Is Tech Looking Better? Retail Sure Isn't -- Jarvis Update June 3, 2022

Winning weeks in a row, a welcome change that we'll cover on this week's Jarvis Weekly Update. I'm your host, Brian Dress, Director of Research here at LeftBrain, joined as always by our CEO and Chief Investment Officer, Nolan Langford. Nolan, welcome to the program.

Thank you, Brian. Looking forward to this edition and definitely looking forward to Game 1 of the NBA Finals tonight.

I thought you might say that. Yeah, me too. Just a quick preview for everyone on this week's video. It's been a holiday-shortened week, but we saw continued momentum throughout the broader market with a couple of exceptions. In today's episode, our 3 topics are: first, sustained strength in the enterprise tech sector; secondly, continued weakness in consumer stocks; and third, we're going to talk about some opportunities we're seeing in the mid-cap sector. We get started, a couple of announcements for subscribers to the Left Brain Investment Research Service. We've got 3 new reports, so check those out. The first is on a foreign oil producer. We've also got a report on an alternative energy play, and thirdly, a stalwart name in the food and beverage category. So check those out. And if you're not a subscriber, we'll put the details below so you can become a subscriber. And then finally, it's an on week for the newsletter, so check that out. And if you're not on the mailing list Make sure you do that so you can— with that, we'll go right into the market recap. So all 3 indexes that we cover are up. S&P was up 2.06%, NASDAQ was up 3.53%, Russell about 2.5%, and that's since Friday of last week. We had a few more earnings coming in, especially in enterprise tech. We're going to cover those in the first topic. Also wanted to mention that energy continued its strength again. We also had an OPEC decision that came out this morning. That, that took oil down, but it was strongly back once again by the end of the day. We also seen pretty broad-based strength in the market itself aside from retail, which we'll cover in the second topic. So, Noland, what are your general thoughts on what we've seen this week?

Obviously, the price action was a lot better. More importantly, on the fundamental side, the company reports were a lot better, and even companies that didn't do well, uh, meeting analyst guidance, the stock reaction's much better than what we've seen earlier in the year. So I think these are all positive signs.

Absolutely good to see 2 weeks in a row of positive after 7 negative weeks. So maybe we're at the beginning of a trend here. So we'll jump right into topic 1. Topic 1, we're calling Enterprise Tech Showing Signs. I'm hearkening back to my favorite NBA announcer, Marv Albert, Nolan, with the old showing signs. Mega tech, mega cap, mega cap tech has shown some strength, especially in NVIDIA, NVDA, Tesla, TSLA, both up sharply today on Thursday session. We also saw a lot of strength in cybersecurity. SentinelOne, which just reported earnings, CrowdStrike, CRWD, which also just reported earnings that looked good. We also had Palo Alto Networks, PANW, and Fortinet, FTNT. They were all strong this week. And we're going to zero in and say what we seem to have learned from earnings is that enterprise software businesses seem to still be doing well, and the enterprise is spending still on its tech stack. But more evidence of that came from the strong report from salesforce.com CRM. Also saw a good report from MongoDB, MDB. Nolan, what's your takeaway on tech generally, and then of course the enterprise tech spending?

It's good to see that enterprise spending is holding up. That doesn't surprise us if you think about things that, like digital transformation. And one of the ways to beat back inflation or labor shortages is technology. And so it's refreshing to see that, that being validated. Companies are still spending, updating, modernizing their tech stacks. We expect that to continue. What we didn't know is how the market would react when these corporations produced good results. And it's really positive and refreshing to see that the shares are getting bid up afterward.

Were there any particular earnings reports or, any companies that really stood out for you this week?

