us.

I'm excited to be here and really excited to watch my former favorite team, the Detroit Lions, tonight take on the Cheeseheads.

Nolan, are you bandwagoner now?

No, but I'm still rooting for my Lions.

Excellent. Well, let's jump right in. First of all, we'd like to ask you to like and share the video if you find it useful. It does help other investors find it and certainly helps our channel. Also hit the bell for notifications and subscribe to the channel. That way you know next time we're out with our videos, and we're out on a biweekly cadence with these. We'd also ask you to comment. We'd love to have interactions with our, with our listeners and our viewers. So can you comment below with your answer to, have you made your holiday plans yet? A continued rise in interest rates has put a lid on stock prices. We've got two topics for you, as we usually do. First of all, what's going on lately in markets? And secondly, we're going to talk about our expectations and plans for the fourth quarter. We've got a few announcements. First of all, we'd like to ask you to sign up for the Jarvis newsletter. We were out last week with our last edition of the Jarvis newsletter for September. We covered the importance of patience in long-term investing and a number of other topics. So definitely sign up at the link below and you can get on your mailing list to receive that in your inbox every month. We also talk stocks here, but it is a means to an end. We want to help clients, prospects, and listeners build their portfolio to reach their financial goals. Whether or not you currently work with an advisor, we would love to be a resource for you and help you achieve your objectives through investment in public securities. If you're interested in learning a little bit more about how we help clients achieve their dreams, call us at the number below, and that's 630-547-3316. For the podcast listeners out there, we've also got something for institutional investors. That's our database of investment ideas. We've got our model portfolios, we've got dozens of actionable securities in those, and we update those quarterly. These are the same models that we use in order to build our customized portfolios in-house. Take a look at the link below on the screen and we'd love to set a meeting with you and, and discuss that with you. Let's jump right into our market recap. First of all, we've had a bit of a choppy week. S&P and the NASDAQ were both down slightly. Russell was up slightly this week, slightly better than the other two. No clear pattern. Nolan, it did feel a little bit worse than that. It felt like we were down, uh, quite a bit more than what the indexes suggest, but I guess that's something that we've seen over the last few weeks. What's really going on here is 10-year Treasury rates are gaining steam higher. They're now above 4.6% on the 10-year. That's the highest we've seen since 2007, which is a long time ago actually. Bond prices have been weak for the last 3 straight years, and also we're in the quiet period between earnings. So all of those events are sort of working against investors right now. Nolan, how are you viewing the current landscape?

Yeah, I agree with you. You use the word choppy and I could not agree more. Everything's being driven right now by these pesky interest rates. Uh, both the short and long-term rates have continued to move higher and stocks have continued to move lower. The relationship sort of makes sense. Markets are fairly rational. I think there's a lot of angst about the uncertainty. There's always uncertainty, but right now we got a trifecta of them. So we not only have interest rates moving higher, we have inflation moving higher, and we have economic conditions weakening. So those generally aren't the 3 cherries you'd like to see, uh, show up in the window, more like 3 jokers in this case. And so that really has caused havoc in stock prices. We do have some things coming around the corner that should help. One, we do have earnings season coming up. I know you're gonna be talking about this a little bit later. So that'll help give us an up-to-the-minute view of kind of how CEOs are handling it, what their thinking is, and how they're positioning themselves going forward. So we really are looking forward to that. The other thing is markets have just been so weak. They're really oversold. I would expect some bounce to come up here and coming up. I don't know what the catalyst might be. It could be tomorrow when we get the PCE inflation report. That could be it. Or it could be any number of things that we're not factoring in. But we do know markets are oversold. The coil to spring, and at some point they will. And then we also know that valuations are really, really cheap. There's a lot to like. And generally when you get cheap stock prices in a prolonged downward spiral, that could be another catalyst to move things up. But the market actually, as you mentioned, is obviously preoccupied right now with those two things, inflation and interest rates.

