Jarvis Weekly: Ukraine and Earnings Dominate Investment Headlines

Hello everyone and welcome again to the Jarvis Weekly Update. We had another volatile week in the financial markets. Earnings and war in Ukraine dominated the headlines yet again. I'm your host, Brian Dress, Director of Research here at Left Brain. Joining us— joining me is our CEO and our fearless leader, Nolan Langford. Nolan, welcome to the program.

Welcome everybody. And speaking of fearless, With market action that we've seen, you need to be fearless to even look at the tape. What a week.

Yeah, what a week. It's one of those weeks you don't really want to open your brokerage statement, but here we go. Um, so Nolan, we'll just start with a quick market recap. Um, you know, we're not a foreign policy show by any means, but we obviously have to cover the main news of the, of the day and of the week, which is the beginning of a hot shooting war in Ukraine that grabbed most of the headlines. Drove a really large, uh, move downward in the overnight session, and then also, um, a huge reaction upward after. So we'll get into that. S&P was down just under 3% over the last 5 days that we cover, which is Friday to Thursday. NASDAQ was about 3.5% down, and everything was pretty much straight down, uh, until Thursday morning, uh, when we saw, you know, the Ukraine war began overnight last night, huge move down. And then obviously when, when the markets opened this morning, there was a lot of buying. So before we go through our 3 topics, Nolan, what was your view of the overall market action? And Thursday, did we see a bear market rally or was it the beginning of a new and positive period in the markets?

Well, I'll start with the latter first. And, uh, I don't know if this was the bottom or a bottom, and, uh, and only time will tell. So we'll have to see. I will tell you there's a few things, um, for the listeners that we'll be paying attention to. One of them is the VIX, the volatility index. So even though the markets had risen today, um, volatility— the VIX index stayed high. And for those who aren't familiar with the volatility index, It's, um, options. It's kind of a complicated formula, but it, um, what ends up is a number. And if the VIX, that volatility number, is high, that means people are paying up for insurance. There's a lot of nervousness in the market. And when the VIX is low, there's a lot of comfort and confidence in the market, and you tend to get stability. The volatility index, the nervousness index, stayed very high even though there was a rally. So we'll have to We certainly like to see that move around. The other thing is energy or oil prices, which had been well bid. You know, there's a fear that if this Ukraine-Russia thing really goes bad— Russia is a huge producer of oil, we're already in short supply of oil— you can see an oil spike. So interesting market action in that oil spiked early, and then as the rally took hold, oil sold off. And oil stocks sold off. Toward the end of the day, though, that sort of reversed, and not too much damage was done. So oil and oil stocks stayed well bid. So that would be another thing to, to watch. And then more importantly, our hearts and thoughts and kindnesses go out to the people of Ukraine and all of the soldiers fighting And even we have US troops. I know I have family members that have been deployed. So the first thing that we want to pay attention to, you know, we can make money again, markets go up, markets go down, but the human casualty and toll, you know, certainly is something that we want to give our hearts and our thoughts to.

Yeah, Nolan, this is really an infuriating and horrific situation that's taking hold. Yeah, the futures trader in me, former futures trader before I joined This Life, taking a look at what was going on overnight, it looked like the opportunists were out in force selling the stock market, buying oil, buying gold, and it looked like they got a little bit offsides. And as we came into the daytime, all that seemed to unwind and then some. So time will, time will only tell whether this is the start of something new or whether it was just a positioning-led situation. So with that, we'll move on to our first topic. So topic one, Nolan, we're calling it the whack-a-mole market. In our conversations over the last few weeks, this term has come up a number of times. It really seems like there's not really anywhere to hide in the market right now. You know, we started out this year looking for defensive names as the growth stocks started to have problems. We looked at healthcare, financials, energy, all that seemed to do pretty well at the beginning, maybe not healthcare, but certainly energy and financials. That's starting to reverse a touch. I guess the takeaway is there's not really anywhere to hide right now. So I guess I'll tee it up for you anywhere. Tell us a little bit more about this whack-a-mole term. And yeah, how do you see things in the first couple of months here?

