Most stock markets around the world have moved up this year, continuing the move from last fall when markets began to anticipate a shift in Federal Reserve policy. The market, particularly in the U.S., fluctuated as sentiment towards a Fed pivot changed. The S&P is up over 7% year to date (the Nasdaq more than doubled that, and the Dow just over 1%, as tech roared back).
International markets (outside the U.S.) are up almost 8%. European stocks are the leaders, with most markets up by double digits, while most of Asia is also up, but by low single digits. Only Brazil, among major markets, is down on concerns about the new leftist government; India, and several small Asian markets, including Thailand and Malaysia, are also down.
Economic Outlook Would Be Weak for Equities
We may be close to the last hurrah for stocks. As the U.S. economy slows amid persistent inflation — in other words, stagflation — stocks in the U.S. and other major markets may underperform.
Stocks generally perform well during inflationary periods as investors look for assets to preserve purchasing power. They perform less well, generally, during recessionary periods when earnings are declining.
In both cases, much depends on the reaction of central banks. If banks go full-on QE in response to a slowing economy, then that can be positive, but it's not the recession but the resulting QE that is responsible. A stagflationary period, however, is typically bad for both stocks and bonds in major markets, while smaller markets, as well as commodities, typically outperform.
Retail and Professional Investors Are Complacent
Right now, the stock market is far too complacent. Even after the banking crisis, fewer than half of retail investors are bearish; the number who are bullish has increased each week for the last three weeks. Analysts are even more complacent, with consensus estimates for S&P earnings for the year ahead down just over 1% over the prior 12 months.
Even this forecast decline is more than analysts were expecting just a week ago. That beggar's belief. Persistent inflation with companies unable to pass through the full extent of their higher input costs; the possibility of more wage increases; the final end of covid handouts from the Federal government; and a slowing economy all mean, to me, that the estimate is optimistic with the risk firmly on the downside.
Other earnings estimates have dropped. Refinitiv, for example, is estimating a 5% decline in the first quarter. That's down from an estimated gain of 1.4% at the beginning of the quarter and a 10% gain for the quarter six months ago. Companies begin to report their first-quarter earnings next week. That sounds like a more realistic estimate, but stocks are not yet reflecting the decline.
Valuations Remain High as Technicals Deteriorate
This comes as valuations remain high, if down from the excessive levels of the last few years. But 19 times earnings is not a low valuation, and certainly not the kind of valuation we expect at the beginning of a new bull market. If we enter a recession, stocks will be hit both by lower earnings and valuation contraction. During recessions, average multiples are in the nine to 14 times range.
In all, there is significant downside. Moreover, Treasuries yielding 4%, though not keeping pace with inflation, represent more competition for equities than they have in the last several years. There are also technical indicators pointing to lower prices, including distribution and lack of breadth.
Just three stocks (Apple, Nvidia, and Microsoft) are responsible for 91% of the S&P's gains this year, while nine companies are contributing 160% of the gain (that is, without those nine stocks, the index would be down).
Certainly, on the other side of the ledger, there is still a lot of cash on the sidelines, especially in the higher net-worth population who are, after all, more likely to buy stocks. And there is still a "buy-the-dip" mentality, which has been the way to play the market for the last 30 years, that is, for the entire working lives of most professional investors today. Those sentiments take time to change. Lastly, investors are betting that if the economy slows, the Fed will cut rates.
If the Fed Starts To Cut Rate, That Might Not Be an All-clear for Stocks
Whether this is accurate or not, we would note that the last rate hike prior to the 2008 financial crisis was in June 2006, and the Fed made its first rate cut in September 2007.
Despite this, it was downhill all the way until the S&P bottomed in March 2009, and the index did not regain its September 2007 level until April 2013. The belief that rate cuts are ahead might boost the market. That is what we have seen in the market since the fall, an expectation of a future pivot, with stocks fluctuating by how deeply that narrative is believed. But when rates start to decline, stocks may have already peaked.
Few Global Markets Are Attractive
The story is much the same for Europe. In Japan, higher rates could help stocks as money returns from abroad. However, valuations in most of Europe and Japan are not sufficiently attractive for broad investing right now, while the geopolitical risk for Chinese stocks, admittedly undervalued, is too high. The MSCI World Index is trading at valuations just a little better than those for the U.S. but still above historical norms, and with analysts expecting an increase in earnings this year.
And sentiment is also optimistic: according to State Street's Global Investor Confidence Index, investor sentiment rose for the third straight month in March, somewhat surprising given the banking issues in the U.S. and Switzerland, but once again showing that investors are putting their faith in the central banks' willingness to bail out troubled institutions.
