Is This a Market in Transition? Jarvis® Update August 30, 2024

We're getting ready to put a bow on earnings and move out of the summer doldrums. What trends are we following into year-end? We answer that question and much more on this week's Jarvis Update. I'm your host, Brian Drust, director of research here at Left Brain, joined as always by our CEO and our chief investment officer, Nolan Langford. Nolan, welcome to the program.

Happy to be here on this Labor Day weekend.

Happy to have you, Nolan, and happy to be moving into the football season. A quick preview for everyone before we jump into the meat of the program. Much is happening as interest rates begin to fall and markets are trying to size up the economy moving into this election. We've got two topics for you as usual. The first is an earnings update. The second is a question: is it a market in transition? But first, the market recap. We've had a pretty turbulent month of trading in the markets. The S&P is actually up about 2%. The Nasdaq is flat. That's the tech-heavy index. And then the small-cap index actually not doing as well. The Russell 2000 down about 2% on the month. It is being treated as a foregone conclusion right now that interest rates are going to move lower in September from the Federal Reserve. Along with that, the 10-year US Treasuries are now down below 3.9% on an annual rate. That's down from a high of close to 5% in 2023. More importantly, for many consumers out there, the mortgage rate is now 6.43%, where it was much over 7% for a little while. Nolan, these are the overall market data right now. Do you have any reactions to those and any thoughts on the mortgage rates that we're seeing right now?

Happy to see mortgage rates down from 7%. I'll tell you that much. You know, we're listening to some housing CEOs and on their wish list is a mortgage rate that starts with a 5. So I guess if we go down another 45 basis points, we're about that 5.99 handle, I think people will start to smile. But it's good that we're off the boil at 7, and, uh, we're headed in the right direction.

Thank you for that, Nolan. Let's jump right into the topics. So topic 1 is our earnings update. It's been a monster week. The big kahuna this week that everyone was looking for was Nvidia earnings. That's NVDA. We'll throw a chart up on the screen. Things look pretty good there. The stock didn't go up too much, didn't go down too much, but we did hear from a number of other major tech firms out there, including CrowdStrike, Okta, O-K-T-A. We heard from Pure Storage, P-S-T-G. And then we also heard from a pretty large one, salesforce.com, that's C-R-M. Colin, what's your reaction to earnings? And what about some of these puzzling stock price moves we saw in response to some decent and strong earnings, specifically out of Okta and Pure Storage? And then finally, how do you respond when the stock move doesn't match what you saw out of earnings?

So remember, the, the earnings come out 4 times a year and it's one data point, and it gives you a, a really good snapshot of how a business performed the past quarter. And what's more insightful is the commentary that you get about what the CEOs expect for the upcoming quarter and how they're preparing themselves. And a lot of times the two won't match, and not all the times they will. Sometimes you'll get a good earnings report and the stock will sell off. It could be commentary, and sometimes you can see a huge earnings miss and then the stock rise, and that's because of the future expectation. So I would just say you have to really be careful around earnings, and sometimes you see whatever happens on the earnings release will tend to reverse itself in the weeks ahead as people really digest what happened. So I would say the earnings season right now is sort of a mixed picture. We're going to talk about the consumer a little bit later. But I do get the sense that, you know, a lot of these technology buyers sort of ran up tech shares sort of coming in over the last couple of quarters. And it seems like in the last, I'm going to say, 6 to 8 weeks or so, a lot of that buying has kind of cooled. Now the buying is starting to show up in other areas. But one of the areas it has not shown up in persistently is small caps. It wasn't that long ago we said the leadership was changing and small caps had that one or two-week run where small caps were up 8 or 10% and large companies were down. And that's so far in the rearview mirror, we don't even remember it. So you're right, it's probably a market in transition, churning a little bit, positioning itself for lower rates in the year end ahead.

Thanks for that, Nolan. Good to kind of get some perspective on earnings. It's been a pretty highly anticipated season here, and it is important not to just look at the stock price but also looking deep into what's going on within these businesses. That's what we're doing ultimately, is trying to own the best businesses. I'm glad you mentioned the consumer. Let's talk a little bit about the consumer. There's been a lot of talk about consumers and how they've been kind of stretched over the last few months and quarters. We did hear from a number of consumer areas this week. We heard from Best Buy, BBY. We heard from Nordstrom, JWN. And then we heard from Dollar General, DG. What's going on with consumer? And then speak a little bit about housing and how that all works together.

