CWS Market Review – December 28, 2021

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The Honey Badger Market

This continues to be the Honey Badger Market. It just doesn’t care. The stock market seems to effortlessly brush aside every problem standing in its way.

Highest inflation in 40 years? No problem.

Supply-chain issues? Move over.

Omicron? Please.

Higher and higher the market goes. Since October 4, the stock market has gained more than 11%. This looks to be one of the strongest quarters for the stock market in years.

Earlier today, the S&P 500 broke through 4,800. Although we closed down by a small bit today, the index is getting close to doubling from its March 2020 low. Who would have predicted that?!

Yesterday, the S&P 500 closed at its 69th record high this year. That’s nearly a record high for record highs. Only 1995 had more.

Not only that, but the Santa Claus Rally is off to its best start in 20 years.

There are lots of definitions for what the Santa Claus Rally entails, but if we say it’s the last week of December and the first two trading days of the new year, then the rally got off to a big start this year.

On Monday, the S&P 500 gained 1.4%. That’s the biggest start to the season in two decades. Every time the Santa Claus Rally has started with a gain of 1% or more, the whole period has been a positive one for the market.

By the way, the S&P 500 first broke 480 on January 31, 1994, nearly 28 years ago. That means that despite all the sturm und drang of the last 28 years, the stock market still rose tenfold, which comes to more than 8.5% per year—and that doesn’t include dividends.

Despite being the final week of trading for this year, this is a slow week for financial news. That will change next week with the December jobs report due out on January 7. There’s a decent chance that the unemployment rate will fall below 4%.

Soon after that, the Q4 earnings season will begin. That’s Judgment Day for Wall Street. Let’s take a closer look at what we can expect.

Preview of the Q4 Earnings Season

What’s the reason for the market’s bullishness? It’s not always so easy to divine the market’s thinking from its behavior. As we know, the market likes to be a bit of a drama queen. Still, I suspect that Wall Street is starting to feel that the upcoming Q4 earnings season will be a good one. After all, Q3 was pretty good.

Also, expectations for Q4 have improved markedly. That’s counter to the usual playbook. Typically, earnings estimates start out too high and are gradually pared back as earnings season approaches. They’re lowered just enough so Wall Street can beat expectations.

Ironically, it’s expected that your company beat expectations. If you merely meet expectations, well…no one saw that coming and your stock can get clobbered. The stock market is all about exceeding expectations.

Let’s look at some numbers. In early 2020, before Covid wrecked the economy, Wall Street had been expecting very good earnings for Q4 of 2021. Of course, it’s always a little sketchy to predict something that far in advance.

For Q4 2021, Wall Street was expecting the S&P 500 to report Q4 earnings of $49 per share. That’s the index-adjusted number (every one point is about $8.5 billion). As Covid set in, the number crunchers on Wall Street lowered their forecasts.

By the start of this year, Wall Street was expecting Q4 earnings of just $44 per share.

Since then, the news has been much better. It’s the twin effects of very diminished expectations and actually good earnings. The S&P 500 earned over $52 per share for both Q2 and Q3. That compares with less than $20 per share in Q1 of 2020. That was a scary time.

According to the latest figures, Wall Street now expects the S&P 500 to earn $50.45 per share for Q4 of 2021. If that’s right, that would be a remarkable turnaround in just a few months. Now you can see what has the stock market so excited. It’s not just fluff. Corporate earnings have improved by an impressive degree.

Here’s a look at the S&P 500 (red line, left scale) and its earnings (black line, right scale. The two lines are scaled and a ratio of 20 to 1. That means whenever the lines cross, the market’s P/E ratio is exactly 20.

Assuming Wall Street’s Q4 estimate is correct (and it’s probably pretty close), then the S&P 500 will have earned $202 per share for this year. For 2022, Wall Street forecasts earnings of $220 per share. That means the S&P 500 is going for 21.7 times earnings. The earnings yield, which is the inverse of the P/E Ratio, is 4.6%.

