Market Responds: Something New or Just a Head Fake? June 24, 2022 Jarvis Update

The market got up off the mat this week. Is it the start of something new or just another head fake? We answer that 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, Nolan Langford. Nolan, welcome to the program.

Thank you, Brian.

Excited to get started. It's been a better week after we had a little bit of a, a long losing streak in the markets. We're here on better circumstances. Markets had a good week buoyed by lower rates and a a few other topics which we'll get into this week. The 3 topics we're going to cover, as we usually do. The first is, is energy an opportunity? Second is, are we looking at a turnaround in growth? And third, the 2022 losers are leading. Before that, we got a couple of announcements for you. First of all, we've got our new report from Garvit Mandari this week for subscribers on an oil company that just emerged from bankruptcy and is showing signs of strength. and it's also an off week for the newsletter. But of course, if you wanna receive the newsletter and all of our other content in your inbox every Saturday, make sure you get on the mailing list and we'll put all those details in the description below. With that, we'll jump into our market recap. As I mentioned before, we actually had a positive week in the markets. S&P was up around 3.5%. NASDAQ led the way 5.5%, and the Russell was up 3.8%. That's the small cap index. Interest rates are starting finally to come down. I'll put a chart up of, of the 10-year. They topped out around 3.5% a couple of weeks ago, but they've been moving down slowly since. And that's certainly a positive sign for a lot of market participants. I would also mention the VIX is still near 30, so certainly can't say it's an all clear. There's a lot of volatility still in the market. So with all that, Nolan, what are your general thoughts on what we've seen this week?

I'm going to say confusion still reigns. You know, the markets never go straight down, nor do they go straight up. It's nice to see some buying come into the market this week. The recent winners have been recent losers, and the recent losers are now recent winners. And that's why I say there's a little bit of confusion. We're coming up on earnings season here in the next couple of weeks, and we'll, and we'll know more. It's good to see gains, uh, on the board. Certainly we question it a little bit. Bitcoin's been in the news a lot for not good reasons, and some of the riskier stocks are some of the ones that are leading on the way up. I know the interest rates you mentioned were 3.5% some time ago, and the TLT, which is the long bond, has been showing strength. I think that's what's driving a lot of these growthier or higher-valued stocks that have been punished earlier in the year. They're starting to get a reprieve on valuation. The reason I say it's confusing— interest rates have been going down, not because we sense that there's anything fundamentally changing. It's fundamentally changing for the worse, meaning I think the market's starting to price in, hey, all of these interest rate increases that the Fed's been plotting, they're going to plot them right into a weaker economy, and therefore they may not be able to put as many interest rate increases through as possible. So the market's starting to price in a softer economy, i.e., a recession.

Sure, folks might be buying bonds because yields look attractive here and they're expecting a slowdown. So, um, definitely something to keep in mind. We'll jump right into our first topic. So topic 1 is energy. Is the pullback an opportunity? Energy stocks have dropped more than 20% in the last 2 weeks. This is the only sector of the S&P 500 that's been up for the year. So, uh, it's been a refuge for a lot of investors. Um, but that certainly hasn't worked the last couple of weeks. Fundamentally, there's a lot to like here. Cash flow from the businesses. You know, we certainly think supply-demand conditions are in the favor of oil companies, and they're also starting to buy back stock. So Nolan, obviously we've seen these stocks pull back. Significantly over the last 2 or 3 weeks. A lot of people are still underinvested in energy. Is this the time to get— for those people to get started as an opportunity? Are we, are we starting to see the beginning of a collapse here?

