Alchanati Campbell & Associates
Technical Analysis. The best technical analysis consists of looking at the trends coming from monthly indicator charts. Is technical analysis a great way to base your investment decisions on? The graph below shows a similarity between Caterpillar and the Nikkei Index for a span of 5 years. Does it mean anything? You should base your investments on multiple analyses: technical, fundamental, comparative, and macro.
The Bulls are Charging. Investor sentiment is at an extreme high, with all market indexes hitting new highs. Investors are heavily invested in equity while holding the lowest cash reserves. With low levels of cash reserves and extreme investor confidence, how much longer can the markets sustain new highs? Key indicators to look at are manufacturing, consumer confidence, consumer spending, GDP growth, household-debt-to-GDP ratio, new home sales and the number of new homes being built. If we see a slowdown in any of these, it’s a bearish sign. Besides these economic indicators, the 2020 elections, the Feds hiking/cutting/holding interest rates, the slowing of the Chinese and US economy, and the US-China trade war are the events that will be dictating the direction of markets. Based on banking sentiments, cyclical stocks, emerging markets, and economically-sensitive sectors like financials, industrials, and materials will be good plays if the market continues to go up. If not, look for hedges in assets like TIPS, REITS, Treasury bills, VIX, and defensive stocks like consumer staples and utilities.
The Superiority of Investment Companies and Asset Classes. The comparison of the Vanguard Growth Index Fund ETF (VUG) and the Fidelity Growth Company mutual fund (FDGRX) is done to show how the difference in asset type, asset allocation, investment company reputation, and expense ratio influence fund performance. VUG is a Vanguard large-cap growth ETF with $95 billion net assets, the inception date of 2004, Beta of 1.04, an expense ratio of 0.04%, and a 1-year return of ~21%. This ETF is made up of large market cap US growth companies, with its top holdings being Microsoft (8.52%), Apple (7.87%), Amazon (5.81%), Facebook (3.59%), and Alphabet (2.93%). FDGRX is a Fidelity large-cap growth mutual fund with $41 billion net assets, the inception date of 1983, Beta of 1.20, an expense ratio of 0.85%, and a 1-year return of ~16%. This mutual fund is made up of large market cap US growth companies, with its top holdings being Amazon (6.44%), Apple (5.41%), NVIDIA (4.95%), Microsoft (4.37%), and Alphabet (3.93%). Now from a basic analysis, we can make the hypothesis of: because the Vanguard fund is more well known, has a lower expense ratio, has a lower Beta (lower riskiness), is an ETF (not a mutual fund), and has allocated their fund by buying more heavily into Microsoft, Apple, and Amazon (higher returning equities), they outperformed Fidelity’s mutual fund.
China's Slowdown. China just posted its third straight month of declines in its industrial profits, being down 9.9% in October, over last October. This marks the steepest declines in industrial profits since 2011, most of which can be accounted for by severe overcapacity, with a lack of demand in the international economy, brought on by a harsh trade war. China, being the second-largest economy, has been in a trade war with the US, the largest economy, over the past year. Industrial profits have been falling severely for the last 6 months, with their equity market following suit, with fears of a looming global slowdown. With declines in industrial profits, China has been able to slightly offset this decline through growths in the mining sector, as-well-as utilities. This offset has not been enough to increase GDP growth past their historical growth, sitting currently at 6% over the last year. This overcapacity has led to decreases in raw materials, and final product prices, shown by a decrease in PPI (Producer Price Index).
Valuation at its Finest. You may have heard about how certain companies are overvalued, undervalued, “a great buy right now”, “stay away at this price level”, etc. Analysts from Goldman Sachs, J.P. Morgan, Morgan Stanley, Credit Suisse and the like make a living telling investors what to do. This is all great, except by the time you hear about the investment opportunity from them, it’s already too late. In a way, it’s almost a self-fulfilling prophecy. An analyst puts out an article saying how this stock is a great buy, expected to increase by 20% in the next year, etc. Everyday retail investors see this and then race to buy the stock before they miss out. All of these people buying the stock causes the price to increase (pumping or dumping), which then fulfills the prediction originally set out in the article. As you can see, the stock price is often shot up without a true dive into financials. This leaves us a higher price, with less evidence to back it up and renders it more prone to a drop. (Example: when LVMH Moet Hennessy made an offer to acquire Tiffany & Co., TIF jumped ~50%. Example #2: recently, Morgan Stanley downgraded Dollar Tree, Inc. When a big bank downgrades a company, it can cause a selloff of that equity.)The key to investing is to know when a drop is coming, and when a stock is about to soar. How do you do this? You have to use at least one valuation method. The most popular being Discounted Cash Flow; this involves projecting the Free Cash Flow (the money after all cash expenses to be distributed) into the future. Once you reach a certain point, it makes sense to stop projecting the annual cash flows and come to a terminal value (the value of a firm in that year for all the years going forward). After all of this is done, you must discount all cash flows and the terminal value back to the present day. This is the #1 rule of finance. Money today is worth more than money tomorrow. You must always account for it. The basic formula for Free Cash Flow is “Operating Cash Flow – Capital Expenditures – the annual net change in working capital. Discounting all the cashback to the present day will give you Enterprise Value. Enterprise value is the true amount you would have to pay to acquire the firm. For instance, if I were to buy a company outright, I would not only be acquiring all the operations, but I would be acquiring all the debt that the company owed which I would now have to pay off. Similarly, I would also be acquiring all the cash the company has. This leaves us with the formula: Enterprise Value + Debt – Cash = Market Capitalization. Take the market capitalization and divide by shares outstanding to get a true value for a single share of stock.
You may be wondering, “If it’s all based on the numbers, why do people come to different values?” The answer is that the numbers require reasonable assumptions to be made. Things like sales growth, research costs, etc. The skill of an equity analyst lays in their ability to make assumptions. That is what separates a fine analyst from a fantastic analyst.
The Alchanati Campbell and Associates Team
WHAT'S UP FRIDAY? is a weekly newsletter that will give you a summary of "What's up?" on Wall Street, in the US and around the World written by The Alchanati Campbell and Associates Team. What makes us unique is we focus on long-term knowledge; knowledge that will still be useful to you 10 years from now.