Yes, the, um, we spoke, we spoke about the digital transformation. So the MongoDB, uh, report really stood out. Um, Elastic stood out. These may not be household names, Pure Storage, in storage, uh, that one really stood out. Dell came out earlier in the week, and it's kind of a stodgy name, and sort of PCs, you don't think about that being real sexy, but the shares were up over double digits, which tells you how depressed things were. And the other one that surprised me is just in cybersecurity in general. You mentioned SentinelOne reported, we had Splunk the week before. Palo Alto Networks, we've had recently, uh, CrowdStrike tonight. And we're not surprised that cybersecurity spending is holding up, you know. If you think about the government telling us to be on alert because of the Russian potential hacks, if you think about people still working remotely or hybrid, corporations still have to keep the bad guys out of their networks. So we're not surprised that spending's held up, but a lot of these stocks that operate in the space are expensive. And these are exactly the type of targets that the market was shooting down earlier in the year because of valuation. And so if you go back and look over the last 30 days, interest rates are up and these sort of high multiple stocks have still performed. So yes, it has our attention.

Nolan, I think it's definitely, um, still challenging out there for investors trying to figure out what to do with these stocks because the fundamentals continue to be strong. but we really don't know what multiple people want to pay for them. So, uh, that remains to be seen. All right, with that, we'll move on to topic 2. Topic 2 I'm calling this week: consumer is weak, weak, weak. We did hear some conflicting views, or we have over the last couple of months, especially out of the banking sector. So, uh, CEO Moynihan out of Bank of America, he maintains the consumer continues to be strong, um, although this week we heard from JPMorgan's Jamie Dimon telling us to gird for an economic hurricane. So sort of mixed messages coming out of there. What really hasn't been a mixed message has been the stock action in retail. We saw weak reports from Abercrombie Fitch this quarter, ANF, and also Gap, GAP. And a lot of the consumer stocks are trading at single-digit multiples. So obviously investors don't really believe in the story there too much. Consumer seems to be squeezed. Obviously, gas prices are higher, food prices are higher. So they have less discretionary income. And then of course retailers are squeezed by some of the same phenomenon, you know, higher transport costs, higher fuel costs. Nolan, what's your take on retail? What are you seeing there and how investors should, uh, respond?

Well, they should probably respond by looking elsewhere. Not a lot to like in retail, uh, there's just not. Even if you think demand is holding up, you don't know that supplies are going to get there because supply chains are really having an issue. We saw that a couple weeks ago in the Target Walmart report. And if they do get supplies and the supplies are priced higher, we're not really sure if they're going to be able to pass those on to the consumer, even if they wanted to. You add in, they're still getting nipped at the heels by e-commerce, which as a group, e-commerce still isn't profitable, but it does take away their sales on the top end. You add in, and maybe consumers with the gas prices being up, maybe they won't be taking as many trips to physical stores in the future. At best, it's a mixed picture. And there's other places to look for investment opportunities. For us, we're not spending a lot of time on retail these days. There's a couple of select names we like. Costco's one of them. But in general, I think there's other places to look for investment opportunities.

Where's a good place for investors to look if they've got retail allocation? Where's a good place to shift to?

There's a few areas. You know, my favorite these days is still energy. I thought it was a big tell today. OPEC came out last night, this morning, depending on the time zone you're in, and they announced that, hey, they are going to increase the amount of barrels that they produce to make up for the lost production from Russia. And we came in this morning and oil was down about 3%, but by the end of the day it worked itself into a positive. And what that tells us is when markets don't go down on bad news is that they're very strong markets. And we've been saying this for a very long time, it seems like for well over 9 months or so. The oil markets generally, or specifically in commodities generally, are probably a very interesting place to make money. But sticking with oil, we've been undersupplied, demand continues to improve. The one area that was weak in oil was jet fuel, and now that we're back traveling, even that's strong again. So the refiners are full. And the EMP companies, the energy and production companies, have committed to not increase production. And so you have capped supply, you have strong demand. Basic economics will tell you that that should be strong pricing and strong markets. And if we look at the energy sector and these energy businesses and we take a look at the valuations, you know, we can argue about enterprise tech, you can tell me about the semis or enterprise tech or cybersecurity, and how good these businesses are. And you can still make a counterargument the businesses are great, but they're still overpriced. And it'd be hard to argue. What you can argue in energy is that the businesses are overpriced. You're paying the same price on a multiple basis as you paid for these businesses 10 or 15 years ago. And in most cases, the fact that the energy shares are up, it's only because earnings are up. You haven't gotten multiple expansion yet. It's just an increase in earnings. So that's one area that investors can look and have a really good degree of confidence.