It's gonna be— I think it's gonna be hard to have a collapse when the fundamentals are so strong. You know, these businesses, you know, we'd mentioned before earlier in the year, they had gone up, but it wasn't because people were willing to pay more for them. Price increases only match the increases in earnings expectations. You get no multiple expansion for these stocks. So a little bit a head-scratcher that they're selling off so hard. You know, most of these companies in the energy space, anything over $70 or $80 a barrel, these companies are wildly profitable. In most cases, you're looking at very clean balance sheets. They've learned their lessons from the last 2 or 3 oil crashes. And it's just a very healthy, healthy sector of the market. For energy investors, you know, you're always going to have some cyclicality in that sector because oil prices move around a lot. Probably wasn't so helpful, the Russia-Ukraine thing, because oil prices would have been up this year even if Russia hadn't invaded Ukraine. I think that you got an oil spike and then maybe you had a perfect situation here in the last couple of weeks for oil to come down. One, prices are a little bit softer, but the big one is the focus from Washington. They're putting forth some proposals hoping to bring these gas and oil prices down. I think a lot of industry participants, us included, are very doubtful that they amount to much, but I think it's just the investor psychology. And then the other thing is they've gone up so much, it looks like you're starting to see some sort of rotation. I wonder if investors are selling energy, this year's winners, and rotating into the biggest losers, uh, with that catch-up trade. We'll see how, how things shake out. Remember, in the end, fundamentals always move stock prices.

Absolutely, Nolan. I think I think that's a perfect segue into our second topic. So topic 2 is, is the question is, is this a beginning of a turnaround in growth? As Nolan, you alluded to, uh, we are seeing a bit of rotation in, in from, uh, oil stocks and gas stocks to the more growthy type of names. I mean, it's hard to tell if it's a one-for-one, but a few data points that we wanted to share with you. The first is biotech is beginning to break out over the last 2 weeks as oil continues to fall. Among our best performing ETFs in the list that we follow, XBI, which is the biotech index, IPO, which is an index of recent IPOs. You got ARKK, which is sort of the poster child for growth stocks, especially in the smaller cap realm. You got TAN, which is a solar ETF, and then KWEB, which covers China internet and other tech. So Nolan, are we seeing the beginning of a turnaround in growth here, or is this just another bear market phenomenon?

I don't think we're going to know definitively for some time. I think it is encouraging that you mentioned some of these risk measurements that we follow actually do very well. Uh, the XBI, which is the biotech index, uh, IGV, which is the software index. And I don't think it's a coincidence that they're doing well at the same time interest rates are really starting to back down a little bit. Remember earlier this year that there was a sort of a valuation correction. When interest rates are low, people are willing to pay more for businesses, but When interest rates rise, you get this multiple compression, particularly when a lot of these growth stocks aren't showing profits today. They're taking cash flow, funding their business, expanding it in hopes that the profits will come later. So that's a long-duration investment, and when interest rates rise, those are most negatively impacted. So I think that's one of the things that, uh, that's sort of mechanical. Interest rates are down now, so you can get valuations back up. I don't know from a fundamental standpoint, you know, most of these businesses, at least in the software sector, just the sector alone, you haven't seen their businesses do less well in this environment. And as you and I alluded to earlier, you know, people talk about inflation, it's a problem. And one of the ways you fight inflation is productivity. And there's very few other factors that drive productivity more than software. Not all growth has really participated. The semiconductors have still been, um, still been somewhat weak. So I think there's more of a demand issue and a supply chain issue that still impacts that sector. But let's hope we can build on these gains.

It's interesting what you mentioned about productivity. I think, I think that's the thesis, um, behind Cathie Wood at ARK. A lot of the A lot of the investments they make over there are talking about how tech technology is one of the more deflationary forces in the economy. Obviously, given the inflationary environment we're in, I think that's some, you know, that's a way that a lot of businesses are going to try to combat that inflation. So with that, we'll move to topic 3. So topic 3 is the losers are leading. We're talking about the 2022 laggard so far actually had a pretty strong week this week. What we noticed was that small-cap growth has led the charge this week. Quite a few names are up over 10% for the week. So, uh, pretty sharp rally in a number of these names. I've also seen some strength in large and mega-cap stocks like Microsoft, Adobe, Apple, and a number of other large and mega-cap stocks, but it hasn't been quite as strong and quite as sharp as what we've seen in the small caps. Nolan, what do you make of the fact that small-cap and the most downtrodden stocks are the ones leading this week? And is it something that you expect to keep happening, or are you tempering your enthusiasm there?

