Category: Financial Markets Commentary

Monthly financial markets commentary from Sabino Investment Management, LLC

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U.S. Corporate Profits

S&P 500 earnings declined in 2022 by 18.0% and subsequently increased by 7.8% in 2023.  Standard and Poor’s currently estimates that 2024 earnings for the S&P 500 index will be $216.61, representing 10.6% growth for the calendar year.  At the current price level of 5,283.4, the S&P 500 Index sells at 24.4x 2024 estimated earnings.

There has been much commentary about the “Magnificent 7” (Microsoft, Amazon, Meta Platforms, Apple, Alphabet, Nvidia, and Tesla).  The Magnificent 7 sell for roughly twice the P/E ratios than most other US stocks.  While five of the stocks have high growth rates, Apple and Tesla have negative revenue growth when we compare the most recent quarter to a year ago.

Richard Bernstein Advisors (RBA) has this to say in their commentary about the divergence between the large cap tech stocks and the rest of the stock market.

Our work in the early-1990s demonstrated that stock market leadership narrows when profits cycles decelerate because fewer and fewer companies can accelerate or even maintain growth in an increasingly adverse environment.  Markets effectively reflect Darwinistic survival of the fittest as earnings growth becomes increasingly scarce.

However, the opposite occurs when profits cycles accelerate.  Markets tend to broaden as the cycle accelerates because an increasing number of companies are growing, and investors become comparison shoppers for growth.

RBA notes that a high percentage, 32% of S&P 500 companies, have more than 25% earnings growth based on the last 4 quarters.  In their opinion, “profits are accelerating and credit conditions remain healthy.”  They expect the performance of the stock market to broaden and the Magnificent 7 to “substantially underperform.”

The Atlanta Fed’s GDPNow forecast for the second quarter has declined during the last month from 4.1% to 1.8%.  A slowdown in economic growth will make it difficult to sustain earnings growth for many companies.

One of the reasons why small capitalization companies have been underperforming the S&P 500 since 2021 is that they typically have a higher debt load with a greater proportion of variable rate debt.  Interest rates have been rising since June 2020, so small companies with more interest-sensitive debt have suffered.  According to Pacer Financial, an ETF provider, the S&P Small Cap 600 has net debt/EBITDA (earnings before income tax, depreciation, and amortization) of 3.5 compared to 1.4 for the S&P 500.

Pacer’s US Small Cap Cash Cows ETF (CALF), which is included in many portfolios, has a lower ratio of net debt/EBITDA at 1.26, but sells at a more attractive valuation than either index.  CALF has a price/free cash flow ratio of 8 and a price/earnings ratio of 11.

While there are reasons to be concerned about the economic future of the country (see my May 3 blog, “Prepare for All Eventualities), some stocks offer better fundamentals and more attractive valuations than other stocks.  Also, we deal in a world of probabilities rather than certainties, and an allocation to common stocks makes sense as a hedge against inflation.

If you have any questions or comments, please contact me.

Sincerely,
Robert G. Kahl
CFA, CPA, MBA

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Reading the Fed’s Tea Leaves

Financial markets price securities based upon future expectations.  Based on the shape of the yield curve, financial markets reflect anticipation of the Federal Reserve (Fed) cutting rates aggressively in response to a recession.  Given the recent market rally and high equity valuation levels… READ MORE

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Don’t Underestimate BRICS+

For more than 20 years, international organizations have been evolving that serve as an alternative to the US-led organizations such as G-7, G-20, and the World Bank.  The Shanghai Cooperation Organization was first created in 2001 as a security and defense organization.  It includes Russia, China, India and five other countries.  In addition, many other countries participate as “dialogue partners,” observers or guests.

The BRICS nations (Brazil, Russia, India, China, South Africa) represent a group of nations with the same core group that seek intergovernmental cooperation.  BRICS is headquartered in Shanghai and its five core countries have a combined population of 3.21 billion people with a total GDP on a purchasing power parity (PPP) basis of US$ 56.65 trillion or 32.5% of global GDP-PPP.  It is responsible for the creation of the New Development Bank, which is an alternative to the World Bank and funded with $100 billion of initial capital.

Since the war started in Ukraine, a US-backed global task force claims that $300 billion of assets owned by Russia’s central bank and $30 billion of assets owned by sanctioned Russians have been frozen.  The actions by the US government and its allies did not go unnoticed by other countries.  Since then, more international transactions have been paid for with national currencies and central banks have been diversifying their reserve assets.  There are now 41 other countries that are interested in joining BRICS, so the core countries plus the 41 potential new members are often referred to as BRICS+.

BRICS+ will have their annual summit in Johannesburg, South Africa on August 22-24 this year.  While there has not been an official announcement yet, there have been recent posts by Russia and Iran regarding a new gold-backed currency for international trade.  On July 5, RT News, the English language news agency sponsored by the Russian Government, announced that the BRICS group of countries is set to introduce a new currency backed by gold.  Some other headlines posted on RT.com during the last three weeks include:

    • July 16 – Italian businesses want to switch to rubles in Russia trade
    • July 15 – Taking the dollar down a peg
    • July 12 – Russia seeks to expand de-dollarization drive
    • July 10 – China and Russia should lead “global governance reform” – Xi
    • July 6 – Russia proposes alternative to EU clearing houses
    • June 30 – Central American country (Nicaragua) wants to ditch dollar in Russia trade
    • June 30 – BRICS diplomat comments on what is drawing countries to the bloc

Since 2010, central banks around the world have been net purchasers of gold, after being net sellers for the years 1989-2009.  The pace of central bank gold acquisitions has accelerated in 2023 in anticipation of a new gold-backed currency.

The remainder of the year promises to be an interesting time for the international monetary system and precious metals.  If you have any questions or comments, please contact me.

Sincerely,
Robert G. Kahl
CFA, CPA, MBA