by Louis Navellier
June 1, 2022
Fortunately, energy and commodity companies are largely paid in U.S. dollars. This partially explains why inflation has peaked in the U.S. but is still running high in countries with weaker currencies. As a result, domestic stocks should continue to outperform multinational stocks for the foreseeable future.
According to S&P Global, Britain’s Purchasing Managers Index (PMI) plunged to 51.8 in May, its lowest reading in 15 months, down sharply from 58.2 in April. Although any reading above 50 still signals an expansion, clearly manufacturing activity in Britain is sputtering. By comparison, S&P Global’s PMI for the euro-zone declined less, to 54.9 in May, down from 55.8 in April; so manufacturing in the euro-zone is doing better than in Britain, but it is still slowing down. Higher costs for energy and metals are clearly hindering manufacturing in Europe, since their weak currencies are causing commodity prices to rise.
One reason why the U.S. dollar is strong is the fact that the European Central Bank (ECB) has a negative key interest rate of -0.5%. ECB President Christine Lagarde last week said that the ECB’s now-8-year experiment with negative interest rates will soon end. Specifically, Lagarde implied that the ECB will likely raise its key interest rate to zero – still not very attractive to investors – in September.
Lagarde’s interest rate guidance was very dovish, since ECB observers were expecting the ECB to end its negative rates much sooner. Interestingly, Lagarde implied that the ECB may change its rate in July but added, “Based on the current outlook, we are likely to be in a position to exit negative interest rates by the end of the third quarter.” Since the ECB is moving so slowly, I expect that the euro may hit parity with the U.S. dollar (one euro equaling one dollar, down from $1.22 a year ago) in the upcoming months.
My favorite economist, Ed Yardeni, is now estimating the chances of a recession are 40%, saying that (1) investors are in a foul mood, (2) consumer sentiment has dropped sharply, (3) regional business surveys are depressed, (4) consumers are losing purchasing power, and (5) there is a chance of a credit crunch.
In his Wednesday briefing, Yardeni said that analysts are still revising their 2022 & 2023 earnings estimates higher and there is aggressive insider buying, which bodes well for a stock market recovery.
Speaking of a stock market recovery, our friends at Bespoke Investment Group issued a report after NASDAQ’s Tuesday plunge that showed that there have only been six 30% corrections in NASDAQ and the median duration was 127 days. Coincidentally, after the Tuesday NASDAQ sell-off, the correction was 127 days old. Historically, the NASDAQ Composite has rallied by a median of 3.5% in the next three months, +6.7% in six months, and +14.4% in the following year after its six previous 30% drawdowns.
Our Stock Strategy Focuses on Inflationary Growth Sectors
Portfolios that focus on inflationary growth sectors are benefiting from high prices for copper, crude oil, natural gas, fertilizer, lithium, and other higher commodity prices. These higher prices are expected to persist as the European Union (EU) strives to break away from Russian energy sources. Normally, natural gas prices can soften during the summer months, while crude oil can ebb in the fall as seasonal demand drops; but due to all the LNG and crude oil exports to Europe, these seasonal pressures have dissipated. As a result, our big bet in energy stocks looks to be safe for the foreseeable future. As always, our best defense is a strong offense of fundamentally superior stocks that are benefiting from high energy and commodity inflation – being paid in U.S. dollars.
There is one last element boosting energy stocks, namely the ESG (Environmental, Social & Governance) overlay on public pension funds in approximately 38 states! ESG essentially banned fossil fuel investing, causing energy stocks to fall to barely 2% of the S&P 500 last year. However, energy stocks now represent approximately 5% of the S&P 500 and continue to rise steadily. The S&P 500 ESG index recently kicked out Tesla and added Exxon Mobil in its annual rebalancing, which is raising questions of what is ESG?
According to the University of Massachusetts’ 2021 Toxic Air Polluters Index, which ranks the 100 largest corporations based on 2019 data, Tesla ranked #22 in least pollution, while Exxon Mobil ranked #26. The vast majority of Tesla’s “pollution.” according to the University of Massachusetts, is attributable to its lithium-ion battery plant outside of Reno, Nevada. But doesn’t ESG want more electric cars?
Confused? We all are, including Elon Musk, who is now mocking what ESG stands for, since social and diversity standards were cited by S&P Global for Tesla being booted from the S&P 500 ESG index.
Essentially, what is happening is that since ESG funds and indices have severely lagged the S&P 500 this year, and since energy is the strongest sector, many pension funds are starting to panic. They are looking for any excuse to add energy stocks, or they risk grossly underperforming the S&P 500 and other indices.