Well, Nolan, we definitely are building that wall of worry. So it remains to be seen, will we climb that wall of worry? Let's move swiftly on to our first topic. So topic 1 is what the heck is going on lately? At the time of recording here, the S&P is down about 7% since the beginning of August. The, the Nasdaq Composite, that's the tech-related index, is down around 8%. Nolan, what do you think is driving things in a general sense? I think we know interest rates is certainly part of the equation there. Are there any sectors year to date that have surprised you either to the upside or to the downside?

I'm going to take that It's two different questions. In the first part, what is going on? Has anything surprised me? I think one of the things that's, that's going on, I think investors are worried maybe the Fed is being too aggressive on the upside. They are really trying to slow down the economy and we worry, is that going to tip us into a recession or is it going to be a soft landing? And if you take a look the last 8 weeks or so, investors are placing their bet that it may be something worse than a soft landing. Whether that'll come to fruition or not will go a long way to determine how we finish the year. But that's certainly what it looks like is being priced. One of the evidences that we get for this is if you take a look at the divergence between small caps and large caps, and if you take a look at some of the more growthy names in the market, and you mentioned since August 1st, the Nasdaq was down 8%. It certainly feels like a lot worse than that. If you take a look at a lot of stocks, at least some that we follow, some since August 1st are down 25%, 30%. In some cases. And these are companies that are really good, really good profitable businesses. And if you take a look at small cap in particular, and these are companies that the market size is less than $10 billion, a lot of those are down in meaningful amounts. But the business outlooks for the individual businesses haven't changed at all since August. So that tells me that investors are pricing in a recession. And in a recession, small companies have a tougher go of it. Than large companies for a variety of reasons. So, um, those are the things that are going on. And yes, there are a few things that have surprised me. Again, I mentioned prices, uh, being down, but some prices being down dramatically. So the swiftness and the violence on the downside with some individual names surprises me. Another thing surprises me a little bit. If you take a look at oil, oil's been really strong. If you take a look at oil prices, you know, we're back over $90 a barrel. But if you take a look at oil stocks, they have not kept pace at all with the price of oil. So certainly that has my attention as well. And then the final one you mentioned is just bond prices. If you take a look at Treasury bonds, which people typically are going to buy Treasuries for safety, they're hitting new lows, reversing earlier gains that they had earlier this year. So that surprises me as well.

It's been a long time since we've received any earnings reports in any kind of volume you know, a few are trickling in here and there, but it's going to be, you know, a few weeks before we get back to earnings season. As we approach the end of the third quarter here, Nolan, that's, that's going to be done here at the end of the week and we move back to earnings season. What are you expecting to see?

So I'm really— I don't know what I'm expecting to see, but I am expecting to see fireworks. I don't know from whom, but I am expecting, you know, we've had some, again, violent moves here and a lot of volatility the last 8 weeks. I don't expect that to settle down when businesses actually release their results. So I expect to see more of that. What I expect to hear, or what I'm interested in hearing, has my attention quite a bit as well. And that is how these CEOs are planning themselves in this current environment. So we've heard earlier last quarter about a lot of businesses kind of delaying decision-making, the sales cycles being elongated, and deals being a little bit more tough, tough to close. And I'm looking to see if that trend continues in the future. I'm also looking to see for CEOs, are they still cutting costs or are they back in growth mode themselves and spending money to grow their organizations? And then finally, I'm really looking forward to— prices are much cheaper. I'm really looking forward to M&A, companies getting purchased by other companies. We've seen one deal in the last couple of weeks where we've seen Splunk, which is a big observability software, uh, cyber company that we've talked about at length. They had a deal, they were getting, they're getting purchased by Cisco Systems. And I was kind of surprised that that wasn't the first domino that would make other companies galvanize them to, to start more M&A action. But it hasn't happened yet, but I expect it to. And finally, the IPO market is back open. So we had Instacart and Klaviyo, two highly anticipated IPOs. It just hit the market a couple of weeks We'll be watching to see how those stocks perform over the next couple of weeks as well. But this earnings season is like all of them, definitely has our attention.