Asia, oddly, the region most removed from banking troubles, was the only region to see a downturn in sentiment last month. Smaller markets are trading at better valuations and are, in other ways, more attractive. Nova Royalty Corp. (NOVR:TSX.V)
Stocks in those markets have generally lagged in the last few years. Smaller markets, painting with a broad brush, tend to do better when inflation is higher, and the dollar is falling.
We have few global equities on our list of current positions, with most in smaller markets in Asia. We will add either special situations or after a meaningful pullback in the indexes, which we expect later this year.
RECENT RECOMMENDATIONS We had two sells in a recent Bulletin, and both would now have filled, Azucar Minerals Ltd. (AMZ:TSX.V; AXDDF:OTXQX) at 9 cents and Cartier Resources Inc. (ECR:TSX.V) at 10 cents.
We had large losses in both.
Our average return on all closed positions is now a gain of 89.95%, with an average holding period of 49 months. In our last Bulletin, we recommended Nova Royalty Corp. (NOVR:TSX.V) at a limit of CA$1.45. Orogen Royalties Inc. (OGN:TSX.V)
The stock traded at or below our limit for over two hours before starting to move up, closing today at 1.55 x 1.58. Given that it did trade for a while below our limit, we have added it to our table of current positions. Pan American Silver Corp. (PAAS:TSX; PAAS:NASDAQ)
If you missed it, keep the order for now, and we'll like to raise the limit after the stock settles down.
Profits for Orogen
Orogen Royalties Inc. (OGN:TSX.V) reported full-year results which showed its first year of profitability, with strong revenue from its royalty of the Ermitaño gold-silver mine in Mexico, as well as an active prospect generation business and disciplined cost controls, with G&A down 7%.
Net revenue for the year was CA$840,000, with the fourth quarter being the strongest. The company ended the year with a working capital of over CA$12 million and no debt, more than sufficient to maintain its business activities.
We plan an updated review of Orogen in the near future. There is an overhang of in-the-money warrants that expire next month, but this is providing us with an opportunity to accumulate the stock.
Pan American Silver Corp. (PAAS:TSX; PAAS:NASDAQ) completed its acquisition of Yamana on the last day of the month. It expects a revised outlook for the combined company around the middle of this quarter.
TOP BUYS this week, in addition to those mentioned above, include Midland Exploration Inc. (MD:TSX.V); Lara Exploration Ltd. (LRA:TSX.V); and Hutchison Port Holdings Trust (HPHT:Singapore).
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Adrian Day’s Global Analyst is distributed for $990 per year by Investment Consultants International, Ltd., P.O. Box 6644, Annapolis, MD 21401. (410) 224-8885. www.AdrianDayGlobalAnalyst.com. Publisher: Adrian Day. Owner: Investment Consultants International, Ltd. Staff may have positions in securities discussed herein. Adrian Day is also President of Global Strategic Management (GSM), a registered investment advisor, and a separate company from this service. In his capacity as GSM president, Adrian Day may be buying or selling for clients securities recommended herein concurrently, before or after recommendations herein, and may be acting for clients in a manner contrary to recommendations herein. This is not a solicitation for GSM. Views herein are the editor’s opinion and not fact. All information is believed to be correct, but its accuracy cannot be guaranteed. The owner and editor are not responsible for errors and omissions. © 2022. Adrian Day’s Global Analyst. Information and advice herein are intended purely for the subscriber’s own account. Under no circumstances may any part of a Global Analyst e-mail be copied or distributed without prior written permission of the editor. Given the nature of this service, we will pursue any violations aggressively.
1) Adrian Day: I, or members of my immediate household or family, own securities of the following companies mentioned in this article: Nova Royalty Corp., Lara exploration Ltd., Midland Exploration Inc., Pan American Silver Corp., Orogen Royalties Inc. I personally am, or members of my immediate household or family are, paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this article: None. Funds controlled by Adrian Day Asset Management, which is unaffiliated with Adrian Day’s newsletter, hold shares of the following companies mentioned in this article: Nova Royalty Corp., Lara exploration Ltd., Midland Exploration Inc., Pan American Silver Corp., Orogen Royalties Inc. I determined which companies would be included in this article based on my research and understanding of the sector.
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5) From time to time, Streetwise Reports LLC and its directors, officers, employees, or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in the securities mentioned. Directors, officers, employees, or members of their immediate families are prohibited from making purchases and/or sales of those securities in the open market or otherwise from the time of the decision to publish an article until three business days after the publication of the article. The foregoing prohibition does not apply to articles that in substance only restate previously published company release. As of the date of this article, officers and/or employees of Streetwise Reports LLC (including members of their household) own securities of Nova Royalty Corp., Lara exploration Ltd., Midland Exploration Inc., Pan American Silver Corp., Orogen Royalties Inc., companies mentioned in this article.