January 28, 2023 | Personal Consumption Expenditures, Tesla’s Reported Earnings, Home Price Affordability, Debt Ceiling, Layoffs and Over-Hiring, Stock-Based Compensation, Federal Reserve...

Personal Consumption Expenditures
The Personal Consumption Expenditures index (PCE) for December came in with an annual growth rate of 5.0%. This is down from the November level of 5.5%. Looking at the Core PCE, which strips out energy and food and is the indicator, the Fed closely monitors the inflation number looks even better with an annual growth rate of 4.4%. I've heard people continue to use the CPI and say that inflation is running at more than 3 times the Fed's 2.0% target. That is extremely misleading as the Core PCE is not nearly as high as the CPI. Overall, we still have work to do on inflation, but it is still decelerating at a good rate and I'm optimistic it will continue to improve as we progress towards the end of 2023. My projection is still that we will see one maybe two quarter point hikes from the Fed and then that rate would be maintained through the rest of the year. I do not see any rate cuts this year from the Fed as I believe the economy will be better than many fear.

Tesla’s Reported Earnings
Tesla reported earnings and they did very well. This sent the stock up as much as around 11% in trading. I have been against Tesla for years not because it’s a bad company but because it was too richly valued. That is now changing, the earnings for December 2024 stand at $5.79 with a price of the stock around $150 that gives a forward PE of 25.9. That's not great, but not as terrible as in the past. When the stock was at the low of $102 that would’ve been a forward PE of 17.6, much more reasonable. I’m not saying that Tesla is a buy, it still has more to drop or needs to see a larger increase in earnings for it to be considered a value. It is getting close, maybe in a year or two it could become a buy?

Home Price Affordability
Even with the recent declines in home prices, there is still a major affordability problem. In fact, looking at an affordability index from the National Association of Realtors (NAR) shows we are still out of line with pre-pandemic levels. The index is based on home prices, median family incomes and mortgage rates. Over the 12 months prior to Covid the index averaged 162 and the current estimate for January is a level of 106. The lower the number means the higher the problem is for affordability. There are a few ways the number could get back to the pre-pandemic level of 162. First, the average mortgage rate would need to fall to about 2.6%. Next, family incomes would need to increase by about 50%. Finally, prices for homes would need to fall by about another third. The most likely case is a combination of all 3 factors, but unfortunately, I don't see rates coming anywhere close to the 2.6% level nor do I see incomes spiking close to 50%. Therefore, I believe there is still more downside for home prices ahead.

Debt Ceiling
If you’ve been wondering why the yield on the 10-year treasury has been dropping it is because they have stopped issuing notes since we hit the limit. We just hit the debt ceiling, but anticipation of hitting that mark put a lot of downward pressure on the yield as demand and purchases of 10-year treasuries increased in anticipation of the debt ceiling. Once the limit is increased, then the government can go back to issuing more 10-year treasuries, and I believe the yield will increase.

Layoffs and Over-Hiring
You have heard about some major tech companies making big layoffs of 10,000 maybe 20,000 people and think, "oh my gosh this is huge." But if we go back just a few years to 2019, you will see that some companies may have over-hired. For instance, Meta-platforms back in 2019 had 44,942 employees. Now with data available for the 3rd quarter of 2022, the total headcount was at 87,314. That's an increase of 42,372 employees or over 94% in just a few years. Alphabet also over-hired with 2019 employees equaling 118,899 and as of the third quarter last year they increased their headcount by 67,882 to 186,779. The worst company with overconfidence in future growth would have to go to Amazon which had a 2019 headcount of 798,000 employees. That ballooned almost 100% to 1,544,000 employees, an increase of 746,000 employees. You may hear about more layoffs in 2023 for some tech companies, but keep in mind the 2019 numbers and realize that some companies let their hiring policies get out of control.

Stock-Based Compensation
Companies that use stock-based compensation when their stocks were rising made both employers and the employees happy. But what happens when the stock goes in reverse? No one is happy and shareholders lose the most. As a stock declines in value employees want more shares to equal what they received before, and employers need to keep the game going. They will issue more shares, but what that does is dilute future earnings even more. Be careful of investing in companies that excessively use stock-based compensation, the stocks could be flat for many years. Two companies that come to mind are Snap and Roku.

