Markets Come Roaring Back as Inflation Slows: Jarvis® Update November 11, 2022

Markets came roaring back as inflation shows signs of plateauing. We cover this 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, Nolan Langford. Nolan, welcome to the program.

Thank you, Brian. And I would just say Happy Veterans Day to all the veterans out there, to my dad, who's a veteran. My girlfriend, and all the veterans that are out there on the front line keeping us all safe.

Very much so, Nolan. I second that emotion. We'll jump right into our preview. Markets had a significant move higher this week, all coming in Thursday's session. We've got two topics for you as we usually do. The first is a changing inflation picture, and then topic number two is going to be blowup in crypto. What are the alternatives? Before we get started, we got a couple of announcements for you. First of all, we produce this show for you, the everyday investor, where you've— whether you've got a 401k or an IRA, if you handle your own investments, or if you work with an outside advisor, we'd love to be a resource for you and provide a second opinion. In a volatile market, we want to help you position yourself for a potential market recovery. We'd love to talk. Make sure you give us a call on the number below. Also, if you're an institutional investor, we've got something for you as well, and that's our research service, Left Brain Investment Research. We put out 5 to 10 full-length stock reports per month from our investment analyst team. And also The Chosen. That's our favorite bond and favorite stock opportunity each month. And also for premium subscribers, you get access to our model portfolio. So click the link below if you want to learn how to subscribe and get access to our library of hundreds of reports. Either way, we'd love to have you sign up for a biweekly newsletter that's on this week. We'll be out with our thoughts and our analysis of the market this week. And also, if you want to get on the mailing list to receive that in your inbox every Saturday morning, Make sure you click the link below. Finally, we always ask you to like and share the video if you find the content useful, and also subscribe and hit the bell for notifications. It'll let you know when the next video is out, and we're out every Friday morning with these. And we have one last announcement for you, and that's our free Zoom webinar that's going to be on Thursday, November 17th at 4 PM Central. We're going to be talking income securities and also end-of-year portfolio management strategies. Put the link in this— in the description below. We'd love to have you with us. And talking stocks and bonds, as we always do, we'll see you on the 17th. We'll jump right into our market recap. The S&P 500 was up 6.3% this week. The NASDAQ was up 7.5%, and the Russell 2000, that's the small-cap index, was up nearly 5%. So it was a major reversal from last week. Most of those moves came on Thursday, of course. CPI, that's the Consumer Price Index, that's a measure of inflation, came in much more benign this week than was expected. We had year-over-year inflation of 7.7%, which sounds insane already on its own, but actually came in below expectations of 7.9%. And then we had month-on-month inflation of 0.4%, but we were expecting 5 to 6 tenths of a percent. So again, very positive news. S&P 500 was up more than 5% on Thursday, a huge day in the markets. NASDAQ up more than 7%. Nolan and I were chatting here a minute ago. We don't remember a day like that in the NASDAQ. So pretty impressive move. And then also the 10-year Treasury, which we've been watching everything in the fixed income space prices off of this, off of this bond that dropped down to 3.82% today. We've been above 4% for some time the last few months. Nolan, what are your initial impressions on the CPI data and also that market reversal?

As you mentioned, it was a strong move. It was powerful. We've been saying here for weeks on this show that things change quickly and that can change at any moment. You know, hey, we have been seeing the data become softer and softer as it relates to these inflation numbers, and it was just a matter of time. The market's interpreting that the Fed is probably going to cool it for some time, and I would agree with them.

We'll jump right into topic 1. So topic 1 is a changing inflation picture. Of course, inflation has been the driver of pretty much everything this, this year. It's been a tough year in 2022 in the markets, and it has a lot to do with inflation and interest rates. We are still receiving quite a few earnings reports. We're still in earnings season, but really inflation data dominated everything in this week's trading. Nolan, I guess a simple question is, can we say we've hit peak inflation? And if so, what does that mean for investors?

I think at least temporarily we can say we've hit peak inflation. Of course, you know, going back this year, we've had several of these occasions where it looked like inflation had rolled over only to become— come roaring back. That's part of one of the reasons that we've seen so much volatility. But I'm going to go out on a limb and say this time is different. Oh, boy. I think so. Only because the last several months we've been seeing data points that shows us that the numbers should be getting lower. You know, housing has really topped off. We've seen car prices come down, steel prices, lumber. No matter where you look, it seems that these prices are coming down. It was only a matter of time before it flows through the official data.