Housing is at the forefront of probably what's happening with the consumer. It's like, I guess, the yin and the yang. And the yen part is job. The job market's still really, really strong. We have a low unemployment rate. So that's the yen part. The yang part is, you know, as we know, we've had these shocking price increases that have stuck with us over the last few years. And a lot of these price increases, you know, if we go back in earnings releases over the last 8 to 10 quarters, all you hear is about companies taking price. And that's shorthand for raising prices and decreasing the number of items on sale. And that hits you in the pocketbook. The other part of the yang for consumers, just housing. A lot of people psychologically feel sort of trapped in housing. If you're in a mortgage at 3, 4, sub-5%, and in order to make a move in your house, you know, you have to pay 6.5%, it's really not a trade most people are willing to make. Because of that, inventories are low. So even if you decide I'm going to forego my low-interest mortgage for a higher-interest mortgage or pay cash, I don't think there's a lot of attractive inventory at reasonable prices available in most parts of the country.

Absolutely. Great, great points all there in terms of housing. That's something we're going to be keeping an eye on. Housing is such a huge part of the economy and such a huge part of each consumer's balance sheet. I think we have to really keep an eye on as rates fall. I want to ask you finally, Nolan, as far as earnings, let's put a bow on earnings. Any takeaways you've got from what we've seen over the last quarter?

Yeah, most businesses are doing okay. You know, we have heard kind of the, the same comment both from the consumer side and the business side. Consumers are evaluating their purchases with a lot more discriminating eye. And so they're being real careful about how they buy and when they buy and where they buy. And even travel's been affected. But before, enterprises were sort of immune to that until now. Now we're starting to hear from from all these tech firms that deals are starting to get pushed out. They're starting to be more highly scrutinized, even going up to the CEO or board level. We're hearing a lot with this AI. Companies are having to spend a lot of money on artificial intelligence to really keep up, but they only have a certain pie to spend on technology in general. I think they're looking to cut in certain areas to spend more in artificial intelligence and cybersecurity. So there's certainly going to be some, some winners and losers. So all in all, businesses are kind of managing themselves responsibly. We came into this year, people were worried about corporate debt. That hasn't really been an issue. The debt wall has been pushed out. All in all, things have gone pretty well. Although I will be remiss, we did have a huge big technology blowup this week in the market, and that's Supermicro, which is the maker of AI servers. Those AI chips that NVIDIA sells so many of, you can't just take those off the shelf and use them. You actually have, have to have them packaged and put into a server. And that's the Supermicro business. And shares had done wonderfully this year, but there was a, a negative article out earlier this week. And because of that, yesterday Supermicro said they were gonna delay their annual filing. I'm sure behind the scenes they're probably getting their defenses together and dotting the i's and crossing the t's, but it caused a huge downturn in the shares of that stock. We'll watch and see what happens on the other side. Generally speaking, I think business in tech land is fairly healthy. The spending should continue into new year and into next year. And according to NVIDIA, you know, we're still in very early innings of artificial intelligence. So excellent.

Now let's move on to topic 2. So topic 2, we're asking, is it a market in transition? Not surprisingly, the strongest sectors year to date have been IT and communication services. We're talking about over 20% return in each of those in the S&P. Couple of the next two winners are, are more surprising. That's financials. They're up about 19% and you've got utilities up 18%. That one really floored me. And then the last 3 months, it's really kind of changing. So the biggest winners in the last 3 months are real estate, financials, healthcare, and consumer staples. Complete departure from what we've seen earlier in the year and even in last year. Nolan, do you have any thoughts on what we're seeing from this point of view? And then how should investors respond to what they're observing, uh, in these sector data?

There were these sectors that were punished as interest rates went up. Now that interest rates have crested and they're on the way down, those same sectors that were tired and feathered on the way up are starting to get their day in the sun. And utilities is a poster child for that. You know, it takes a lot of capital and a lot of debt to manage and run a utility. So on the way up, they were really punished, and, and now they're having their day in the sun. And I think the same with real estate. You know, real estate's always a debt business. And if you can borrow money cheaper, you know, that boosts the value of what you own. So I think that's what we're starting to see. The question is, will it persist? You've gotten good returns so far. There were— those are the easy returns. We'll see what happens from here. Okay.