Yeah, so we still have some caution on, and we also know that we're in a time of declining liquidity, so it could just be a liquidity issue. And again, more mechanics that are at play because we haven't seen an increase in earnings estimates at all. As a matter of fact, we've seen the opposite. We're getting ready to head to earnings season, and so you'll start to hear the earnings confessional where companies come out and start to guide lower. And then you'll see the analysts start to chop expectations moving forward. So we won't know for a while. It's good to see prices that are up. I mean, certainly we don't want to see the market belly flopping and nosediving, you know, for weeks on end. And I think it was noted, you know, we've had I don't know how many consecutive down weeks. And so you figure as a reflex, at some point we're going to get some buying. It's uncertain. I would expect when a bottom is finally in, those will be the stocks that will probably start to turn around. If it was just interest rate driven, if interest rates settle down and stop going up, it does make sense that those stocks that have been most negatively impacted would see the most relief. So, it's still too early to tell. It's nice to see that prices are up, especially for some, you know, we've noted some businesses that we follow that are really high-quality businesses. The other thing you mentioned earlier about the mega caps, not all of them have participated equally. And we were talking about valuations. We've gone and looked at, you know, at least in the case of Meta, and there's probably other ones that we've looked at, you can go back and the prices have reverted to where they were 4 to 5 years ago. So they've erased all of those gains. And some of these stocks that we consider growth are actually now value if you look at PE ratios and traditional measurements of what's a value stock. As we go forward, it'll be interesting to see what leadership looks like, who has the baton of leadership, and where investors go first.

All right, before I ask you the last question, Nolan, um, just want to remind everyone, please like and share the video if you found it useful, uh, subscribe to get notifications when you get— when the next video comes out, and of course leave a comment. We'd love to engage with any thoughts that you might have about the market, ask, answer any questions. Um, so finally, Nolan, we talked a little bit about small-cap growth. I wanted to call out a name that you've been talking about for the last few weeks. That's Pure Storage, PSTG. We'll throw the chart up for the viewers here. So, Nolan, I think this is the type of growth business that we prefer. Can you just talk about, um, talk a little bit about what, what we like here?

This is a business, for those that don't know, Pure Storage operates in this, in the storage space. I think people understand the amount of data that we're producing. Things are digital, things are online, and the cost to, to produce or do computing is, you know, it's almost zero. So that means there's more data that's out there, whether it's pictures, whether it's videos, whether it's corporate files. And because they're digital, they all need to be stored someplace. And Pure Storage is a business that allows companies to, to be able to store all of that data. They make something called a flash array. So it used to be that digital images or whatever you were producing were stored on hard drives, hard disk drives. But Pure Storage has something called a flash storage array. It makes the retrieval quicker, makes it easier. And this is the storage produced for the cloud. It used to be if you were on-premises, things were stored on a hard disk drive. But now that most of this data comes via the internet, You need a new method of doing it, and Pure Storage has that. They're in the right space at the right time. They have the newer technology. They have a big agreement with Meta with some of the AI and other things that they're producing, which is, you know, the amount of data is just exploding. The growth rates are high. They're double-digit growth rates. They're organic. The market cap is very digestible. It's a mid-cap stock, for those listeners who aren't aware. We consider mid-cap stocks anything generally north of $3 billion. It's not a large company yet, but it's outgrown being small. Healthy balance sheet, no debt. So, organic double-digit grower. And the stock price is very reasonable. It's about a 20 times forward PE. They have a positive earnings stream, but they have positive cash flow. And they've just instituted, I believe it was a $100 million share buyback. So there's a really, uh, there's a lot to like in this business.

I think I wanted to bring this one up, Nolan, just because I thought it was a good kind of a poster child for what we're looking for, uh, when we start picking into some of these tech stocks that have been downtrodden. It's, it's, uh, reasonable, reasonable valuations. It's cash flows. It's, it's positive earnings. I think Pure Storage kind of fits the bill in a number of those, uh, in the number of those areas. So we'll close it out here. Um, again, we talked about energy. Is it an opportunity? And we also discussed a little bit of a turnaround happening in growth, or beginning to start. So Nolan, thank you for being with us. We want to thank the audience, and we'll see you again next week.