If you look at the sectors of the S&P, for the most part, they're all showing red with the exception of energy. And energy has done well. Problem is it's only 3% of the S&P. So even if an investor wants to get overweight, you're still going to have to have other things in your portfolio. And those other things haven't been doing well. The few areas that have been doing well, they haven't been consistent. They've been consistently inconsistent. And you're right, one minute it's utilities, then utilities sell off with interest rates, and then it's real estate that does well. And then lately, the last week or so, you mentioned coming into the day where the S&P was down over 3%. Consumer staples are considered a defensive, so we all know the names. Pepsi, Coke, Walmart, Clorox, Johnson Johnson. Those are considered Procter Gamble consumer staples, and they're considered defensive because no matter what happens, they sell goods and services we're all going to need. Kraft Heinz, Altria Group, Vols. But today, even the, the staples have been rolling over and have been selling off. That's what we mean by whack-a-mole. As soon as something pops its head up, the market smashes it down. It'll be interesting to see how this situation resolves and where we see sort of persistent strength. That's what we'll be on the lookout for.

Yeah, absolutely. I, um, was taking a look at the XLE this week. You know, as we said, energy's been one of the strongest categories, but, um, starting to see a bit of weakness in the energy stocks. I'm not sure if it really is meaningful, but just kind of more of the theme that we're discussing here, that it's hard to find anything that you can really grab onto and feel 100% confident in. Brings me also to, you know, something we talk about here at Left Brain. Of course, we're fundamental analysts, but fundamentals aren't everything. You know, we pay attention to the technicals. And, um, you know, Nolan, I'd like to have you talk a little bit more about fundamentals versus technicals in the context of a multi-factor investment approach? And then kind of that being said, is cash the safest place right now, uh, or something else?

Um, so we do have cash and elevated levels of cash in all our portfolios. And full disclosure, we've had more cash than we've had in a very long time, probably going back to COVID even. Um, and it's not that we're bearish It's just that we really want to get our handle on not only what's working today, but what's likely to be working in the future. And, uh, our lens is very foggy right now. Um, so let's go back to fundamentals. When we talk about fundamentals, we're just talking about how a business is doing, the sales that they're reporting. Is the balance sheet healthy? Do they not have a lot of debt? Do they have earnings? Do they have free cash flow? How are they positioned competitively? Those things aren't so difficult. You know, we're in the middle of earnings season, so companies tell us how they're doing, and we can get a good fundamental read on it. The issue becomes, you know, if a company has X amount of earnings, what we pay for those earnings, or if they have X amount of sales, what we pay for those sales, or what we pay for those free cash flow. Interest rates are really important because that's the driver of what those shares are worth given interest rates. And as we all know, the Federal Reserve Board has telegraphed a very aggressive path of interest rate increases, and that really has acted as a headwind on all stocks, but especially growth stocks where you expect the earnings and cash flow to accrue years in the future versus quote-unquote value stocks that pay dividends where you get the cash flows today. And so that's why the former group have been hit harder than the latter group. So that would be the fundamental part. The technical part is, hey, I may love a business. I may be confident it's going to earn $1 or $2 per share this year. But if I look up and I think those shares at $2 in earnings should trade at a 10x PE or $20 a share, Next thing I'm going to do is take a look at a stock chart to see, you know, the pattern of the share price. Has it been stagnant? Has it been moving upward? Has it been moving downward? And I'm going to look and see what the recent price action has been. And that's what we call technicals. If it looks like the business is getting better but the share price is getting worse, it could be a good opportunity Or it could be a setup or a trap. And so we need to go in and investigate why. So that would be the difference between the two.

Yeah, just to break it down into kind of some common terms is, you know, we talk about that term catching a falling knife. Technicals help us to try to keep away from that catching a falling knife of, well, we think this business is worth X, you know, it's trading at a price below that. But, you know, it's falling hard. We try to avoid those situations and we'd rather buy a stock that's on its way up. That's kind of what we mean by technicals. All right. We'll move to the second topic. So, Nolan, topic 2 is earnings. We've been right in the midst of earnings season for it seems like a month now. My general takeaway from earnings has been that if a company does well, you know, maybe the stock will go up a couple of points. but nothing too amazing. And a lot of the times the up move that you see after earnings will go away after a few days. Um, Lowe's is a good example of that. We'll show that on the chart, uh, show that chart up on the screen here. And then, um, an example of the opposite, bad news being punished severely. And, um, we'll use Lowe's competitor Home Depot as an example of that. We saw this week, um, just absolutely brutalized after earnings. You know, they did pretty well, but, you know, the market's looking for any bad news to sell off any business like that. So a lot of other earnings releases this week, like CoStar Group, TDOC, Teladoc, Molson Coors, which is TAP, and also Macy's, letter M. What do you think? What are your takes on earnings and any earnings that jump out to you that are worth discussing?

