CWS Market Review – November 8, 2022

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Some Cautious Reasons for Optimism

For the first time in a long time, I would call myself an optimist on the stock market. Not that we’re out of the woods just yet, but I sense that the recent selling pressure is overdone.

The market has already thrown several false rallies our way, but the current uptrend may last. The S&P 500 is already up close to 10% since its intra-day low from October 13. The index is also above its 50-day moving average (the blue line in the chart below) which has often been an omen for good returns. Interestingly, the market has historically made several important lows during October.

I don’t want to overstate the case. Of course, we should always be prudent, but there are concrete reasons to be optimistic. For example, the Federal Reserve is probably getting near the end of its rate hikes. In fact, I think rates may be held steady for most of 2023.

Also, the stock market is reasonably priced. It’s been a good thing for disciplined investors to see so many “lockdown darlings” get punished harshly this year. From peak to trough, Peloton lost more than 96% of its value. Stocks like Facebook and Netflix have also been hammered.

Meanwhile, to take an example from our Buy List, Silgan Holdings (SLGN), just hit a new 52-week high. Silgan is going for about 12 times next year’s earnings. The shares are quietly up more than 15% this year. It seems like the more attention a stock usually gets in the media, the worse it’s done this year.

While I think the economy will be in a recession next year, it will probably be a shallow one. Inflation is still a serious problem, but it finally has the attention of people who were quick to dismiss it.

We don’t have all the numbers in yet, but it looks like the S&P 500 will post minor earnings growth compared with last year’s Q3 (though not as much as inflation). This is a very different market than we had only a few months ago. The New York Times quoted Patrick Fruzzetti: “The main thing to remember is that the markets tend to rally post election only because markets don’t like uncertainty.” I have to agree.

On Friday, the government released the jobs report for October, and it wasn’t bad. Last month, the U.S, economy created 261,000 net new jobs. While that’s a decent number, it’s the smallest monthly increase since December 2020.

I don’t mean to dismiss the report. It beat Wall Street’s forecast of 205,000. The stock market opened higher on Friday but then zig-zagged for a bit before closing higher by 1.4%. Not that long ago, a report like that probably would have tanked the market.

The details of the report were somewhat mixed. The unemployment rate rose 0.2% to 3.7%. The labor force participation rate declined for the second month in a row to 62.25%.

The labor force participation rate can be easily influenced by demographic factors such as more retirees. If we look at just the labor force participation rate for prime working age people (ages 25 to 54), that’s 82.5%. That’s not far from where it was pre-Covid.

The frustrating part continues to be wages. For October, average hourly earnings rose by 0.4%. In the last year, average hourly earnings are up 4.7%. That’s the smallest increase in over a year. We need to see this number improve. While many workers are seeing their pay go up, they’re seeing prices go up even more.

The government also tracks a broader measure of unemployment, the U-6 rate. For October, that increased to 6.8%. Here are some more details:

Health care led job gains, adding 53,000 positions, while professional and technical services contributed 43,000, and manufacturing grew by 32,000.

Leisure and hospitality also posted solid growth, up 35,000 jobs, though the pace of increases has slowed considerably from the gains posted in 2021. The group, which includes hotel, restaurant and bar jobs along with related sectors, is averaging gains of 78,000 a month this year, compared with 196,000 last year.

Heading into the holiday shopping season, retail posted only a modest gain of 7,200 jobs. Wholesale trade added 15,000, while transportation and warehousing was up 8,000.

After last Wednesday’s Fed meeting, Fed Chairman Jerome Powell gave a press conference that sounded noticeably more hawkish than the policy statement let on. The financial markets took the cue and sold off. That has passed and the market has gained ground for three days in a row.

For the December 13-14 Fed meeting, futures traders continue to be evenly divided. Half think there will be a 0.5% increase. The other half expects a 0.75% increase. Personally, I’m leaning towards another 0.75% hike. In total, we’re probably looking at another 100 to 125 basis points in further rate increases. After that, I suspect the Fed will pause for several months.

Of course, much of this hinges on the incoming data. The next big test for Wall Street will come Thursday morning when the CPI report for October comes out. The last report showed inflation running at 8.2% over the last 12 months. That’s very high but it’s still below the peak of 9.1% in June.

In the last CPI report, the big problem was that the core rate increased by 6.6% over the last 12 months. That was the fastest pace since August 1982. That’s when the stock market reached rock bottom after a nasty 16-year bear market. Even if headline inflation has already peaked, we may be facing a slow decline.

Ansys and McGrath Rally After Big Earnings Beats

I recently highlighted two stocks for you and both have been doing quite well. This week, I want to bring you updates on both stocks.

In our issue from four weeks ago, I focused on Ansys (ANSS). I’ve always been a big fan of this stock but last year, I thought it got way too pricey. We cut the stock from the Buy List at the end of last year, and I’m glad we did. The stock has had a rough year in 2023. Ansys is down more than 45% this year.

Despite the falling share price, business at Ansys has been doing very well. As we know, a strong business can be a very different animal from a strong stock. In August, Ansys had an earnings report that was very good. Last Wednesday, the company released its Q3 earnings report and it smashed expectations.

For Q3, Ansys said it expected Q3 earnings between $1.56 and $1.70 per share. It turns out that they made $1.77 per share. The CEO said Ansys beat its “financial guidance across all key metrics.” What impressed me is that it’s able to maintain an operating profit margin close to 40%. This is such a good business.

For Q4, Ansys now sees earnings ranging between $2.58 and $2.90 per share. That works out to full-year earnings of $7.48 to $7.90 per share. Wall Street liked what it saw. In the four trading days since the report, Ansys has rallied 9.1%. I haven’t made our Buy List decisions yet for next year, but I’m considering adding Ansys back to our Buy List.

Two months ago, I told you about little McGrath RentCorp (MGRC). The company is in the unusual business of renting relocatable modular buildings, portable storage containers, electronic test equipment and liquid containment tanks. This means things like modular classrooms. Or imagine a construction site in the middle of nowhere. McGrath can rent the foremen an instant office. These things are more common than you might expect. I always like small niche businesses like this.

The odd thing about McGrath is that almost no one follows it, but the company has raised its dividend for 31 years in a row. Earlier this year, the company solidly beat earnings for Q1 and Q2, but I wanted to bring you up to speed on the latest earnings report.

On October 27, McGrath reported very strong numbers for Q3. Sales rose 16% to $200.5 million, and earnings increased to $1.25 per share. That beat by eight cents per share. The stock jumped 11.6% on the news. The shares reached a new all-time high today. In the last 30 years, the stock is up 100-fold.

Here’s a stat that tells you so much about Wall Street. Sixty analysts currently follow currently Meta Platforms. Most have it rated as a buy or a strong buy. Only two analysts follow McGrath.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

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Posted by on November 8th, 2022 at 8:17 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.