CWS Market Review – January 3, 2023

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Happy 2023!

If you haven’t had a chance to see it, here’s our 2023 Buy List. I’m proud to say that after one day, we’re already beating the market this year. The bad part is that like much of 2022, we’re down, just by less than everybody else.

I’ll be honest with you, I’m not sorry to see 2022 go. It was a difficult year for investors.

Last year was the fourth-worst year for the stock market in the last 80 years. Some of that, I should add, is due to the calendar effect. The market peaked on the first day of trading in 2022, and things got worse from there.

Investors were also fooled by several bear-market rallies. It seems like the market knows exactly when to lure you in and then hit you with another downturn.

The major investing story this past year was the resurgence of inflation combined with the Federal Reserve’s interest rate hikes. In retrospect, it’s alarming how slow the Fed was to realize the scope of the problem.

I don’t expect the Fed to get everything right, but even after the evidence became clear, the Fed was still slow to react. I’ll give you an example. At the December 2021 meeting, the Fed released its economic projections for 2022. The FOMC members expected inflation to be just 2.6% in 2022. They weren’t even close.

The Fed finally raised interest rates in March 2022, but even that was by just 0.25%. They still didn’t get it. Only after the issue became unavoidable did the Fed snap into action. For the year, the Fed raised rates seven times, and four of those times were by 0.75%.

The Fed’s target range for interest rates is 4.25% to 4.50%, and that will most likely rise another 0.25% in four weeks.

The Fed consistently fights its current battle with what it should have done in its previous battle. When Covid appeared, the Fed and the Federal government responded massively.

I suspect they were trying to avoid the Fed’s slow response to the Financial Crisis. If you recall, Ben Bernanke famously said that the subprime mess was “contained.” The Fed got the message, eventually.

But in 2020, the Fed jumped into action and thanks to the Fed cutting interest rates to near 0% in 2020, that effectively took risk out of the market. Investors responded as you would guess—they frantically bid up all the risky areas of the market. “Why not? The Fed has our back!” was the reasoning.

Shaky stocks like Peloton (PTON) and Zoom (ZM) zoomed. Zoom did so well that shares of ZOOM also rallied even though it was the wrong ticker. That was the thinking at the time.

Not only that, but areas like Crypto and NFTs soared. Once the Fed started to raise rates, then the high-risk rally got undone. It’s not over. Even today, shares of Tesla (TSLA) fell to another 52-week low.

A little over a year ago, Tesla was going for $414 per share. Today it got down to $105 per share. The losses are so bad that Elon Musk became the first person to lose $200 billion. It’s the greatest loss of fortune of anyone in history. (Don’t worry about Elon, he still has plenty left.)

Our Buy List vs. the S&P 500

Let’s look at some market numbers for 2022. Last year, the S&P 500 lost 19.44%. If we include dividends, then the index was down 18.11%. Our 2022 Buy List was down 10.42%. Including dividends, we were down 9.28%.

If there’s a silver lining to 2022, it’s that the selling was largely concentrated away from the sectors of the market that we prefer. Just by looking at the stats, you can see how much better safe stocks did last year.

For the year, the S&P 500 Growth Index (all these numbers are with divs) was down by 29.41%. The S&P 500 Value Index lost only 5.22%. The S&P 500 High Beta Index was down by 20.31% while the S&P 500 Low Vol Index lost 4.59%. The S&P 500 High Dividend Index fell only 1.11%. Safety was in last year.

S&P divides the S&P 500 into 11 different sectors. Here’s how the sectors performed last year.

Energy was the big winner. Both Exxon (XOM) and Chevron (CVX) are poised to make a combined profit of $100 billion this year.

I generally steer clear of making economic predictions, but I’m going to make a few qualified exceptions. The first is that I think it’s very likely the U.S. economy will enter a mild recession this year. The timing may take longer than people think, but that is the safe assumption.

By no means do I encourage investors to cut and run. In fact, times like these are often very good times to invest. That’s what bear markets are good for. I’m most concerned about the weakening housing market. Unfortunately, the housing market always finds itself placed between the Federal Reserve and the economy. When the Fed fights off inflation, the housing sector is collateral damage. That’s what’s happening right now.

From Reuters a few days ago:

U.S. single-family homebuilding tumbled to a 2-1/2 year low in November and permits for future construction plunged as higher mortgage rates continued to depress housing market activity.

The dour report from the Commerce Department on Tuesday followed on the heels of news on Monday that confidence among homebuilders plummeted for a record 12th month in December. The housing market has borne the brunt of the Federal Reserve’s fastest interest rate-hiking cycle since the 1980s as the U.S. central bank wages war against inflation.

I also expect the U.S. dollar to lose some steam this year. The greenback has had a good run from early 2021 until a few months ago, but now the European and American economies are out of sync. Our friends across the pond are still hiking and the Fed could be looking to cut rates before the end of the year. In fact, the dollar has already started to pull back since November. A weaker dollar could help cushion the blow of any weaker growth we may face.

Stock Focus: Dollar General

Speaking of the dollar, that reminds me of this week’s stock which is Dollar General (DG). This has been a remarkably successful company and it has a remarkably simple business model. You can get basic items at a discount.

I came close to adding DG to this year’s Buy List as a good replacement for Ross Stores (ROST). What troubled me was its recent earnings report which showed that Dollar General still has supply chain issues. Still, this is a very good company, and it may be worth a closer look.

First, let’s look at how successful DG has been. In 2009, the company IPO’d at $21 per share. Last March, it got to an all-time high of $262 per share. That works out to a return of more than 21% per year for over a decade.

There are now more 18,000 locations across the United States. Dollar General says it has more brick-and-mortar locations than any other retailer in the country. The company was founded in Kentucky in 1939. Even today, the company has a strong southern focus. There are currently more stores in Mississippi than in New York.

Dollar General didn’t get the present name until 1955. The company IPO’d for the first time in 1968. It was later taken private in 2007, slimmed down and then IPO’d again. The company now has a market value of $55 billion.

A few years ago, the company was part of the great Dollar Bidding War of 2014. This involved Dollar General, Dollar Tree and Family Dollar. Dollar General offered nearly $10 billion to buy Family Dollar. The bid was rejected, and Dollar Tree agreed to merge with Dollar General. Honestly, I’m glad Dollar General lost.

It wasn’t a total loss. Dollar General picked up Dollar Express which was a spinoff from the Family Dollar-Dollar Tree deal.

Dollar General works hard to get the lowest possible prices for its customers. DG’s operating margin runs about 10%. This business is all about cost control. Dollar General is also a good business when consumers are worried about inflation.

Dollar General currently pays a dividend 55 cents per share. That’s a tiny yield but I expect to see the dividend increased soon.

Last month, DG reported its fiscal Q3 results. Net sales were up 11.1% to $9.5 billion and same-store sales were up by 6.8%. EPS rose 12% to $2.33 per share.

The problem was that that was an earnings miss of 20 cents per share. It seems that Dollar General continues to face supply chain issues. This has been a big issue for them. Last year, it helped snap the company’s 31-year run of higher same-store sales.

Along with the earnings report, Dollar General slashed its Q4 earnings range to $3.15 to $3.30 per share. Wall Street had been expecting $3.66 per share. The stock fell more than 7% on the news.

I’m going to continue watching Dollar General, but I want to see these problems get behind them before I can consider it a good investment. It’s a great business and it’s a good example of a stock that’s probably not fully valued due to its capacity for growth.

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 January 3rd, 2023 at 6:48 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.