And then, Nolan, if the market does go into transition here, first of all, does that surprise you? And then secondly, what would be a good way to position for potentially changing market Just talked about rates coming down.

I think the easy thing is things that are going to benefit from the rate decrease, but that anticipated increase in value hasn't shown up in price yet. On our podcast, we've been talking a lot about income securities, and these are securities that they operate their business but not necessarily for growth for the future, but to pay out most of their earnings in the form of high yields. And so a lot of these income securities that we follow trade like stocks, but the movement is really in between stock and that of a bond. But they tend to carry high yields somewhere in the order of 7 to 9%. And in a 5% world, 7 to 9% with that 2 to 4% spread is kind of attractive. But in a 3 or 3.5% world, that 3.5 to 5.5% spread looks delicious. And so I think that's an area that people want to pay attention to, especially as CDs come off. But one of the areas I do like is financial technology companies, fintechs. These tend to be companies that deal with either businesses or consumers, and they make money by loaning money, and they get a spread, and they make money off volume. And they were really, really hurt the last couple years as interest rates rose and as the consumer pulled back. But now things are reversing for them. So we like businesses like that. You know, Square is a name that we've looked at and we've owned in the past that I think is really, really attractive. And then there are some smaller companies in that $4 to $15 billion range that have come down a lot that I think are very attractive and have a good line of sight to having attractive returns over the next year or so.

Always important to take a look at what we're going to do if markets change. And so those are some good thoughts from that perspective. We would like to ask you to like and share the video if you've made it this far. We do appreciate that. It helps others like yourself, smart investors, to find our content and learn more about what we're doing here at Left Brain. And also subscribe, hit the bell for notifications. That way, you know, next time we're out with these. Before we close out, Nolan, I did want to talk again. We're going to keep beating investors over the head with this thought, but cash, as you said, interest rates are starting to fall. People may have cash on the sidelines or CDs maturing. Talk a little bit more about what people need to do if that's the situation they're in right now.

A lot of people have been sitting on cash for a long time and they don't really seem motivated to do anything with it, particularly if you, you know, if you go back 9 months, 12 months, you know, you could get 4.5%, 5% just leaving your savings in a high-yield account or rolling CDs. And that is an attractive return. If you go back 20 years, it may have been a long time since we'd seen 5% notes. Unfortunately, that window was open for, it seems like a very short while. Now it's, it's starting to close and close pretty rapidly. I think we're starting to see 3s in front of these instruments. What's more worrisome is we talk a lot in our office about income taxes, and most of our clients are in a much higher income tax bracket than they would like to be. And if you have money in either a CD or an ordinary high-yield savings account, all of that interest you earn is taxable. So even if you're earning 5% and you're in a 35% tax bracket, that's more like 3.25% after tax. And as I mentioned, we are favoring these income securities. A lot of them pay qualified income, which means you're taxed at the lower capital gain rate instead of ordinary income tax rates. So I'd like investors to really start to think about how much cash they really need in a reserve fund and then think about whether they'd like to step out and earn a little bit more yield with their other monies.

Thank you, Nolan. So if you want to get in touch with us and learn a little bit more about some of our strategies, we've got a number of strategies in order to put cash to work and find a yield that's not necessarily the stock market, get in touch with us. We'd love to have a conversation with you and see if we can help. We also want to mention we do have our newsletter, the Jarvis Newsletter, coming out in the next couple of weeks. So keep your eyes peeled for that. We're in the phase of putting it together right now. So we're excited to be out with that for you in the next couple of weeks. Nolan, any final thoughts as we close out this week?

Yeah, I want to wish everybody a happy Labor Day. It's a really good time of the year. Last big barbecue of the year in Naperville. We got the Naperville Fling. Also remember, we do have elections coming and we have September and October. Historically, the market's been kind of lumpy and bumpy in September and October. So buckle up a little bit. I think we'll get through it just fine. But we do have a big election coming up pretty soon, which will probably cause us some turbulence. So if you get real queasy, just smile and turn on the football game on Sunday. Because the pigskin is back.

That's right, Nolan. We're excited. We're happy that you are with us, and we're looking forward to seeing you again next time.