While that’s certainly low, it’s not out of line when you compare it with the 10-year Treasury which is currently yielding around 1.5%. In other words, the stock market has run up a lot, but there’s been good reason for it. I wouldn’t be so quick to call this a speculative bubble. It’s probably closer to saying that the fear bubble from last year has popped.

Here’s a brief aside. Look at this headline from CNBC:

How would you interpret the news? I would assume that it means that home prices rose 18.4% for the month of October. Right? But that’s not what happened.

Instead, home prices rose 18.4% in the 12 months ending in October. Maybe I’m being pedantic, but that’s quite a big difference between headline and payoff.

Closer Look at Trex

Jack Bogle once said that “reversion to the mean is the iron rule of financial markets.” One exception to that may be Trex (TREX). We added it to our Buy List last year and it was our top-performing stock. During 2020, shares of Trex gained more than 86%.

Instead of reverting to the mean, Trex is having another stellar year, and it looks to repeat as our top-performing stock with a YTD gain of 61%.

If you’re not familiar with Trex, the company is a major maker of wood-alternative decking and railing. In my opinion, what they make looks a lot like wood, but it’s cheaper and involves a lot less maintenance.

Trex is also better for the environment. Pressure-treated wood still dominates which means there’s plenty of room for Trex to grow. It’s also nice to know that with Trex, you don’t have to take another tree out of the Amazon rainforest to make your backyard deck.

Check out their products at their homepage (www.trex.com), and you’ll see why Trex has become so popular.

One of the reasons why I like Trex is their commitment to sustainability. Trex is made from 95% recycled material. Every year, the company effectively takes 500 tons of plastic out of landfills and uses it for alternative wood. It’s not just good for the planet, but it’s smart business.

Trex takes all those used bags and bottles and combines them with recycled sawdust from cabinet and furniture manufacturers – and that’s what Trex is made of. By the way, this also saves a lot of water.

Some other key advantages are that Trex weighs less than wood and is also more resistant to mold and insects. You don’t need expensive staining or sanding, and repairs are much less frequent.

You’ll often hear people say that Trex looks fake. I think that used to be true, but it’s much less the case today. Commercial railing is another big business for Trex. Their railings are especially common at stadiums and arenas across North America.

Trex is sold in 40 different countries and at over 6,700 retailers. The company IPO’d 20 years ago, and it’s been a big winner for shareholders. I don’t think we’re anywhere near the end of this story.

Now let’s look at some numbers. Trex will probably do about $1.2 billion in business for 2021. I think that can rise to $1.4 billion, give or take, in 2022.

For earnings, last year Trex made $1.55 per share. When the final numbers are in for 2021, Trex will have probably made about $2.10 per share. But for 2022, I think Trex can make as much as $2.60 per share. That’s an optimistic forecast, but it’s possible.

Last month, Trex reported Q3 earnings of 64 cents per share. That was six cents higher than expectations and 73% higher than a year ago. Quarterly sales rose 45% to $336 million.

I’ve been impressed by the way Trex is managing itself. On one hand, the company faces higher prices for raw materials and higher labor costs. Trex was able to expand its gross margins by 150 basis points last quarter. Some of these comparisons are distorted because last year was so unusual. The important fact is that Trex has been able to pass along higher prices without damaging sales. There will be more price increases in 2022.

Here’s an interesting stat. On the earnings call, management said that composites have been gaining market share at the rate of 1% each year. Now that’s accelerated to 2%.

Trex said it sees Q4 revenue of $295 million to $305 million. The midpoint is up 31% from last year’s Q4. The company also expects “strong double-digit revenue gains” next year. Trex plans to open a new manufacturing facility on 300 acres in Little Rock, Arkansas.

I like that Trex can maintain an operating profit margin near 25%. That’s very impressive. Also, Trex has a solid balance sheet and doesn’t carry a dime in long-term debt. The price isn’t dirt cheap but there’s a lot of potential for Trex.

That’s all for now. I want to wish everyone a happy and healthy New Year. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

P.S. Don’t forget to check out our ETF.

Posted by on December 28th, 2021 at 7:49 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.