What we are watching next week, including Wells Fargo earnings
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Signage for Wells Fargo in New York City, May 5, 2021
Bill Tompkins by Michael Ochs Archives, Getty Images| Michael Ochs Archives | Getty Images
(This article was originally sent to Jim Cramer and members of CNBC Investing Club. Get the latest updates directly to your email subscribe here.)
The new year began with a slow start for the markets. The major indexes suffered weekly losses but the Dow Jones Industrial Average, which is economically sensitive, was relatively strong. Investors are preparing for an year when the Federal Reserve will likely raise interest rates and shrink its balance sheet. The relative laggard of the Nasdaq Composite, tech-rich, was more than 7 percent off its November all-time peak.
We don’t find the actions surprising and we believe that it aligns with our views that 2022 will see you owning stocks in companies that “do things and make stuff” and avoiding “story stocks”, i.e. those with long durations and low earnings.
Stocks are valued based on their future cash flows and earnings. These outyear numbers are used to generate the company’s present value. Then, we use a discounted cashflow (DCF), model to discount them to today. When rates are at essentially zero, the discount rate (the denominator in a DCF model) is minimal and as a result, investors can speculate and look out into the future as far as they want — because the value in the future is essentially the same as today’s. However, rates will rise and the discount rate or the rate investors need to return for their risk by holding equities must go up. The present value of future earnings or cash flows will decrease due to this higher denominator. With every tick of higher rates, earnings that are further away from the actual value are less valuable today.
Here’s an example to show how increasing rates affect valuations
Let’s look at an example to illustrate how higher discounts can impact future earnings.
Company A, a tech stock with high potential (think of something that was listed via SPAC) or enterprise software companies. It has a promise for the future and no current earnings power. This makes it an asset with longer term than stocks. The value cyclical name Company B, which is similar to a large-cap industrial or financial stock, is called a large capital financial. These companies have been traditionally regarded as assets with short duration.
The earnings of Company A are expected to be $10 per share five years hence in 2027, while those of Company B should reach $10 per share at the end of 2022. A rate increase means Company A’s earnings will be reduced to the current five-year period at a more favorable rate. Company B must, however, only discount back one year.
The impact of discounting today’s rates on future rates is greater when they are higher. This makes it more attractive for investors to invest in shorter term assets, such as Company B rather than stocks like Company A. Ultimately, A and B will both generate $10 in earnings. As interest rates rise, however, company B’s current earnings of $10 are worth more than company A’s.
We want to invest in stocks that make real profit today. Higher rates will have a smaller impact on the future value of those earnings if they are closer to current day profits. This makes them more appealing than high-fliers whose intrinsic value drops at higher rates.
Let’s take a look at some market indicators we keep our eye on. The U.S. Dollar index lost a little but is still below its 96 mark. WTI crude oil prices traded around $1,800 and gold was almost flat for the week. WTI crude prices rose to the $70s-per barrel region. The Fed’s hawkish minutes, as well as the decline in unemployment rates resulted in a strong yield for the 10-year Treasury Note. Now, the yield on the 10-year Treasury note is around 1.77%. This level marks its highest point since January 2020.
There were no reports from portfolio companies this week.
Neben earnings, several macroeconomic developments were provided to us:
Monday
Tuesday
–ISM Manufacturing: 58.7% vs. 60.0% estimate
Wednesday
–ADP Employment Survey: 807,000 vs. 375,000 estimate
Thursday
–Initial Jobless Claims: +207,000 vs. +195,000 estimate
Average for the past four weeks: 204.500 (+4,750)
-Factory Orders: +1.6% MoM vs. 1.5% MoM estimate
Core Capital Goods Orders: Unchanged MoM
-ISM Services: 62.0% vs. 67.0% estimate
Here’s what we’re watching:
Next week will see the start of earnings season as banks report. In the portfolio, you will hear from Wells Fargo (WFC) on Friday, before the opening bell. Other reports we will be watching include:
Monday
Open: AZZ (AZZ), Commercial Metals (CMC), Tilray (TLRY)
Close: Accolade (ACCD)
Tuesday
Open: Albertsons (ACI), TD Synnex (SNX)
Close:
Wednesday
Open: Jefferies (JEF), Shaw Comms (SJR)
Close: KB Home (KBH)
Thursday
Open: Delta (DAL), Taiwan Semi (TSM)
Close:
Friday
Open: BlackRock (BLK), Citigroup (C), First Republic Bank (FRC), JPMorgan Chase (JPM)
Close:
The macroeconomic side, as well as keeping an eye out for geopolitical events and following release (all times ET),:
MONDAY
10:00 Wholesale Inventories SA (Final
TUEDAY
NFIB Small Business Index at 06:00
WEDNESDAY
08:30 Consumer Price Index, (CPI).
08:30 Hrly Earnings SA M/M Final
08:30 Hourly Earnings (Y/Y)
8.30 Average Workweek SA Final
14:00 Treasury Budget NSA
THUESDAY
08:30 Continuing Jobless Claims SA
08:30 Initial Claims SA
08:30 Produce Price Index, (PPI)
FRIDAY
08:30 Export Price Index NSA MM
08:30 Import Price Index NSA NSA M/M
08:30 Retail Sales
Capacity Utilization NSA 09:15
09:15 Industrial Production SA M/M
09:15 Production Manufacturing M/M
10:00 Business Inventories SA M/M
Michigan Sentiment NSA Preliminary 10:00
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(Jim Cramer Charitable Trust was long WFC.
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