Yeah, first I'd like to say that this is our favorite time of the season. It's like the, uh, March Madness for investment people. The earnings season, unlike March Madness, we get 4 times a year instead of once a year. And this is when companies come out and they report their last quarter, what the business conditions were like, how their businesses are doing, how they're positioning them for the future, and And so it's just a treasure trove of information. It's fantastic if you're an information junkie like we are. And we're in earnings season now. So it's an interesting dynamic. Typically when we're in earnings season, you see a lot of strength and you're sort of insulated for what's happening in the macro. We tend to call it micro versus macro. So if some company is doing extraordinarily well, Um, then they release earnings, and if they report earnings better than what the market expected, um, a traditional reaction would be the shares would go up or do very well. And the opposite, if a company's struggling and the market expected to do well, you would expect the share price reaction to be negative. And we would consider those normal market environments. And during earnings season, the market tends to be much stronger generally, um, because the companies that are reporting good earnings, you know, it tends to flow through their other related businesses, and investors focus on one thing, which is the business environment. It just so happens in this earnings season, there's all these outside influences that investors have to pay attention to, and how a company's doing is just one single input. And so it seems to be a bigger, broader emphasis on not just what that company's doing but what the Federal Reserve's doing, the pace of interest rates, the pace of inflation, um, what's happening overseas with the war. And so you get all these other impacts that influence stock prices outside of just how a business is doing. And so there's all of these cross-currents that we need to pay attention to. And it's very interesting, the dynamic that we've witnessed that you mentioned earlier, because we've had occasions where companies have come out with fantastic earnings, the stock moves up a lot like you would expect it to, and then within a short period of time, a few days or a week, all the gains have evaporated. We've seen that time and time again through this earnings season. So as it winds down, I think next week is the, uh, the last big week of earnings releases. We'll have to see if that pattern changes with today's market action.

And another quick thing I want to say on earnings, Nolan, or get your thoughts on, is, you know, a lot of the time we're in a sea of bad news. Earnings is kind of the, the positive catalyst that we see. Um, we didn't really see that play out this quarter. So what, what are your thoughts after earnings? Um, without the earnings catalyst or without any possibility for really positive news, you know, how do you expect things to go? Um, you know, in the month after earnings.

That's a really good point. You know, there's been all this discussion: are we at peak earnings and are we at peak margins? And for the listeners, it just means, you know, the S&P index— you often hear people talk about it's expensive, or stocks are cheap, or they're expensive. And basically what they're doing is taking a look at the aggregate earnings for the S&P 500, or companies in the index, and then you put a multiple on them. So as an example, if the aggregate earnings are 200 and we put a 10 multiple on it, you would expect the S&P index to be 2,000 or something. And if earnings go down and the multiple holds, you would expect stocks to go down. There's all this talk about, hey, have we seen the best in earnings? And if that's the temporary top on earnings, should we be paying— still paying a premium if they're no longer going up? And one of the factors, if you're one of these people in the camp that think we have peak earnings, one of the reasons they say that is, have we reached peak margins? Meaning the profitability per dollar of earnings from these corporations. And if you assume inflation, that means companies have to go out and have a cost of goods sold. If their cost of goods sold go up, meaning their input costs, energy, plastic, labor, whatever those things are, are eating up a bigger share of that dollar, And that means our earnings have to fall if the margins have peaked. I don't know that we're there, but certainly there's talk that we may be at peak earnings and that we may be at peak margins. And the reason that I mentioned that, Brian, you mentioned earnings season. And if earnings season is over, what do we expect after earnings season? Well, the analysts will go back, at least the Wall Street type that follow the S&P as a general rule, and they'll update what their estimates are or forward earnings. A lot of people will price off of that. But once you're past earnings season, then it's really no more focus on fundamentals. Now you're at the whims of other things. What do we expect the Federal Reserve to do with interest rates? Hey, if we get a big CPI, consumer price print, and that gets priced into the market where it looks like inflation is heading up and the Federal Reserve, or hey, may have to be more aggressive on interest rate hikes, then people will discount stocks a lot more harshly. So inflation, interest rates, and then these other macro concerns. And again, macro— macroeconomics is things that are outside of this little small micro sphere. So anything outside of what a company's doing as far as their sales growth and earnings, these other outside factors we consider macroeconomic— oil prices, inflation, political uncertainty, all of these things. Once you're past earnings season, those have a lot greater impact on stock prices than when you're in earnings season.