Yeah, regular listeners will know we love earnings, so we're looking forward to that. Let's move to topic 2. So topic 2 is our expectations for the fourth quarter. Uh, if you're one of the type of investors that likes to look at historical returns by month, I'm a little dubious on whether that is meaningful, but August and September tend to be two of the worst months over the last 50 or 60 years. So we're right in line with that this, this year. October through December tend to be some of the better months for investors. If history plays out, should be on for a better few months here coming up. Nolan, are you expecting that to happen in '23?

I'm out of the predicting what the market's going to do next business, especially over the short term. Over the long term, I'm overwhelmingly optimistic. We haven't had an opportunity like this in a long time where you're getting really high-quality businesses. And we define those as revenues growing organically 10% or more. In some cases, we're getting 20, 25% organic growth. And you're also getting profitability. So that means these companies are making money. They don't need to have any external financing. They don't have to go to the banks or the bond markets to borrow money. They can fund themselves with their internally generated cash. In a lot of cases, you're getting these type of companies at a very low price, in some cases 12 to 15 times earnings, which is unheard of. And if we're judging by the free cash flow yields, some of these free cash flow yields on some of the stocks that we like and that are going to be coming out this quarter in our quarterly model portfolio updates, the free cash flow yields are 6, 7, in some cases 8% from really good businesses. So at some point I expect investors to stop worrying about inflation and interest rates, start paying attention to the winners, and we expect higher prices in the future. Now, whether that's this quarter or 2 or 4 or 5 quarters from now, I have no idea, but high degree of confidence that it's coming.

Okay, Nolan. So kind of in a related question, earnings are coming up. Which earnings reports are you looking for to give you some read-through to the rest of the market?

I, I'm interested in all of them. That way. All of them. But I'll be paying really close attention in a few areas. One of them is cybersecurity. And we know cybersecurity, especially with the dawn of AI and digital transformations and work from home and hybrid cloud, the demands for cybersecurity protection and compliance is high and growing. So I'm interested when these companies release to see what they say about the current demand environment. Also to anticipate if there's gonna be any consolidation in this industry. There's a lot of point solutions that are out there. So a lot of businesses are using multiple vendors. So I'm looking to see if there's gonna be any consolidation. So, uh, customers have fewer vendors and make their lives a lot easier. The other area is AI and what's happening in the chip sector. Chip sector's really big, but one that has got every investor's on notice is the artificial intelligence sector. The growth there has been triple digits. It's come on very fast and companies have to adopt or die. And so I'm interested in the chip companies, particularly those in the artificial intelligence space, to see what's happening in the current demand environment. That'll be one I'm paying attention to. And finally, what we all talk about is I'm really interested in what's happening in streaming. There's been a huge difference on how— difference today versus a couple of years, even a couple of years ago. About how we get and consume content, whether it's your sports that you're watching, your favorite show at night, or streaming movies. That's been totally disrupted. The user experience, in my opinion, is not very good. It's actually at an all-time low where you really have to hunt for whatever show you're watching to make sure that, um, you're subscribed to that specific app instead of there being one interface like the old Comcast. So the viewer experience is not great. This transfer from analog to digital that's caught all these media businesses like Disney and Comcast unawares. I'm interested to see how that'll flow through the earnings. The streamers has been getting all the growth in subscribers. They just didn't have profits. And so it's caused havoc in a lot of these media companies. So I'm really interested to see what's happening in streaming, what the pace of revenue growth is.

I'm really looking forward to earnings season. As always, we want to learn more about what's happening in individual businesses at the micro level. And that's the best chance for us to do so. We're going to leave it there. Nolan, any last thoughts for the viewers before we bid adieu?

Yeah, we're— October is here. By the time most of you listen to this, it probably will be October. So happy Halloween, everybody.

For me, looking forward to seeing the Chiefs play this week on Sunday Night Football at the Jets. What other people might be looking forward to is Taylor Swift in the audience. So we will see how it all World's colliding here, Nolan. I don't know, I might have to pay $2,000, $3,000 to go to the next Chiefs game if these— oh boy— have their, uh, if the Swifties have their way. So we welcome the new fans for the Chiefs. We thank you all for being with us, and we will see you again next time.