Margin Expansion Is Behind The Recent Boom In Energy Stocks

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In his podcast addressing the markets today, Louis Navellier offered the following commentary.

Four Strong Sectors

The damage to the seven largest capitalization stocks in the NASDAQ 100 (QQQ) appeared to happen last Friday since most of these stocks opened stronger this week.  The other 93 stocks in the QQQ index were the beneficiaries of the reduction in weight of the seven largest capitalization stocks. The bottom line is the breadth and power of the overall stock market continue to improve as investor confidence and economic growth persists. 

The Fed should signal in its FOMC statement on Wednesday that it is effectively done raising key interest rates as inflation cools and Treasury bond yields settle down.  There are now four strong sectors that we can invest in which is much better than a year ago, when predominately energy stocks dominated our portfolios.

We are now in the midst of the second quarter earnings announcement season.  Already many of our stocks are exhibiting relative strength, which is a sign that money is gravitating to those companies that will post the strongest quarterly results and guidance.  We are in the midst of a “rolling recovery” as our favorite economist, Ed Yardeni, likes to say.  

There are essentially four improving industry sectors where we can find stocks, namely (1) semiconductors/cloud computing, (2) oil refining/integrated energy, (3) consumer discretionary, and (4) homebuilding.

There is no doubt that the AI craze is very viable in the wake of Nvidia and Super Micro Computer’s positive guidance. The only glitch is the Biden Administration wants to restrict China’s access to AI via cloud computing, but we suspect that will fail since China is pretty good at outsmarting its trading partners.

The Boom In Energy Stocks

The recent boom in energy stocks is due largely to margin expansion. The refiners are benefitting from high seasonal demand and wide crack spreads. In the meantime, integrated energy companies have boosted their production and no longer need high crude oil prices to improve their earnings. Finally, Russia remains a wildcard in the world energy market and it is widely perceived that their production will systematically decline when winter arrives.

As far as the consumer is concerned, we just have to follow where they are spending money, which lately seems to be home improvement, restaurants, travel and entertainment.  The service sector is responsible for virtually all the economic growth in the U.S. since the manufacturing sector is sputtering.

Finally, the homebuilding sector remains strong due to the fact that the inventory of existing homes remains suppressed since homeowners with low mortgage rates are reluctant to sell.  As a result, homebuilders have to build more homes to meet demand in growing areas.  I should add that due to cooling inflation, mortgage rates are anticipated to continue declining in the upcoming weeks.

Auto repossessions are rising, so used car prices will likely be falling as these vehicles are resold.  There is no doubt that consumers remain pinched since credit card debt continues to rise, which is causing banks to increase their loan loss reserves.  Typically, credit card companies expect a 1.5% default rate on credit card debt, but based on new higher loan loss reserves, banks seem to be anticipating a 3% or higher default rate.

Expensive Green Policies

Interestingly, consumers are even more grumpy in Europe, due largely to inflation from green policies, so right-wing parties are rising. Spain just elected a far-right party that will now wield its influence for the first time since the Franco dictatorship ended in 1975.  Italy is led by an anti-immigration and pro-traditional family Prime Minister, Giorgia Meloni, that has widely rejected many European Union (EU) reforms. 

In Germany, the support for the far-right Alternative for Germany (AfG) is now at a record 22% and undermining Chancellor Olaf Scholz’s ruling coalition of three parties.  Growing discontent over issues ranging from record immigration, persistently high inflation, and costly climate-protection measures have fueled the rise of AfG. 

The movement in Germany is similar to the rise of the BoerBurgerBeweging (BBB) in the Netherlands, which is a farmers’ citizens movement that won 15 of the 75 seats in the Senate back in March and is now blocking legislation to seize more farmland since the Netherlands was striving to have 30% of its land in a “natural state” to comply with EU’s climate goals. The bottom line is going green is expensive, which causes higher prices for food and electricity, so big groundswell revolts are underway within Europe.

In preparation for the upcoming G20 meeting, several countries, led by Saudi Arabia, rejected the G20’s goals for reducing fossil fuels.  John Kerry’s main goal during his recent visit was to convince China to transition away from coal for electricity generation, but he had virtually no success. India is also pro-coal, like China, and had no intention of complying with any green agenda.

Specifically, India’s minister of power, RK Singh, acknowledged that the reduction of fossil fuels production was a “sticking point.”  Finally, Japan is striving to blend ammonia with coal so it burns cleaner and is obviously reluctant to shut down its coal plants that generate approximately a third of its electricity. As a result, there will be no updated green energy mandate at the upcoming G20 meeting.

Obviously, our energy stocks are benefitting from rising global demand for fossil fuels from emerging markets, as well as strong seasonal demand in the U.S. Furthermore, the chaos in Russia makes them an unreliable source for crude oil, despite the fact that Russia is currently producing more crude oil now than Saudi Arabia after its 2 million per barrel per day cut.  Western sanctions and harsh winter weather is anticipated to continue to curtail Russia’s crude oil production long-term.

Our energy stocks have also been aided by the tension in the Middle East as Iran continues to hijack ships.  As a result, the U.S. Navy dispatched two amphibious warships and thousands of Marines to the Middle East to counter Iranian threats.  China imported 11.4 million barrels per day of crude oil in the first six months this year, which is 11.7% higher than a year ago.

Interestingly, 2.13 million barrels per day of crude oil came from Russia and China has boosted its stockpile of crude oil to take advantage of cheaper Russian crude oil.  So overall, due to China stockpiling crude oil and the tension in key crude oil shipping lanes, like the Strait of Hormuz and the Gulf of Oman, crude oil prices may continue to meander steadily higher.

Clearly, the world is a confusing place. The green agenda and the chaos in Ukraine are causing global food prices to rise.  Energy prices are expected to remain firm, simply because there are too many global uncertainties.  In the U.S., we are fortunate to be food and energy independent. 

However, many workers are upset that their wages are not keeping pace with inflation like UPS workers.  Furthermore, the UAW is worried about losing their jobs due to the transition to EVs as GM and Ford move their EV production to Mexico, so they are not endorsing President Biden’s re-election yet.

Everything Is About To Get Better

Amidst all this chaos, an investor’s best defense is a strong offense of fundamentally superior stocks. Our average stock is characterized by strong average annual sales growth and thanks to margin expansion, even stronger average annual earnings growth. 

Additionally, the analyst community has revised their consensus earnings higher for our stocks in recent months, which boded well for future earnings surprises.  So we expect it to be every stock for itself during the second quarter announcement season.

I want to assure you that everything is about to get better.  It will become evident on Wednesday that the Fed will no longer be raising key interest rates.  The Consumer Price Index (CPI) and Producer Price Index (PPI) recently proved that inflation has cooled immensely.  Corporate earnings are forecasted to steadily improve for the next four quarters. 

There are at least four improving industry sectors where we can find strong stocks to buy:

  1. semiconductors/cloud computing,
  2. oil refining/integrated energy,
  3. consumer discretionary, and
  4. homebuilding. 

Although we are in a rolling recovery, more sectors are now participating.  What makes America great is that our states are great economic laboratories, so even if some states hinder economic growth with stupid policies (like the NYC war on coal and wood-fired pizzas), other states will succeed and prosper.

Coffee Beans: Rabbit Season

Dozens of domesticated bunnies have overrun parts of Wilton Manors, a suburb of Fort Lauderdale, two years after a resident let loose lionhead rabbits from their backyard. East Coast Rabbit Rescue, a nonprofit organization, is spearheading an effort to rescue and rehome the bunnies. Source: NPR. See the full story here.