It's interesting, Nolan. We've been talking energy for a while, like you mentioned earlier today, but we might still be early in the cycle. Before we move on to topic 3, we're going to just remind you again, drop a like at the bottom of the video and share it with your colleagues if you find it useful. And of course, hit the subscribe button and hit the bell for notifications to make sure you get the next video as it comes out. We're up weekly. With these update videos. So, um, definitely would appreciate that if you found the video useful. With that, we'll move on to topic 3. So topic 3 is a simple question: mid-caps opportunity. Nolan, mid-caps and small caps to a lesser degree, uh, kind of been left for dead for a number of years, you know, um, since, since COVID Market outperformance was really driven by a narrow number of stocks, mostly large-cap, many mega-caps. Um, but we've been studying some names in the $3 to $10 billion space here that seem to trade at reasonable prices. There's also some takeover buzz. A lot of, uh, large companies still have cash on the balance sheet, you know, they might want to put to work with some companies on a discount. And I'm going to throw up a chart up here of the S&P 400, which is a mid-cap index. You can see there's a bit of a slight outperformance both year-to-date and month-to-date versus the S&P 500. And we've also seen the Russell's been relatively strong over the last few weeks. What are you thinking of mid-caps, and are there any particular names that, uh, that you're thinking of?

I think mid-caps are an interesting space. And again, just for the listeners, in case you're not a professional investor, Ryan mentioned it earlier, um, typically when you think of stocks, the stock market, most people are thinking of household names, i.e., large caps or large companies. And by and large, these are companies with market capitalizations, really it's north of $20 billion, and a lot of the big, big companies are north of $100 billion, and some of the really big ones are over a trillion dollars. We say mid-cap, we're talking about companies with market capitalizations of somewhere between, I'm going to say, $3 to $5 billion on the low end, and depending on who you talk to, I think generally we think about $10 billion. So not small companies, And the best ones are this midsize on their way to becoming large. And so you still get really good growth rates, but they're healthy enough and big enough to be sort of financially stable or more stable than small companies. And there's a few interesting dynamics. You know, there's this inverse relationship that generally speaking, the smaller you are, the higher your growth rate. The other thing that you get is the possibility for them to get purchased by bigger companies because they're small enough to swallow. As earnings season has rolled on, we've noted quite a few of these companies in the mid-cap space that have produced really good sales, revenue, earnings, and free cash flow numbers. A few names that come to mind: Box.com in the collaboration space is one. Pure Storage came out yesterday with earnings after the, after the bell that were very strong. A couple weeks ago, a consumer beverage company, Celsius, came out, reported really good earnings. And, uh, at Left Brain Investment Research, we produced a report on an alternative energy company, Darling Ingredients, which posted really good results. So a lot to like in the mid-cap space.

You know, I think a lot of investors have got caught up in doing a lot of large-cap investing. Of course, there's value in that, but it's left a lot of these companies in this, in the smaller area without a lot of constituency. And we think that does create opportunity. So, Nolan, that wraps it up for this week. We definitely saw more strength in enterprise tech. That was the biggest takeaway of the week. More weakness in consumer stocks, you know, may or may not have been related to the strength in energy. And finally, opportunities in mid-cap. Any final words for the investors as we bid them adieu this week?

Yeah, we're rooting on the Golden State Warriors. This is game 1, so send good energy to Steph Curry's way if you're a Golden State fan. And I guess if you're a Boston fan, you'll have to send it to Tatum's way. But no, this is, uh, hopefully this is the start of the summer season. It's that old adage, sell in May and go to— go away. That may have held true the early part of May, but we certainly have seen the markets start to recover. Let's hope we get some sanity and some clarity on some of these crosscurrents that face us with inflation and interest rates and supply chains and Russia and China lock now now, and that as the summer moves on, we have more answers than questions.

Yeah, other than those 8 or 9 things you just mentioned, Nolan, everything seems smooth. Thanks to the investors, and we'll see you again next week.