Okay, Nolan, that's really helpful. Let's move to topic 3. So topic 3 is a simple question: what should we do next? So a couple of things here, Nolan. The first is, it seems like from reading earnings from reading the reactions to earnings, it seems like free cash flow is really what investors are looking for over anything else. So that means we're looking at companies that are in sort of the energy space, materials, and a few others. And we're also looking at making our shopping list. So, Nolan, your thoughts on cash flow and also your shopping list.

Yeah, so as I mentioned, I absolutely, as you do, Brian, and everybody in our shop, love earnings season, um, because the best businesses separate themselves from the also-rans— motorboats versus sailboats, if you will. And it's interesting because when the, the motorboats report that business is getting better and they have catalysts and things are going well and the stock reaction is muted or negative, uh, that's very interesting because that just means that business got cheaper. And a couple takeaways for me during earnings season this year is there are some businesses that are still doing extraordinarily well. And what we, we are developing a shopping list here, or a short list of the absolute best businesses where the momentum to the upside is still very strong, where you do have accelerating free cash flow, where you have catalysts in their businesses, um, they can just sort of sail through and do very well. And then you have other businesses which have really belly-flopped, uh, on earnings, and those are the ones we, we certainly want to move away from. But yes, the takeaway for me is there are some wonderful businesses that are still doing well. Well, really what um, really just has me shaking my head is the unbelievable, unbelievable amount of cash that these energy businesses are generating. Uh, I have never seen— it's been a long time since you've seen numbers like this. You'd almost have to go back to 2008 when oil prices were over $140 a barrel to see energy companies gushing this type of cash flow. And back then, obviously, they were plowing all that cash flow back into drilling more wells. And that was at $140 a barrel. So in this reporting season, you know, the average earning— the average oil prices last quarter were probably somewhere in the $70s or $80s that these companies realized. And the cash flow in most cases are that or higher than where they were at $140. And that just tells you how much more profitable these energy companies are. And you're starting to— they have discipline now. So you're starting to hear CEOs —en masse, almost every one of them—pay off debt. So you have very low leverage levels where they were criticized before for taking on this debt to pump. Now they're just paying off debt. You're seeing very low leverage, like less than 2 times, in a lot of cases less than 1 times, which means these companies, what used to be high-yield issuers, are now investment grade. And with the excess cash flow, they're buying back stock, an unbelievable amount. And increasing dividends. And we've seen a lot of these energy companies have yields approaching 10%. So that really stands out to me in my mind.

Yeah, for, for me in energy, it's the growth in dividends. It's the fact that these companies are buying back stock, paying off debt. Um, all of— all three of these are positive for shareholders. So, um, we do like energy, and those are the reasons.

There's one more thing I will say about earnings. Hopefully we have time, and that is in the consumer discretionary space. We talk about energy a lot, but there's another category that, um, really surprised me. Actually, there's two, um, healthcare and consumer discretionary, but I want to stay on consumer discretionary now. For those who are, uh, really enlightened investors, the ETF is XLY. And if you look at consumer discretionary— discretionary spending or purchases are things that we don't— they're, they're not mandatory. We don't have to do them. So going shopping, going to the mall, buying a car, buying home furnishings, these are things that are considered to be consumer discretionary. And what surprises me is some names that are in consumer discretionary, which just haven't done well even though earnings have come out. So you mentioned Home Depot, but there's other companies like, you know, Costco, Target, Starbucks, a name that we followed for a long time, Bath Body Works, BBWI, and, um, Chipotle Group, CMG. Wonderful businesses, really good earnings. You would expect them, their sales and revenue, to hold up in almost any economic environment. And the fact they've reported earnings in most cases that have topped estimates, but the share price have sold off so much That has caught my attention. It's really a surprise.

Yeah, Nolan, we like to say the market's always right, but, uh, maybe not in this case. Um, so again, thanks, Nolan, uh, for your insights. We want to thank everyone for joining us. And again, we want to remind you we have the Jarvis newsletter that comes out every week. If you want to get that in your inbox on every Saturday morning, check the link down in the description below and we'll get that out to you. Uh, we also have our Left Brain Investment Research subscription service, um, where we put out our 8 to 10, uh, new analyst reports that we, that we use for our own business in order to make investment decisions. And, uh, before we end it out, we want to tell you to like, share, and subscribe. It helps everyone else find, uh, the video. So with that, we're going to say, uh, goodbye for this week. And, uh, thank you, Nolan.

Thank you, Brian, and happy trading.