Federal Reserve
You may not know it, but the Federal Reserve has the ability to actually make profits. In 2021 the Fed earned $107.9 billion in profits but in 2022 that profit was cut in half to $58.4 billion because of rising interest rates. You may be wondering where the profits go. The Fed does not get to keep them. They send all their profits to the US treasury and if the Fed loses money, they create an IOU on the balance sheet. This is known as a deferred asset. They will carry that IOU until they once again make profits, and they will pay that IOU down before sending any more profits to the treasury.

Declining Attention Span
In a recent research study at the University of California Irvine, it was no surprise to learn that the attention span of both younger and older people has declined over the years. Back in 2004 people on average spent 150 seconds on a screen before switching. It has now declined to 47 seconds, a drop of over 2/3. The research also found that on average, people check their inboxes 77 times a day. I was surprised by that number, but it is on average. To restore our attention spans, people need to be more disciplined about when they check emails and use social media. If you only check it during certain times of the day, your attention span will increase, and your stress level will decrease. Try it. Let me know what you think.

Working From Home
Some employees working from home are still living in the Covid years thinking that they control the narrative of working from home. I remember people saying this was the new way of doing business. I said no it will go back to people going into the office. Those employees who are saying they would rather quit than go back in the office, be prepared to be unemployed. Those employees forget that if it’s so easy to work from home and not go in the office, then the employer can find someone overseas or in other places who will do the same job remotely for perhaps half the pay, and no health insurance or 401(k). I think over time we will see more employees heading back into the office because like it or not, a business is in business to make a profit not provide a social service.

Offshore Oil Drilling
There’s some good news long-term on the energy front. As of December 2022, approximately 600 rigs worldwide are available to lease for offshore oil drilling. It has been estimated that approximately 90% are working or under contract to work in the future. Looking back just five years, that number was only 63%. Another positive, based on demand, is contractors are now receiving about $400,000 a day for leasing their drill ships, that is nearly double what it was just two years ago. This is a big positive to the supply side of the equation for oil.

Q4 GDP
The headline advanced reading for Q4 GDP came in at 2.9%, which surpassed the estimate of 2.8%. Consumption (adjusted for inflation) was up 2.1% and 1.42% added to the headline number as goods were up 1.1% and services were up 2.6%. Residential investment was hit extremely hard as it was down 26.7% in the quarter and subtracted 1.29% from the headline number. Overall, private investment had a benefit of 0.27% to the headline number as the change in private inventories added 1.46% and nonresidential had a small positive contribution of 0.09% which was mainly due to an increase of 5.3% for intellectual property products. Net exports added 0.56% to the headline number as imports fell 4.6% in Q4, but exports fell at a lower rate of 1.3%. Government consumption added 0.64% to the headline number as spending grew 3.7%. A large portion of this came from federal non-defense spending which jumped 11.2% in the quarter. Overall, the report was lackluster and points to an economy that is decelerating.

Chevron Buyback
Chevron announced a $75 billion stock buyback to the shareholders. I can already hear the government and others saying how dare they do that; they should take that money and invest it in oil production to reduce prices. First off, shareholders take the risk of investing and should be rewarded when a company does well. The job of the CEO is to produce a good product and have returns for the owners of the company who are the shareholders. Why would a company invest billions of dollars into producing oil when down the road we know demand will be lower as we see more electric vehicles on the road not using oil. This is the best strategy for a company with a long-term time horizon. Remember, the government did add this year a 1% excise tax on stock buybacks which means the government will receive $750 million in extra tax from Chevron as it completes this buyback. Will that money go to something productive? Or will the government squander it away and waste it as usual on some silly programs. If you don’t like the company don’t buy their stock or gasoline.

Peloton
I keep seeing the commercial for Peloton that 92% of owners are still active on their Peloton. As the stock has now fallen to around $12-$13/share from its all-time highs of around $170/share, I’m curious how many people are still using their Peloton? I'd still rate this stock a sell and would like to see it become a profitable company before investing.

S&P 500
One of my major concerns for the S&P 500 index remains its valuation. At the end of 2022 the index was trading at a Forward P/E of 16.65. That was down from the recent highs of over 22x, but I would still not consider it an attractive valuation as the 25-year average has been 16.82. There are two ways that the S&P could grow. There could be earnings growth, or the multiple could expand. For earnings growth I have seen estimates of around 4-5% earnings growth, which I think could still be optimistic. This means if the multiple were to remain constant, the S&P would grow around 4-5% this year. As for the multiple expansion, with interest rates rising and slowing growth I do not see the case to have the multiple rise. This is why I continue to believe the right stocks will outperform the market in 2023.

 

Harrison : "Shared Equity Agreements"