This means that the energy stocks that were once shunned by Wall Street (remember, that is part of why Exxon-Mobil was kicked out of the Dow Jones Industrials) are now being embraced. In fact, in my view, the institutional buying pressure in energy stocks is just part of the effect of pension funds re-embracing energy stocks in their efforts to “catch up” and improve their respective performance.
In other words, we are likely still in the early innings of the resurgence of fossil fuel company stocks, a trend which is expected to persist until Europe can diversify away from Russian energy sources.
I should add that the electric vehicle (EV) revolution remains alive and well in Europe, but an acute battery shortage persists. In fact, some popular EVs now have up to a two-year waiting list. Furthermore, due to soaring prices for cobalt, lithium, and nickel, some EV manufacturers have closed their long-term order books due to the fact that they most likely have to follow Tesla and raise prices due to soaring lithium-ion battery costs. This is great news for one of my stocks, namely Chile’s Sociedad Química y Minera de Chile (SQM), which mines lithium and has a booming fertilizer business.
Overall, I want you to feel good about our fundamentally superior stocks, which more than ever, represent an oasis in a challenging stock market environment. The commodity inflation that we are prospering from is expected to persist, even though inflation may have peaked in the U.S. thanks to a strong U.S. dollar.
We can thank the Federal Reserve as well as a good U.S. economy for a strong U.S. dollar, which is causing a massive institutional shift in the components in the S&P 500. This combination should boost many of our fundamentally superior stocks substantially higher for the foreseeable future.
U.S. Economic Growth Slows, but Remains Positive
Last Tuesday, the Commerce Department announced that new single-family home sales plunged 16.6% in April to an annual pace of 591,000, which is 27% lower than 12 months ago. This represents the biggest monthly drop in nine years and substantially below economists’ consensus estimate of 749,000 unit sales.
The median new home sales price is now $450,000, up 19.6% in the past 12 months. Between these high median prices and higher mortgage rates (now 5.25%, up from just 3% at the start the year), new home sales are being priced out of affordable monthly rates for many prospective middle-class buyers.
On Thursday, the National Association of Realtors announced that pending home sales declined 3.9% in April, the sixth straight monthly decline. In the past 12 months, pending home sales have declined 9.1%. The number of existing homes for sale rose to 1.03 million, a 2.2-month supply at the current annual sales pace. Housing prices are expected to remain high until inventories reach at least a 6-month supply.
On Wednesday, the Commerce Department announced that durable goods orders rose 0.4% in April, below the economists’ consensus estimate of a 0.6% increase. Also, March durable goods orders were revised down to a 0.6% increase from the 0.8% gain previously estimated. Core durable goods in April increased 0.3%, substantially below the economists’ consensus estimate of 0.6%. Commercial aircraft orders rose 4.3% in April after falling 8.1% in March. In the wake of the big drop in new homes sales as well as decelerating durable goods orders, I expect downward revisions to second-quarter GDP growth.
I was surprised to see the Commerce Department revise its first-quarter GDP estimate slightly down to an annual decline of 1.5%, compared to its preliminary estimate of a 1.4% annual decline, blaming a drop in productivity and a record trade deficit. Fortunately, the Commerce Department reported that consumer spending rose 0.9% in April, so we should be able to skirt a recession, since 70% of GDP growth is tied to the consumer. Sure enough, on Wednesday, the Atlanta Fed revised its second-quarter GDP estimate to an annual pace of +1.8%, down from its previous estimate of a 2.4% pace, but still positive.
Also on Wednesday, the minutes for the May meeting of the Federal Open Market Committee (FOMC) were released, revealing a lot of hawkish talk about hiking key interest rates to a “restrictive” policy to squelch inflation. However, FOMC members also revealed that they did not want to undermine the strong recovery in the job market, so the FOMC only agreed to raise key interest rates by 0.5% at the next “couple of meetings.” This essentially means that the Fed may pause when the Fed funds rate hits 1.75% (it is currently at 0.75%) and then reassess the situation. These FOMC minutes revealed that there are a lot of doves on the committee looking for excuses to pause after key interest rates hit just 1.75%.
On Thursday, the Labor Department announced that the latest weekly unemployment claims declined to 210,000, compared to a revised 218,000 in the previous week. Continuing unemployment claims rose to 1.346 million vs. a revised 1.315 million the previous week, so the labor market remains healthy.
Navellier & Associates owns Sociedad Química y Minera de Chile (SQM),in managed accounts. We do own Tesla (TSLA) and Exxon Mobil Corp (XOM), in managed accounts for a few accounts only. Louis Navellier does not own Tesla (TSLA) or Exxon Mobile Corp (XOM) personally but does own Sociedad Química y Minera de Chile (SQM), via a Navellier managed account.