Very much so, Nolan. We know there's a lag in some of this data. It does take some time to come through. Good to see one good month of inflation data, but we'll have to see next month if it continues. We also see a number of other tailwinds emerging, Nolan, and that includes low expectations for corporate earnings. Rates are close to topping out. We have potential peace talks in Ukraine. Some of those rumors are starting to bubble up. China is potentially reopening. We're crossing our fingers. We've heard that a number of times, but That's on the horizon. And then of course, high yield bond deals, that it's been difficult for a lot of companies to access capital markets and get bond deals done, but that's starting to thaw a bit. What among all that stands out to you, Nolan? And how are you thinking about it from the long-term investment point of view?

I think all those are positive potential catalysts to come along and help investors. And there's two others that you didn't mention. One of them we're gonna talk about later, which was the blowup in Bitcoin. So if you take a look at competition for dollars that could go to stock, that comes off the board. And then the other one is just earnings expectations. I think these companies, as we've seen earnings get reported, there's been a lot of companies, whether you've made or whether you missed, but earnings expectations have been set sufficiently low, particularly as we head to 2023. So I wouldn't be surprised to see a lot of beaten raises when we get to 2023, and that's another potential catalyst.

All right, to that point, let's talk a little bit about earnings. Uh, we're not going to let a week in earnings season go by talk earnings. So I got a couple of names for you that we can discuss. The first is Axon, ticker AXON. Can you tell us a little bit about what we, uh, what we read in the earnings call?

So for those that don't know, Axon used to go by the name of Tasers. They created the stun gun, but then they developed a whole suite of tools for police departments, military usage. Basically, anytime you see camera footage from an officer, it comes from Axon. So they make their own officers' cameras, and then police department can wirelessly stream that evidence footage back for retrieval during court cases. And so it's developed more from a hardware player to a full-service suite of services for police departments. And a lot of that is software. Software comes with higher margins. You're starting to see more recurring revenue show up as well. It used to be just product cycles drove revenue, and now they get it because they price it as a bundle per month. And you saw that come through with earnings yesterday, which were just fantastic earnings, free cash flow, more recurring revenue, and margins are expanding. So it was a really positive report from Axon.

All right, Nolan, thanks for telling us about Axon. That's one of our favorite Let's talk about another one of our favorites. That's EPAM Systems, ticker EPAM. What do we hear from them this week?

Uh, anybody has, uh, watched our recordings for any length of time, this is the name that we've mentioned for quite some time. It is a company that we definitely have a man crush on. EPAM's involved in digital transformations. So as companies try to get digitally native to connect with customers no matter where they are, EPAM is the company that they generally go to for help. So they have a software and engineering platform that will allow companies to digitally transform their business. About EPAM that made them interesting, the founder himself is a Ukrainian citizen, though he's been in the US for a couple of decades. About a third of their workforce is located in the war zone between Ukraine and Eastern Russia. And so earlier this year in March, when those Russian tanks landed on Ukrainian soil, those shares dropped about 40% in a matter of a couple of days. And that's when we really dusted off the numbers to take a deeper look at this business. It's very durable. And even though they have workforce there, their customers are in Eastern Europe. And so they have workforces strewn throughout the country and still be able to deliver projects to clients and customers on time. Yeah, so business there was not impacted by the war. It's a terrible humanitarian issue. But from a workflow and a business standpoint, business went on unabated. So they reported earnings this morning, which were great. The headlines, we're looking at revenues that are up 29% with the currency headwind. Incorporate the currency headwinds, about 24%. Earnings were up 30%, beat expectations. They generated about $285 million in free cash flow. Cash positive, about a billion and a half on the balance sheet with no debt. This is a company that's firing on all cylinders and they have not been impacted by, uh, by macro very much or what's happening in technology in general.

EPAM is a textbook opportunity, uh, where the business stayed strong but some external event made the stock price go lower. We love those situations. EPAM certainly is one of them. With that, we'll move on to topic 2. So topic 2 is crypto blows up, what are some alternatives? So we watched in astonishment, amazement, and horror this week as we witnessed the blowup of an enormous crypto exchange over at FTX. Sam Bankman-Fried His company was lending customer funds to the hedge fund he controls to make risky bets on alternative coins in the crypto space. It all came crashing down this week as a deal to— for Binance to bail out FTX fell through. Looks like one of your classic fraud situations here. Very sad for anyone who has funds at FTX. We feel for them. However, we have been consistent with our view crypto is wildly speculative and risky. This is one of the type of risks that you're dealing with— counterparty risk. It is a problem. It continues to be a problem. It will continue to be a problem. First of all, no one— do you have any comments on this week's events in the cryptocurrency space?

In our world, which we operate in a regulated world where we do publicly traded securities, we will tell clients even if we're doing something that we quote unquote call a little risky, like if it's a small cap stock or a non-US-based company that trades on a US exchange. One of the things that we have been known for historically is high yield bonds, and we just have to tell clients those are risky. Uh, they're out there on the risk-reward curve, so we have to do things to sort of balance them. Nothing like crypto. Nothing like crypto. I think this reminds investors what speculative means. There's not a lot backing it. You could lose all of your money. And especially in the case of crypto, you know, it's not just us. I bet you a couple million advisors in the country were getting the same inbound queries over the last few years. Crypto, crypto, crypto. Hopefully this will put those calls to rest. It is very speculative. It's being exposed as such. Hopefully for those investors in crypto, they did not quote unquote go all in. My goodness, we're going to hear and see the repercussions from this crypto blowup for, for a very long time.

And it's just a terrible story. We hate to see investors losing money in any kind of way like this. Really shouldn't happen. That's why you want to make sure that you're— when you're investing, you're investing with regulated entities in regulated markets. At the same time, Nolan, we understand there's investors out there, they want to get access to speculative investments in some way, shape, or form. We get it. There's always a place in a portfolio for some level of speculation depending on your risk tolerance. If you're one of those speculative investors, Nolan, maybe that was drawn to a crypto or a Bitcoin or something along those lines. What's a better approach? What's the type of security that we think makes more sense?

Yeah, I think there's maybe a couple of reasons if you were investing in crypto that you did. One of them was that you didn't know much about it, you just knew the price was going up a lot and you didn't want to miss out, so FOMO. And I guess the other people were trying to make some sort of statement. They didn't want to be part of the institution, so they were anti-institution, and they wanted to be a part of this revolution of Mavericks, this currency that nobody knew about, and they could take it offline and do things and not be beholden to a central bank. If you're in the first group where you wanted to have an attraction to something that had a lot of upside to it. Now might be a good time to take a look at stocks. You know, a lot of stocks are down a lot, 70, 80% from their highs, and some of those companies are still good companies. Maybe they were newer companies, maybe they were still losing money, but they had a really good product or service. They just needed a while before the revenue sort of caught up with the expenses so they could start earning cash. It's a really good time to roll up your sleeves and take a look at them. A lot of these companies fall into the small cap category now. They could have been large caps, but fell a lot. We follow a lot of them on our research service, Left Right Investment Research, and we're rolling up our sleeves now. We have our analysts going through looking at a lot of these names. Again, some businesses haven't missed a beat from revenues and earnings even after everything that's happened economically in the last 2 years. The only thing that's got— that's changed is the stock price. And so there is an opportunity to, to double, or if not more, if you buy right and hold on. Timing is good for opportunists.

Absolutely, Nolan. We continue to dig through the small and mid-cap space. We've got more than a handful of those stocks that we actually like. If you want to learn more about those stocks and how they might be a fit for your portfolio and have a discussion, definitely get in touch with us. We'd be happy to talk more about small and mid-cap stocks. There's a lot of opportunity there. All right, Nolan, we're going to call it to a close. Any final thoughts for investors as we bid them adieu this week? You did—

we didn't mention travel this week, but travel has been really, really strong. Royal Caribbean, the big cruise line operator, reported today really good earnings. Capacity is at 96%. They actually had positive adjusted EBITDA and positive earnings per share, and they have bonds that still trade at over a 10% yield to maturity. So I think those are very attractive and it's something that we'll be looking at and possibly highlighting on this week's Zoom.

Thanks very much, Nolan. We'd love to see you on next Thursday's Zoom. Again, November 17th, 4 PM. We're going to be talking income securities and end of year portfolio planning. So with that, we'll say thank you to Nolan and thank you to the viewers for being with us, and we'll see you again next week.